When a product has a high elasticity of demand, a small change in price leads to a large change in the quantity demanded. When companies sell items whose costs increase over time, changing the price to accommodate those cost increases may result in a loss of market share and of total revenue if there is a significant loss of sales due to price elasticity. A company that sells a product with high price elasticity at a time when it can reduce its costs and pass that reduction onto customers in the form of lower prices may realize an increase in total revenue and profit through the greater number of units sold ("Price Elasticity" n.p.). This is illustrated as follows:
In the above example, quantity demanded at $8.50 is 85. If the price can be reduced to $8, the quantity demanded increases to 100, which will increase total revenue from $722.50 to $800. So long as such as price reduction is due to reduction in cost, this action could result in increased profit to the organization ("Elasticity" n.p.). Such cost savings might be realized through lowering variable costs, perhaps through more efficient equipment that is used to produce the widgets. Reducing fixed costs can have a long-term effect on the company's profitability, such as moving to a facility with lower rent, for example.
Of course, there are dangers with this level of elasticity, as well. If the company is forced to raise its price to $9, quantity demanded falls to 75 and total revenue falls to $675. When there is strong price elasticity, there is considerable pressure on companies to keep their costs under control in order to maintain their revenue stream.
"Elasticity." SparkNotes, 2006. Retrieved 15 May 2008: "Price Elasticity of Demand." NetMBA, 2007. Retrieved 15 May 2008: ...