Price elasticity: find the threshold that reverses the decision.
Answer:
Elasticity measures the relative change in demand associated with a relative change in price, with all relevant conditions held comparable. For a decision, a point estimate is not enough: use a range by segment, a time horizon, a competitive scenario and, above all, the threshold elasticity beyond which total contribution declines.
Decision:
Change a price only when contribution remains favourable across a defensible elasticity range and the design separates the price effect from other changes.
Principles:
For two distant observations, arc elasticity uses changes relative to averages and reduces dependence on the starting point. It remains descriptive if prices and demand also changed with promotions or selection. The isoelastic relationship Q₂ = Q₁ × (P₂ ÷ P₁)^ε provides coherent sensitivity over a limited range and must not be extrapolated far beyond observed prices. Critical elasticity equates current and candidate contribution; because it depends on variable cost, two offers with the same demand can justify opposite decisions.
Method:
Separate new customers, renewals, negotiated contracts and segments with different alternatives. Document promotions, availability, assortment, exposure and competitor reactions; without a comparator, a volume change cannot be attributed to price. Compare historical evidence, experiments, discrete choice and interviews. Finally, publish contribution, volume and migration risk for cautious, central and high elasticity bounds.
Worked example — an 8% increase remains viable down to an elasticity of −2.49.
Current price is €100, variable cost €62 and volume 10,000 units. The candidate price is €108 with central elasticity −1.6. Projected volume is 10,000 × 1.08^−1.6 = 8,842 units. Current contribution is €380,000. Candidate contribution is 8,842 × €46 = €406,732. Threshold elasticity is ln(38 ÷ 46) ÷ ln(1.08) = −2.49. The increase is favourable centrally, but must be rejected or redesigned if plausible elasticity falls below −2.49 after migration and communication costs.
Decision rules:
Elasticity is tied to a segment, horizon and price range. Variable cost and net margin are included in the tipping threshold. At least two estimation sources are compared, or one source is explicitly labelled provisional. A rule for returning to the previous price is defined before the test.
Limits:
Historical elasticity can be endogenous when price responds to demand. Competitor reactions and fairness perceptions are not contained in a simple demand curve. Constant elasticity is rarely defensible across large price changes.