This calculation will give an indication of the results a price change will have on total revenue rather than number of sales. If the result is more than 1, then the price is elastic. This means that the increase in price will result in a decrease in demand, but it will also result in a decrease in total revenue. If the result of the calculation is less than 1, then the result is different. The demand may still fall due to the increase, but the overall total revenue will increase. The best way of demonstrating this is to give a simplified example.
A supermarket sells many different types of foods and drinks. Bottles of champagne are sold at 100 a week and a price of $10 with a total revenue of 100 x $10 = $1,000. 00. The supermarket’s have decided to put the price up by 20% to $12 a bottle, and as a result the demand has reduced to 50 a week. The total revenue here is reduced to 50 x $12 = $620. 00. This is an elastic product. Therefore, if the price is already at $12 a bottle, but then is reduced there is the knowledge that the market will be grown as a result of the terms of sales and revenues.
This gives the firm the information it needs in order to attempt to influence the sales. However, there are more factors than a single factor, such as the influence of substitutes, complimentary products and also the role of advising. Moreover, a comprehensive understanding of this can be used to determine how much should be spent on advertising and how much needs to be cut in terms of costs to reduce the price to the required level. In turn this may mean reducing base level costs, such as redundancies, or it may mean increasing costs to meet the additional demand so that the optimum point may be reached.
This may also influence the choice of suppliers. We may also consider the micro factors and the less tangible aspects such as intellectual capital and management. Where there is a requirement for growth employees may be a valuable asset. They may be able to top increase productivity, as well as spawn ideas that can grow the company. This may mean the adoption of better motivational techniques, different pay systems and different social structures or cultures so that there is a maximization of this resource.
In many ways this may take the lowest capital investment, but the highest level of personal investment. There are many different factors, and there are just as many different ways each may be used to impact the growth of the company, and each will have very different reasons and results. The results that are required may need a combination of measures, or a single measure may have the desired effect. Problems may also arise, and these can be due to interaction as well as the unexpected.
Information is never perfect, inaccurate assumptions may be made, the macro environment may change, and some aspects are less reliable than others. For example, key employees may decide to leave. There is also the aspect of competition, where there are changes here, these cannot be foreseen, although game theory does try and account for this. Any environment is dynamic and changing, therefore there is a need to re-evaluate and reconsider regularly, and using a flexible approach that will take into consideration any needs to change. This is also a requirement for any successful company.
Hodrick Laurie Simon. (1999 May), Does stock price elasticity affect corporate financial decisions? Journal of Financial Economics, v52 i2 p225(3) Montgomery Alan LRossi Peter E. (1999 Nov), Estimating Price Elasticities with Theory-Based Priors, Journal of Marketing Research, v36 i4 p413 Nellis J; Parker D (1997), The Essence of Business Economics, London, Prentice Hall