Chapter 2 Demand for Tourism

Learning Objectives• Define tourism demand, distinguishing between demand for travel to a

destination and demand for a particular tourism product.• Differentiate between price and non-price determinants of tourism

demand.• Appreciate the importance of each of price elasticity, income elasticity,

cross price elasticity and advertising elasticity as it relates to tourism demand.

• Understand the important issues that must be addressed in modelling tourism demand.

• Explain the relative importance of the various quantitative and qualitative factors found by researchers to influence the demand for international tourism arrivals.

• Evaluate the strengths and weaknesses inherent in the present state of tourism demand modeling.

Factors influencing Tourism Demand Tourism demand refers to the willingness and ability of consumers to

buy different amounts of a tourism product at different prices during any one period of time.

Following standard theory, the demand for any good or service can be expected to be influenced by a myriad of price and non-price factors.

The market demand function for a product or service is the relationship between the quantity demanded of the product and the various factors that influence this quantity.

For tourism demand it is useful to distinguish between the demand for travel to a destination (eg. visitor arrivals and expenditure) and the demand for particular tourism related products or services within the destination (eg. hotel rooms, restaurant meals, tours or sunglasses).

Demand for Travel to a DestinationPrice Vs non-Price factors

Price factors. The cost of tourism to the visitor includes the cost of transport services to and from the destination and the cost of ground content (accommodation, tour services, shopping, entertainment etc.).

The prices paid by an international tourist who must convert one currency into another will also be influenced by prevailing exchange rates, and prices in the destination as compared to prices in their home country.

Non-price factors. These include socio-economic and demographic factors such as population, income in origin country, education, occupation, availability of leisure time, immigration stock and the like and qualitative factors including consumer tastes, tourist appeal, destination image, quality of tourist services, tourist preferences, special events, destination marketing and promotion, cultural ties, weather conditions, random shocks and so on

Demand for a Tourism Product The most important variables affecting the demand for any good include the price

of the good (Px), consumers income (Y), the number of consumers in the market (N), the price of related products (substitutes Ps and complements Pc), consumer tastes (T), level of marketing/promotion expenditure (M), and other variables such as consumer price expectations, interest rates, and so on.

Thus we can specify the following general function of the demand for the commodity (Qx) measured in physical units, where the dots at the end of the equation refer to the other determinants of demand that are specific to the particular firm and product:

Qx = f (Px, Y, N, Ps, Pc, T, M, - -- ) (2.1)

In a tourism context Qx might refer to visitor numbers, car rentals, tickets to attractions, number of airline passengers, numbers of T-shirts sold, swim suits, hotel rooms demanded, etc.

Tourism demand and price

Economic theory suggests that price and tourism demand have an inverse relationship. As its price falls, the quantity demanded for a tourism product should rise, and as its price rises, the quantity demanded should fall.

This negative relationship (commonly called the law of demand) captures the income effect and substitution effect evident in buyer behaviour.

Income effect: as the price of a tourism product falls, its price relative to consumer income falls and consumers can afford more of the tourism product given the same income.

Substitution effect: consumers can buy more of this now relatively cheaper tourism product substituting it for other now relatively more expensive products.

Changes in Quantity Demanded and in Demand

A change in quantity demanded of a product or service results from a change in its price and can be represented by a shift along the demand curve

A change in demand results from changes in the non-price influences on tourism demand. These factors cause the entire demand curve to shift left or right, indicating a reduction or increase in demand at any given price.

Price $ Price $ (per unit) (per unit) less quantity demanded as price rises rise in price

decrease increase in demand in demand fall in more quantity demanded as price falls price Quantity demanded Quantity demanded Figure 2.1a: price and quantity demanded Figure 2.1b: non-price and demand

Market Demand Curve A market demand curve is the horizontal summation of individual demand curves. This is the case only if the consumption decisions of individual consumers are

independent. This is not the case if there is a bandwagon, snob or Veblen effect present.

The bandwagon effect refers to a situation where people demand a commodity because others are purchasing it and it is regarded as ‘fashionable’ to keep up with the Joneses’.

