Price elasticities are like sausages; everyone likes them, but it’s better not to see them being made.
The most important thing in pricing is to understand the customer. Measuring price elasticity is a widely used method to do so. More specifically, price elasticity is measured to answer the question: “How have customers adapted their purchasing behavior to price changes in the past?” From this it shall be deduced how to set prices in the future in order to achieve pricing goals (e.g. optimize profit, revenue or market share).
In the last elasticity blog we discussed the general concept of price elasticity and saw how to set prices to maximize profit or revenue given a precisely measure price elasticity. In this blog, we will focus on the measurement of price elasticity itself and the reliability of results.
Let’s pick up where we left off last time:
We operate the only lemonade stand in town and offer exactly one product: lemonade.
We tested prices from $0.00, where we “sold” 1,000 units per month, to $2.00, where no one bought from us any more (Graph A). The corresponding elasticity is shown in Graph B.