Nonlinear Relationship between Frequent Price Discounts and Consumers’ Price Sensitivity

Although economists have traditionally considered the relationship between frequent price discounts and price sensitivity to be positive, the present study shows that this relationship could be nonlinear. Price discounts can stimulate sales because of the downward demand curve, but they can depress sales because consumers expect a lower price in the future. An increase in price sensitivity strengthens the aforementioned two effects, and the dominant effect determines whether price discounts can generate sales. In this paper, using a real options model, we show that when the second effect is stronger, an increase in price sensitivity decreases price discounts; the reverse is true when the first effect is dominant. Accordingly, practitioners can design efficient price-promotion programs on the basis of the product's price sensitivity.