The snob effect is the opposite of the bandwagon effect as some consumers seek to be different and exclusive by demanding less of a product as more people consume it.

The Veblen effect refers to a situation where some individuals seek to impress others by demanding more of certain ‘high status’ products or services as their price rises. Also known as ‘conspicuous consumption’.

Tourism Demand and Elasticity

elasticity describes the sensitivity of one variable to changes in another variable.

elasticity measures how much one variable changes in direct response to changes in another variable.

Tourism demand exhibits four main types of elasticity relevant for policy.

Four elasticity measures Price elasticity: the extent to which demand for a tourism product changes because

of a change in the price of that product itself. eg., an increase in airfares will, other things equal, result in reduced passenger numbers in air travel.

Income elasticity: the extent to which demand for a tourism product changes because of changes in the level of consumer income. eg., as individual and national wealth rises, more air travel or leisure cruising will result.

Cross price elasticity: the extent to which demand for a tourism product changes because of changes in the price of substitute goods and complementary goods. eg., the demand for air travel in Europe will be affected by changes in the price of train or ship travel (substitute goods) or changes in the price of accommodation or car hire (complementary goods).

Marketing elasticity: the responsiveness of sales to changes in marketing/advertising expenditures. Thus a tour operator may advertise on radio or TV, or a destination may promote itself in newspapers and magazines, and the internet generating increased visitation and sales revenues.

Price Elasticity of Demand

percentage change in the quantity demanded of the tourism product ε = ----------------------------------------------------------------------------------

percentage change in the price of the tourism product Suppose a boutique Paris hotel dropped the average price of its rooms by 10% and, as a consequence, its occupation rate increases by 20%, ceteris paribus.

% change in quantity demanded 20% ε = ---------------------------------------- = ----- = -2.0

% change in price -10% Note: when discussing price elasticity of demand, we ignore the negative sign (the sign will always be negative for price elasticity of demand) and just focus on the absolute figure).

Demand for Holiday and Business Travel

Determinants of price elasticity for a tourism product

The availability of substitutes. The more substitutes faced by the product, the more sensitive its demand will be to price changes. Thus competition between a large number of motels along a highway may help to keep prices low.

The price relative to income. The price elasticity of demand for a product depends on the importance of the product in consumer budgets. Demand tends to be more price elastic for more expensive products. Thus, the demand for international holidays, for example, tends to be more price sensitive than demand for domestic holidays.

Whether the product is a necessity or a luxury. Demand tends to be more elastic for luxury products. The demand for leisure travel (luxury), for example, tends to be more price elastic than the demand for business travel (necessity).

Time. The price elasticity of demand is greater the longer the time period allowed for consumers to adjust to a change in price. Demand is less elastic in the short run (reflecting immediate needs and limited available choice) but more elastic in the long run since it takes time for consumers to learn about the availability of substitutes and to adjust their purchasing patterns to a price change

Expectations of whether a price change is considered to be permanent or temporary. For example, a ‘one day sale’ of discounted hotel rooms will call forth a different demand response than a permanent decrease of the same magnitude

Elasticity and Total Revenue

a small percentage price increase in a tourism related product:

reduces TR if demand is elastic (ε >1)leaves TR unchanged if the elasticity is unity (ε =1)increases TR if demand is inelastic (ε <1)

Elasticity of Demand and Total Revenue

($)

$

Quantity (units)

Quantity (units)

D

MR D’

)(1 elasticED

)(1 unitaryED

)(1 inelasticED

P0

O

O

Total revenue

Policy Implications Knowledge of price elasticity is important for tourism managers seeking to

maximise sales revenues. Knowledge of the price elasticity of demand for a product enables managers to

answer questions such as: How much of an increase in sales can we expect if we reduce our prices by 5 per cent? To increase the amount we sell by 15 per cent, how much must we reduce price?

Because the price and quantity demanded for any tourism product are inversely related, a firm must ensure that any rise in the price of its product will outweigh any fall in sales or it will lose total revenue, and that any fall in the price of its product will generate extra sales that outweigh the fall in price or it would again lose total revenue.

to increase total revenue, firms should follow the basic rule of thumb: raise the price of inelastic products but lower the price of elastic products.

