Price Elasticity
The relationship between sales volumes an price is a major determinant of optimal price to maximize profit. This relationship is called price elasticity and is defined as the ratio of the percentage change in sales volumes to the percentage change in price, i.e.;
Price Elasticity = % change in Sales volume / % Change in Price
For example, if a company has a price of $100 an increase of 10% causes a sales volume decrease of 20%. In this case the price elasticity is -2 (-20%/10%). The relative volume change is twice as large as the relative price change. According to the definition, price elasticity has a negative sign, because volume and price change go in opposite directions. This can in many cases be taken for granted and the absolute value is used. The value of the price elasticity varies strongly across products, competitive situations and individual customers.
In practice, if a price elasticity less then 1 is found, a price increase can immediately be recommended, since this means that the percentage of decrease is sales volume is smaller then the percentage of increase in price. For instance, if a price increase of 10% reduces volumes by only 5% (price elasticity = 0.5), implementing the 10% increase will boost sales revenue by 5% and profit will increase even more. The reverse is true for price reductions.
Price Elasticity = % change in Sales volume / % Change in Price
For example, if a company has a price of $100 an increase of 10% causes a sales volume decrease of 20%. In this case the price elasticity is -2 (-20%/10%). The relative volume change is twice as large as the relative price change. According to the definition, price elasticity has a negative sign, because volume and price change go in opposite directions. This can in many cases be taken for granted and the absolute value is used. The value of the price elasticity varies strongly across products, competitive situations and individual customers.
In practice, if a price elasticity less then 1 is found, a price increase can immediately be recommended, since this means that the percentage of decrease is sales volume is smaller then the percentage of increase in price. For instance, if a price increase of 10% reduces volumes by only 5% (price elasticity = 0.5), implementing the 10% increase will boost sales revenue by 5% and profit will increase even more. The reverse is true for price reductions.
Source: Robert J. Dolan, Hermann Simon, Power Pricing, 1996, New York (link to latest edition)
