Optimal Product Line Pricing: The Influence of Elasticities and Cross-Elasticities

Abstract

The authors focus on the determination of optimal prices for products in a product line. Most firms offer more than a single brand, and ultimately are concerned with the overall results of the entire line. The most common approach for addressing this concern has been to model the sales response function and optimize the profit function separately by brand. A model is presented which solves for the optimal product line prices simultaneously. The method requires a model which includes cross-elasticity terms and an estimation method which allows for correlated disturbances (seemingly unrelated regression). This approach is compared with results from a model not including the cross-elasticity terms, and an estimation without correlated disturbances. Inferences for optimal prices from the proposed model indicate different results and potential errors in using the more naive models. The authors provide a method for managers to use in evaluating the importance of critical parameters in their product line pricing decisions.