An estimation of the price elasticity of demand, ε, can also help to determine the optimal price of a product. P=MC (1/((1-(1/ε ))

Income elasticity of demand

Income elasticity of tourism demand (εy) is measured as:

percentage change in the quantity demanded of the tourism product

ε y = ---------------------------------------------------------------------------------- percentage change in income

Normal goods, luxuries, necessities and inferior goods

Normal goods when there is a positive relationship between income and tourism demand. Demand for the tourism product rises as income rises, and vice versa. This is the case with most tourism products (εY >0).

Luxury goods are those that have a high income elasticity of demand, exceeding one (εY>1). eg. first class air travel or 5 star hotel

Necessary goods have a low income elasticity of demand, either at zero or marginally above zero. eg. Quantity demanded of basic foodstuffs (salt, bread) may be insensitive to income changes

Inferior goods imply a negative relationship between income and tourism demand. The income elasticity of demand is less than zero (εy

<0). eg. holidays at a domestic caravan park (inferior good) as opposed to a hotel or motel (normal good), or five star resort (luxury good).

Relationship between income and tourism demand

Income ($) Necessary good Normal good (εy = 0 or very low ) (εy > 0) Luxury good (ε y > 1) Inferior good (ε y < 0) Quantity demanded of tourism product

Policy Implications Knowledge of income elasticity of demand can help tourism managers to

determine if their product is a normal good (demand for the product rises as income rises) or an inferior good (demand for the product falls as income rises). Such information can help tourism managers identify more precisely the potential markets for their products given anticipated changes in income over time.

Income elasticity can play an important role in the marketing activities of tourism organisations. If per capita or household income is found to be an important determinant of the demand for a particular product this can affect the location of and nature of sales outlets (eg cheap eats vs gourmet restaurant).

Information on income elasticities is useful in developing marketing strategies for products. Thus they can help to identify more precisely potential markets for products (which types of consumers are most likely to purchase the product) and in determining the most suitable media for promotional campaigns to reach the targeted audience).

Cross-price elasticity of demand

Substitute goods are those that can be used in place of one another. The products exhibit positive cross price elasticity - a rise in the price of one product will lead to a rise in the quantity demanded of the other product and vice versa.

Complementary goods are used in conjunction with one another. The products exhibit negative cross price elasticity - a rise in the price of one product will lead to a fall in the quantity demanded of the other product, and vice versa.

Eg., a rise in the price of air travel to a destination resulting in less visitation may lead to a fall in the demand for hotel accommodation in that destination.

Cross Elasticity of Demand between goods A and B = % change in the demand for A - - - - - - - - - -- - - - - - - - - - -

% change in the price of B

Substitute and complementary goods If goods A and B are substitutes, the quantity demanded of A is directly related to

the price of B. If A and B are complements, the quantity demanded of A is inversely related to the

price of B.

Price of B

Quantity of A

A & B are complements

A & B are substitutes

Policy Implications Firms need to know how the demand for their products are likely to respond to

changes in the prices of other goods and services. eg. if the cross-price elasticity of the demand for a product with respect to the price of a competitor’s product is high, a firm should respond rapidly to a competitor’s price reduction if it is to avoid a loss of its sales.

Box 2. 1 addresses Cross-elasticities of demand for travel in UK Information on cross-price elasticity is essential for formulating pricing strategy and

analysis of the risks associated with various products, particularly for firms with extensive product lines, where substantial substitute or complementary relations exist among the various products.

Cross-price elasticity also allows managers to measure the extent of competition across industries. While a firm might be a dominant supplier of some service within the local tourism industry, a high cross elasticity of demand between the firm’s products and products of firms in another industry indicates that the firm will not be able to raise its prices without losing sales to other firms in other industries.

Marketing elasticity of demand

Marketing elasticity (εa) measures the responsiveness of sales to changes in advertising/marketing expenditures.

It is measured by the ratio of the percentage change in sales to a percentage change in adverting expenditures.

percentage change in the quantity demanded of the tourism product ε a = ----------------------------------------------------------------------------------

percentage change in advertising expenditure

Policy Implications

Knowledge of marketing/advertising elasticity can assist tourism managers to determine appropriate levels of advertising outlays.

