Academic journal article Iranian Journal of Management Studies

The Effects of Price Elasticity Dynamics on a Firm's Profit

Academic journal article Iranian Journal of Management Studies

The Effects of Price Elasticity Dynamics on a Firm's Profit

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

This study investigates the role of dynamic behavior of price elasticity in dynamic pricing over the product life cycle. A considerable number of researches have been done in the area of optimal pricing on new product decision models.

Chin Chun Wu, et al (2009) and Chin Chun Wu, et al (2006) developed two models to maximize the profit by making the optimal price, warranty length and production rate decisions in the first model and optimal price and warranty length decisions in the second one, using a predetermined product lifecycle. DeCroix (1999) derived the optimal price, warranty length and reliability for maximizing profit in an oligopoly. Teng and Thompson (1996) developed a general framework to determine the optimal price and quality policies of new products for a monopolistic manufacturer during a planning period. In the proposed model, they assumed that the demand is determined by price, quality level and cumulative demand. Pei-Chun Lin (2008) proposed a model to jointly determine the price, warranty length, and production rate to maximize the total expected profit of a new product for a monopolist. Glickman and Berger (1976) proposed a model in which they assumed that the customers' demand is determined by a function of price and warranty length. The optimal price and warranty length were obtained by maximizing the manufacturer's profit function.

What is common in all above researches is the invariability of price elasticity during the product lifecycle. This assumption, however, can be faulty because of marketing environment dynamics such as external influences including economic conditions and seasonal variation of customer demand.

For better understanding, assume that there is a monopolist which produces durable products. It is obvious that its customers' sensitivity about the price of the product in the primary stage of lifecycle is different from middle stages and consequently from final stage of product life cycle.

Price elasticity variability, however, may be low in few cases, and constant assumption of this factor does not affect optimal path of decision variables considerably, but in majority of cases, this assumption leads to remarkable deviation from optimal profit.

A considerable body of work has evolved over the last years on the dynamic behavior of price elasticity over the product life cycle in the marketing literature.

Simon (1979) analyzed the price elasticity of consumer products over the "brand" life cycle. In his paper, brand life cycle is distinguished from product life cycle significantly. The only few authors who noticed the distinction between brand and product life cycle, has referred to Mickwitz (1959) who presented some theoretical considerations without any empirical evidences.

According to Mickwitz (1959), Kotler (1971) and Lambin (1970) price elasticity increases in the first three stages of the product life cycle and decreases during the stage of decline, whereas Parsons (1975) does not seem to be fully consistent when he first states, "the absolute magnitudes of ... elasticity exhibit a nonlinear decline over time", and then, "At maturity ... both price elasticity and price cross-elasticity are high."

Simon (1979) derived his empirical study based on prices and quantities sold of 43 brands in seven different markets. Reasonable results however, were obtained only for 35 of these 43 brands. The following relationships are found finally:

1. In 18 of 19 cases (95%) the relation εIntroduction>εGrowth is confirmed.

2. In 10 of 14 cases (71%) the relation εGrowth>εMaturity is confirmed.

3. In 8 of 8 cases (100%) the relation εMaturity<εDecline is confirmed

Shoemaker (1986), though, is not in agreement with Simon. He attributed Simon's findings to particular used function in his research. Shoemaker has pointed out that Simon's findings might be correct if a different estimation process is applied. …

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