Price Elasticity the Elasticity Coefficient

Price Elasticity

The elasticity coefficient "measures how much consumers respond in their buying decisions to a change in price," in other words, how demand for a product is modified when the product's price is changed.

In our case, a price elasticity of 2.5 is equivalent to the fact that at any increase in price by 10%, the demand for our product will decrease by 25%. However, if the company implements the 10% price cut that has been recommended, there is nothing to guarantee that the sales will increase by 25% and this is because there are also several other factors involved.

The most important of them is the competitors' response. In practice, game theory is often applied to determine both the opponent's response to a certain strategic move that the company makes and the consequences that these will have. There are several alternatives to be analyzed in terms of the opponent's move to the company's price cut.

First of all, we may consider that the competitor will keep his prices at the same level. Economic logic will obviously let us believe that the customers will be inclined to purchase our products and that the demand will increase, as will the sales. We may assert at this point that profits will definitely increase, however, we also need to consider the fact that the taxes paid will be higher.

This is competitor response is the less likely of all. In my opinion, economic practice has shown that, in general, to a price cut the competitors respond with another price cut. This may lead to an extremely unprofitable price cut, both for our respective company and its competitors. Turning back again to game theory, we are in the case of the prisoners' dilemma when telling the truth is the most unwanted and unprofitable alternative solution, because the company is likely to proceed with another price cut as a response and this will most likely decrease overall profits, even if net sales may somewhat increase.

As such, when evaluating the change in profit, we need to consider both alternatives and how the possible responses from the competitor will affect it. In the first case, with no response from the competitor, as I have mentioned previously, net sales are likely to increase due to positive price elasticity. In order to evaluate whether the net revenue is modified, we should use a figure example, considering the quantity sold

100 and price P = 10. The total net sales is 1000. On a 10% price cut (P = 9), we should estimate the quantity Q. At 115 (it shouldn't go up to 25%). As such, the net sales will be V = 1035, an increase of 35 units or 3.5%.