A Note on Demand Elasticity, Opportunity Costs, and Additions to the Retail Assortment

Abstract

IN a recent article in The Journal of Industrial Economics, Richard H. Holton suggested that the elasticity of demand is the main consideration determining whether or not a new item will be added to the assortment carried by a retail store. 'To qualify for admission to the product-mix ... a candidate item mu-st [my italic] have a relatively inelastic demand. It is this requirement which seems to be of overwhelming importance in influencing the choice of new lines'.' It is true that, in the case of supermarkets, the store-type specifically considered by Holton, most of the recent (principally non-food) additions to the product-line have had high percentage margins and therefore, it may be inferred, rather inelastic demands, at the price set. But it seems misleading to attribute the addition of such items to this low elasticity, which is only one of the factors relevant to the decision whether or not to add an item. Consider two new item candidates for a store's assortment and assume that the acquisition cost of a unit of each is the same, and constant. Assume, as seems reasonable, that operating costs are not affected by the addition of either item, so that the acquisition cost of each is its marginal cost, and these are, therefore, for the two items identical and constant. For each item there is a family of demand curves relating quantity sold to the price, the demand curves moving to the right, as the amount of space allocated to the item is increased. Suppose a given amount of space is available for a new product. The profit-maximizing price for each item can then be determined. Although the product with the less elastic demand (at the price selected) will produce a greater profit per unit of product sold, the product with the more elastic demand may well produce a greater profit for the amount of space allotted to it. If this is so, the profitmaximizing retailer should add, if it is in fact profitable to add a new item, the item with the more elastic demand. Whether or not it is profitable to add a new item to a retailer's assortment will depend upon the relationship between the gross profit increment attributable to the new item and the opportunity cost of adding the new item; this opportunity cost will be the decrement in gross profit that results when the space made available to the