Pricing and Elasticity

What would happen if your firm increased its prices by 5 percent? The fact that many firms cannot answer this question suggests they know too little about the responsiveness of customer demand to price changes – what economists know as the price elasticity of demand.

Often, one doesn’t need to know price elasticity precisely. Even a good approximation of a firm’s demand curve can allow for reasonable assumptions about how elastic or inelastic that demand is. Where the demand curve is believed to be inelastic, a firm can experiment by increasing prices slightly to validate the assumptions made.

Knowing the elasticity of demand can also allow a firm to avoid making a second error: discounting prices when demand is inelastic. Injudicious use of discounting in the face of inelastic demand makes little sense and erodes profits unnecessarily.

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