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Price Elasticity

Research on Magnitude and Determinants

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Evelyn Friedel

Price is a fundamental profit driver. It is by far the most sensitive profit lever that managers can influence. Very small price changes translate into enormous changes in profit. Price elasticity indicates how sensitively consumers react to price changes. Not only the knowledge about the magnitude of price elasticity, but also the knowledge about the determinants influencing the price reaction is essential. It is crucial for the development of a successful marketing strategy to understand how price elasticities vary with market and product characteristics. Reflecting the academic and managerial need, the objective of the research is to gain a comprehensive understanding in two main areas, the magnitude of price elasticity and the determinants of price elasticity.
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2 Foundation of Research

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The most common measure of the impact of price on demand is price elasticity. In general, elasticity measures the relation of a relative change of one variable to the relative change of another variable. Specifically, price elasticity of demand is defined as the percentage change in quantity relative to the percentage change in price (Simon/Fassnacht 2009, p. 95; Diller 2008, p. 75; Monroe 2003, p. 32).



Price elasticity therefore shows the percentage change in demand, if the price is changed by 1 % (Diller 2008, p. 75; Frank 2008, p. 112). If a price decrease of 10% causes an increase in demand of 30%, the price elasticity is −3. The negative value of the price elasticity is due to the inverse relationship of the change in demand and price. The price change in the example is −10% (numerator) and the demand change is +30% (denominator), which leads to a negative value of −3 for the price elasticity. The percentage change in demand is three times as high as the percentage change in price.

If the price change is not infinitely small, then the price elasticity is called arc elasticity (Simon/Fassnacht 2009, p. 95). Arc elasticities are commonly used in managerial practice. Frank (2008, p. 112) states „When interpreting actual demand data, it is often useful to have a more general definition of price elasticity that can accommodate cases in which the observed change in price does not happen to be 1 percent.“ This highlights...

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