10.1177/0092070304267108 ARTICLE JOURNAL OF THE ACADEMY OF MARKETING SCIENCE WINTER 2005 Fibich et al. / PRICE ELASTICITY OF DEMAND The Dynamics of Price Elasticity of Demand in the Presence of Reference Price Effects Gadi Fibich Tel Aviv University Arieh Gavious Oded Lowengart Ben Gurion University The authors derive an expression for the price elasticity of demand in the presence of reference price effects that in- cludes a component resulting from the presence of gains and losses in consumer evaluations. The effect of reference price is most noticeable immediately after a price change, before consumers have had time to adjust their reference price. As a result, immediate-term price elasticity is higher than long-term elasticity, which describes the response of demand long after a price change, when reference price effects are negligible. Furthermore, because of the differ- ential effect of gains and losses, immediate-term price elasticity for price increases and price decreases is not equal. The authors provide a quantitative definition for the terms immediate term and long term, using the av- erage interpurchase time and the discrete “memory” pa- rameter. Practical consequences of the distinction between immediate- and long-term elasticities for the esti- mation and use of elasticity values are discussed. Keywords: Reference price; price elasticity; immediate term; promotional elasticity 1. INTRODUCTION Price elasticity of demand is the percentage change in quantity demanded as a result of a 1 percent change in price. It is defined as ε= = dQ Q dp p dQ dp p Q , (1) where p is price and Q(p) is market demand. Numerous factors can affect the price elasticity of demand, including closeness of substitute products, importance of the good in terms of expenditure, time for adjustment, product dura- bility, and range of uses. In this study, we explore the effect of reference price on the price elasticity of demand, an effect that has not been considered previously. Specifi- cally, we examine the dynamics of price elasticity that result from changes in quantity demanded over time. Under this framework, changes in demand occur once there is a price change, and deviations between this new price and consumers’ reference price occur. Consumers’ reference price adjustments, a process that evolves over time, yield changes in these price deviations. The impact of these changes is reflected in the time dependence of quantity demanded that creates the dynamics of price elasticity. Changes in price elasticity of demand over time have been investigated before in the marketing literature. Such studies, however, were mainly concerned with the changes Journal of the Academy of Marketing Science. Volume 33, No. 1, pages 66-78. DOI: 10.1177/0092070304267108 Copyright © 2005 by Academy of Marketing Science.