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Mid Term Assignment

Subject: Managerial Economics Batch: 2013-15

Section: F

Group No: 8

News: HUL hikes soap prices to offset rising input cost.

NEW DELHI: In a bid to offset high input costs, FMCG giant Hindustan Unilever today said it has hiked
the price of its Lifebuoy soap by over 6 per cent, while reducing the pack size of popular soap brand Lux.
The company confirmed that the price of its 120 gm Lifebuoy soap has been hiked to Rs 16 from Rs 15.
Besides, it has also stopped the promotional offer for its Lux soap, under which 110 gm soap was sold
for Rs 18 earlier. Now HUL is selling Lux at Rs 18 for a 100gm bar.
Industry analysts attributed the price change to the rising commodity prices.
"Though inflation is in single digit now, it is still a concern...Besides, palm oil prices have not come down
and cost of packaging is high," an analyst with AnandRathi Financial services said.
As per data available the price of crude palm, oil a key ingredient for making soap, has touched Rs 433
per kg in August as compared to Rs 391 per kg in June, up 11 per cent.
Source - http://articles.economictimes.indiatimes.com/2010-08-24/news/27567457_1_palm-oilpricesinput-cost-soap

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INTRODUCTION: The latest news regarding the soap industry having an economic implication is the rise in the price of
soap by nearly 8%. This rise in price is due to the rise in the price of palm oil. When palm oil turns
bearish, their margins increase.
Palm oil is derived from crushing the oil-palm fruit. Palm kernel oil is derived from crushing the oil-palm
nut. Derivatives of palm oil and palm-kernel oil are also used in soaps, shampoo, cosmetics such as
lipsticks and detergents. Palm kernel oil is also called lauric oil because lauric acid forms half of their
fatty acid content
Many different oils can be used for soap making but a proportion of lauric oil is indispensable,the only
substitute to it is coconut oil which is also rich in lauric oil.
Lauric acid is useful because it can be stored easily at room temperature without becoming rancid
quickly. Lauric oils give hardness, combined with good solubility, quick lathering and a feel of quality to
the soap.

Good soap must contain at least 15% lauric oil for quick lathering. Soap in west Europe and the US
typically contain 20%-25% PKO or coconut oil. Lauric oils give hardness, combined with good solubility,
quick lathering and a feel of quality to the soap.
As lauric acid is the main raw ingredient in soaps, a rise in their prices can lead to higher input costs
which would result in either their lowering the profit margin or increasing the price of soap.
Hence we have a direct implication that the rise in the price of soap is the result of the rise in the price
of crude palm oil. They form a pair of complementary goods where the need of crude palm oil is
relatively inelastic.
Price Elasticity of Demand: The price elasticity of demand measures how much the quantity demanded responds to a change in the
price of a good. Demand for a good is elastic if the quantity demanded responds significantly to a
change in the price. Demand for a good is inelastic if quantity demanded does not respond significantly
to a change in the price. The price elasticity of demand for any good is a measurement of the willingness
of consumers to move away from the good as its price increases.
Soap is basically an essential product for almost all people. So even if the price of soap increases by a
large amount, people still need to buy soap which means that a big change in price will result in a
relatively small change in quantity of soap demanded. So, like any essential good, the price

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elasticity of demand for soap will be low. In other words, the demand for soap will be inelastic in nature
as shown by the following figure:
From the figure, it is clearly evident that Price Elasticity for Demand of Soap < 1,
therefore its demand is inelastic. This means that the percentage decrease in quantity of soap
demanded is less than the percentage increase in price of soap.
External Factors affecting Demand: Consumers now prefer vegetable-based fatty acids because they are natural and biodegradable. This
increasing awareness about the versatile range of products in which fatty acids and their derivatives can
be used has raised demand.

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Supply of Soap: The price of soap is directly correlated to the price of Palm Oil. As palm oil derivatives are the
keymanufacturing ingredient in soaps, a rise in their prices can lead to higher input costs. So when palm

oil prices rise sharply, the big soap and detergent brands come under pressure and supply gets reduced.
This event is shown in the following figure:
From the figure, we can see there is a left-ward shift in the Supply curve indicating
that Supply of soap has decreased due to an increase in the prices of Palm Oil.
Impact of Palm Oil price changes on Market Equilibrium: When price of palm oil increases, there is a left-ward shift of Supply Curve, but the demand curve
remains same. So the Market Equilibrium changes with a simultaneous increase in Price and decrease in
quantity demanded. But since the demand is inelastic, the decrease in quantity demanded would be
relatively less.

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The impact was clearly exemplified by FMCG giant Hindustan Unilever when it hiked the price of its
Lifebuoy soap by over 6 per cent, while reducing the pack size of popular soap brand Lux in a bid to
offset high input costs.
Availability of Close Substitutes: Goods that possess close substitutes tend to have a greater elastic demand because it is easier for
consumers to substitute another good for that particular good. In this case, coconut oil is a close
substitute for palm oil. Usually, Palm Kernel Oil (PKO) sells at a $50/tonne discount to coconut oil. So
demand for palm oil is still more than that of coconut oil due to its lower price.