At the destination level, estimates of marketing elasticities can inform the allocation of marketing expenditure between different tourism products or different market segments.

Modelling Tourism Demand A large number of research studies have attempted to cast

light on what factors actually affect tourism demand, and to what extent.

Demand functions can be formulated for domestic or international tourism, or for particular tourism market segments, products or services.

The most common method of estimating demand is regression analysis.

Model specification The first step in using regression analysis is to specify the model to be

estimated. This involves identifying the most important variables that are considered to affect the demand for the product.

Suppose that our problem is to estimate the demand function for a tourism product (for example, rooms in a four star hotel). The hotel manager might consider the most important variables to include the price of a room (Px); consumers income (Y); the number of consumers in the market (N); the price of boutique hotels (substitute goods, Ps); airfares to the destination, (complementary product, Pc); consumer tastes, (T); marketing expenditure (A).

Qx = f (Px, Y, N, Ps, Pc, T, A, dummy variables, …) (2.2) The dots at the end of eqn 2.2 refer to any of the determinants of

demand that are specific to a product or destination.

Measuring demand for international tourism arrivals

A model of international tourism demand of the type that is typically estimated and tested can be written as:

Qij = f (Yj, TCij, RPij, Ai, Mi) (2.6)

Where: Qij = demand for international travel services by origin j for destination i;

Yj = income per capita in origin j;

TCij = transportation cost between destination i and origin j;

RPij = relative prices (that is, the ratio of prices in destination i to prices in origin j and in alternative destinations, adjusted for exchange rate);

Ai = marketing/promotion expenditure by destination i.

Mi = migration levels in destination i

Equation 2.6 can be written in explicit linear form asQij = α0 +β1Yj + β2TCij + β3RPij + β4Ai + β5Mi + dummy variables + μ (2.7)

Dependent variables

Researchers use a variety of proxies to measure the dependent variable (Qij) in a tourism demand function.

These include tourist arrivals and/or departures; tourist expenditures and/or receipts; travel exports and/or imports; tourist length of stay; and the amounts of nights spent at tourist accommodation.

The demand can be in total covering all travel motives or the demand from a particular market segment

Typically, demand modellers lag the tourism demand variable on the grounds of habit persistence and risk aversion on the part of visitors, and the presence of supply constraints.

Independent (explanatory) variable: income

An increase in real income provides consumers with greater spending power, resulting in the increased discretionary consumption of many types of products including tourism.

Wealthy countries and regions with strong currencies are important origin markets for international tourism.

The appropriate income variable is per capita personal disposable income or per capita private consumption expenditure in the origin country (in constant price terms).

Studies show that per capita income is the single most important determinant of demand for international tourism

Some empirical results for the influence of income on tourism demand are summarised in Box 2.3

Independent (explanatory) variable: relative prices

In their destination choice decision, tourists will consider the price (cost of living) at the destination relative to the costs of living at the origin and substitute destinations.

Thus, two types of prices must be considered in the demand function of tourism:

relative price between the destination and the source country; relative price between different competing destinations which

generates the substitution price effect.

Cost of living at the destination relative to the origin

The relative price variable which is typically used in the demand for tourism function is the ratio of the consumer price indexes between the host and the origin countries adjusted by the bilateral exchange rate.

A higher exchange rate in favour of the origin country’s currency can result in a greater flow of outbound tourism to other destinations.

When the exchange rate-adjusted CPI ratio is used to measure the relative prices of goods and services in the destination, the impacts of inflation and exchange rate movements are measured through one “relative price” variable, referred to as the "real exchange rate"

Limitations in use of CPI as a relative cost of living measure

because the expenditure pattern of a tourist is quite different from that of the average household, the CPIs of the origin country and the destination may not reflect the prices of goods which tourists actually purchase

trends in general price levels as implied by CPI measures may not necessarily coincide with changes in tourism prices.

