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Chapter 2 Demand for Tourism


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Learning Objectives

Define tourism demand, distinguishing between demand for travelto a destination and demand for a particular tourism product.

Differentiate between price and non-price determinants of tourismdemand.

Appreciate the importance of each of price elasticity, income

elasticity, cross price elasticity and advertising elasticity as it relatesto tourism demand.

Understand the important issues that must be addressed inmodelling tourism demand.

Explain the relative importance of the various quantitative and

qualitative factors found by researchers to influence the demandfor international tourism arrivals.

Evaluate the strengths and weaknesses inherent in the presentstate of tourism demand modeling.


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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-pricefactors.

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 orsunglasses).


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Demand for Travel to a DestinationPrice Vs non-Price factors

Price factors. The cost of tourism to the visitor includes the cost oftransport

services to and from the destination and the cost ofground 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


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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 thecommodity (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.


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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.


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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 risesrise inprice

decrease increasein demand in demand

fall in more quantity demanded as price fallsprice

Quantity demanded Quantity demanded

Figure 2.1a: price and quantity demanded Figure 2.1b: non-price and demand


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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 effectrefers 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 effectis 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 effectrefers 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.


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Tourism Demand and Elasticity

elasticitydescribes the sensitivityof one variable

to changes in another variable.

elasticitymeasures how much one variable

changes in direct response to changes in another

variable.

Tourism demand exhibits four main types ofelasticity relevant for policy.


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Four elasticity measures

Price elasticity: the extent to which demand for a tourism product changes becauseof 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.


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Price Elasticity of Demand

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

percentage change in the price of the tourism product

Suppose a boutique Paris hotel dropped the average price of its rooms by 10% and, asa consequence, its occupation rate increases by 20%, ceteris paribus.

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

% change in price -10%

Note: when discussing price elasticity of demand, we ignore the negative sign (the signwill always be negative for price elasticity of demand) and just focus on the absolutefigure).


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Demand for Holiday and Business

Travel


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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.

Theprice 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 tobe more price sensitive than demand for domestic holidays.

Whether the product is a necessityor 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 bepermanent or temporary. For

example, a one day sale of discounted hotel rooms will call forth a different demandresponse than a permanent decrease of the same magnitude


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Elasticity and Total Revenue

a small percentage price increase in a tourism

related product:

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

increases TR if demand is inelastic (


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Elasticity of Demand and Total Revenue

($)

$

Quantity (units)

Quantity (units)

D

MR D

)(1 elasticED

)(1 unitaryED

)(1 inelasticED

P0

O

O

Totalrevenue


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Policy Implications

Knowledge of price elasticity is important for tourism managers seeking tomaximise 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, , can also help to determine the

optimal price of a product. P=MC (1/((1-(1/ ))


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Income elasticity of demand

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

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

percentage change in income


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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 asincome rises, and vice versa. This is the case with most tourism

products (Y >0).

Luxury goods are those that have a high income elasticity of demand,

exceeding one (Y>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 andtourism demand. The income elasticity of demand is less than zero

(y


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Relationship between income and

tourism demand

Income ($)Necessary good Normal good(y = 0 or very low ) (y > 0)

Luxury good

(y > 1)

Inferior good(y < 0)

Quantity demanded of tourism product


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Policy Implications

Knowledge of income elasticity of demand can help tourism managers todetermine 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 tourismorganisations. 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 forproducts (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).


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Cross-price elasticity of demand

Substitute goods are those that can be used in place of one another. The productsexhibit 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


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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 aresubstitutes


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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 ofthe demand for a product with respect to the price of a competitors product is

high, a firm should respond rapidly to a competitors 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 withinthe local tourism industry, a high cross elasticity of demand between the firms

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.


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Marketing elasticity of demand

Marketing elasticity (a) measures the responsiveness of

sales to changes in advertising/marketing expenditures.

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

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

percentage change in advertising expenditure


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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.


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Modelling Tourism Demand

A large number of research studies have attempted to castlight on what factors actually affect tourism demand, and

to what extent.

Demand functions can be formulated for domestic orinternational tourism, or for particular tourism market

segments, products or services.

The most common method of estimating demand is

regression analysis.


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Model specification

The first step in using regression analysis is to specify the model to beestimated. This involves identifying the most important variables thatare considered to affect the demand for the product.

Suppose that our problem is to estimate the demand function for atourism product (for example, rooms in a four star hotel). The hotel

manager might consider the most important variables to include theprice of a room (Px); consumers income (Y); the number of consumersin the market (N); the price of boutique hotels (substitute goods, Ps);airfares to the destination, (complementary product, Pc); consumertastes, (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 ofdemand that are specific to a product or destination.


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Measuring demand for international tourism

arrivals

A model of international tourism demand of the type that is typically estimated and testedcan 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 inalternative 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 as

Qij= 0+1Yj+ 2TCij+ 3RPij+ 4Ai+ 5Mi+ dummy variables + (2.7)


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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.


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Independent (explanatory) variable:

income

An increase in real income provides consumers with greater spendingpower, resulting in the increased discretionary consumption of manytypes of products including tourism.

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

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

Studies show thatper capita income is the single most importantdeterminant of demand for international tourism

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


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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.


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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 countrys 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"


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Limitations in use of CPI as a relative cost of

living measure

because the expenditure pattern of a tourist is quite different fromthat of the average household, the CPIs of the origin country and thedestination 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 exchangerates, information on price levels and price changes in destinations isgenerally not known in advance

Some empirical results for the influence of prices on tourism demandare 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.


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Cost of living at other destinations

Tourists may consider a range of competing destinations before choosing anyparticular 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 ofliving 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.


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Transportation costs

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

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


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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 expenditureper 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)


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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 anddiverse 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


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Qualitative factors affecting international

tourism demand

Tourists demographic attributes which may affect leisure time availability or similarconstraints 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.

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