Abstract
It has been shown that repeated myopic use of inverse elasticity pricing rule converges on the profit maximizing price only if demand is sufficiently convex, and that it will never converge for linear or strictly concave demands (Fjell and Pal 2019). By myopic, we mean ignoring that elasticity and marginal cost may vary with output and price. We explore a price adjustment process, where at each stage the new price is a convex combination of the current price and the myopic price that is dictated by the inverse elasticity pricing rule. We show that as long as sufficient weight is placed on the current price, the price sequence converges on the profit maximizing price for all demands. The precise range of potential convex combinations for convergence are determined; both for the traditional (multiplicative) version of the inverse elasticity pricing rule, as well as for the unfamiliar additive version. A comparison of the two shows that the latter appears superior in the sense that it converges for a larger range of convex combinations, and that it seems simpler and more intuitive in its expression.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
The additive version can also be expressed in terms of slope of the demand function and quantity as follows: \(p^{*}=c-\frac{q\left( p^{*}\right) }{q^{\prime }\left( p^{*}\right) }\).
It is even clearer if we refer to elasticity as the a positive value (which is quite common) with a plus sign in front of the last term.
Ray and Gramlich (2016) argue that the local slope of demand can be estimated through minute changes in price. Given a local estimate of slope, one has also identified local elasticity.
References
Baumol, W.J., and R.E. Quandt. 1964. Rules of thumb and optimally imperfect decisions. The American economic review 54 (2): 23–46.
Besanko, D., and R.R. Braeutigam. 2002. Microeconomics: An integrated approach. New York: Wiley.
Besanko, D., and R. Braeutigam. 2020. Microeconomics. New York: Wiley Global Education.
Browning, E.K., and M.A. Zupan. 2002. Microeconomics: Theory and applications, 7th ed. New York: Wiley.
Chiang, A.C. 1984. Fundamental methods of mathematical economics. New York: McGraw-Hill.
Dranove, D., D. Besanko, M. Shanley, and S. Schaefer. 2017. Economics of strategy. New York: Wiley.
Fjell, K. 2003. Elasticity based pricing rules: A cautionary note. Applied Economics Letters 10 (12): 787–791.
Fjell, K., and D. Pal. 2019. On repeated myopic use of the inverse elasticity pricing rule. Economics Letters 175: 12–14.
Krueger, M. 2009. The elasticity pricing rule for two-sided markets: A note. Review of Network Economics 8 (3): 1–8.
Laitinen, E.K. 2009. From complexities to the rules of thumb: Towards optimization in pricing decisions. International Journal of Applied Management Science 1 (4): 340–366.
Mandel, A., and H. Gintis. 2016. Decentralized pricing and the strategic stability of Walrasian general equilibrium. Journal of Mathematical Economics 63: 84–92.
Mansfield, E. 1994. Applied microeconomics. New York: WW Norton and Company.
Monroe, K.B. 2002. Pricing: Making profitable decisions. New York: McGraw-Hill/Irwin.
Monroe, K.B., and J.L. Cox. 2001. Pricing practices that endanger profits. Marketing Management 10 (3): 42.
Nicholson, W., and C. Snyder. 1985. Microeconomic theory: Basic principles and extensions. New York: Dryden Press.
Pindyck, R.S., and D.L. Rubinfeld. 2005. Microeconomics, 6th ed. Upper Saddle River, NJ: Pearson Prentice Hall.
Ray, K., and J. Gramlich. 2016. Reconciling full-cost and marginal-cost pricing. Journal of Management Accounting Research 28 (1): 27–37.
Saari, D.G. 1985. Iterative price mechanisms. Econometrica: Journal of the Econometric Society 53: 1117–1131.
Simon, H., D. Zatta, and M. Fassnacht. 1989. Price management. New York: North-Holland.
Author information
Authors and Affiliations
Corresponding author
Additional information
Publisher's Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
Rights and permissions
About this article
Cite this article
Fjell, K., Pal, D. Adjusted repeated myopic use of the inverse elasticity pricing rule. J Revenue Pricing Manag 20, 559–565 (2021). https://doi.org/10.1057/s41272-020-00272-0
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1057/s41272-020-00272-0