While tourists are reasonably well-informed of changes in exchange rates, information on price levels and price changes in destinations is generally not known in advance

Some empirical results for the influence of prices on tourism demand are summarised in Box 2.4

The role of income and price factors in influencing tourism demand in the global financial crisis is highlighted in Box 2.6.

Cost of living at other destinations

Tourists may consider a range of competing destinations before choosing any particular one. They may compare changes in the cost of living in the choice destination with the cost of living changes in the competing destinations.

Researchers model this consumer thinking in either of two ways: One way to allow for the substitution between the destination and, separately, a

number of possible competing destinations, is by specifying the tourists' cost of living variable in the form of the possible destination value relative to the origin value, therein acknowledging that domestic tourism may be the most important substitute for foreign tourism.

The other way is to calculate the cost of living at any substitute destination relative to a weighted average cost of living in the different competing destinations, adjusted by the relevant exchange rates. This approach allows for the impact of price changes in competing foreign destinations and is used more often in empirical studies as fewer variables are incorporated into the model.

Transportation costs Transportation costs refer to the cost of round-trip travel between the origin and the

destination The demand for transportation is a derived demand, namely to purchase destination tourism

services. Unlike for other export goods, the consumer (tourist) must be transported to the product

(destination) rather than the reverse. While estimation of the price of surface travel tends to be straightforward, whether for

private vehicle, rental car, coach, train or ferry etc, estimating the cost of air travel can be quite difficult.

Studies show that tourist demand is generally more sensitive to transport prices than to ground prices in a destination and that business travellers are less responsive to changes in transport prices than leisure travellers.

Higher incomes are generally associated with relatively higher demand for air transport. Consistent with price elasticities, empirical evidence suggests that income elasticities tend to be higher for leisure passengers and lower for business passengers.

Some empirical results for the influence of transport costs on tourism demand are summarised in Box 2.5

Marketing and Promotion

The extent to which marketing and promotion expenditure influence tourism demand is difficult to measure.

Data permitting, a useful measure of marketing effectiveness, based on estimated elasticities, is the return on marketing expenditure.

Typically, researchers use the marketing budget of national tourism offices as a proxy. There are, however, great difficulties in modeling the impact of marketing and of separating its effect from the other major influences on tourism demand.

Even if marketing expenditure can be estimated accurately across different origin countries (often difficult to do), marketing expenditure per se does not indicate that the promotion is effective. Different nationalities and cultures are likely to respond differently to marketing and different destinations vary in their ability to use marketing effectively to attract tourists.

Studies show that marketing expenditure has a positive, but small effect on international tourism demand (see Box 2.7)

Migration stock The choice of destination is also influenced by ethnic and migration factors, which

generate tourist flows for purposes of visiting friends and relatives in the various destinations.

There are several possible ways in which immigration can affect tourism. the greater the number of permanent migrants to a destination, the larger is the pool of

friends and relatives in the home country who have an incentive to visit that destination permanent migrants who visit their former country for VFR purposes may explicitly and

implicitly 'promote' the new homeland leading to an increased number of short term visits. an increasing number of migrants to a destination means that there is an increasing stock of

accommodation for friends and relatives who visit from overseas. knowledge that numbers of their compatriots have settled in a country is a contributing

factor to a visit to that country. permanent migrants enrich the local culture and render destinations more interesting and

diverse for tourists. permanent migrants who retain or forge business links with their former country may

influence the number of business travellers from their new homeland The larger the stock of migrants in a destination, the larger the volume of outbound tourism

to the former homeland Some studies on the influence of migration on tourism demand are summarised in Box 2.8

Qualitative factors affecting international tourism demand

Tourists’ demographic attributes which may affect leisure time availability or similar constraints including

gender, age, education level, employment, profession; Household size (composition of household, and child/children age); Trip motive or frequency; Destination attractiveness (climate, culture, history, and natural environment); Special events (Olympic Games, World Cup, religious festivals, Expo etc); Political events (terrorism, political unrest, currency crises, grounding aircraft strike,

oil crises); Natural events (tsunami, hurricanes, SARS, Avian Flu, Northern lights) etc. Such factors have varying relevance depending on the specific destination See Box 2.9 for a study of modelling US tourism demand for European destinations.