The harsh reality of price elasticity

19Feb10

If I remember correctly from my first microeconomics course, “price elasticity” refers to the often tricky relationship between price changes and the volume sold. It seeks to answer a simple question: if we raise prices, will people still be willing to buy enough units to keep our revenues at the same or a higher level as they were before? Conversely, if we lower prices, will the increase in units sold give us higher total revenues?

This concept seems to baffle organizations of all shapes and sizes. The examples are everywhere:

– State governments increase income taxes, without considering how many people will leave the state and deplete the tax base.

– Transit agencies raise fares, without thinking about the number of people that will cut back on their use of public transit.

– Traditional airlines impose fees on checked luggage, without any data on how many customers will switch to low-cost carriers that don’t charge those fees.

Granted, the impact of a price change can be hard to predict. But if you blindly proceed with raising prices or adding fees without considering the number of customers that you’re driving away, you may quickly find that your total revenues actually go down in the process. This is a very real risk that many companies just ignore. In short, if you’re not scared by the prospect of alienating customers while generating less revenue, you’re probably not being honest with yourself about how quickly those customers can pick up and leave when you treat them poorly.



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