Credit PolicyThe provision of a cash discount in setting up credit terms is equivalent to a reduction in price. Generally, it is assumed that when a cash discount is administered it will result in a higher level of sales. This assumption is only consistent with price elastic demand (Rashid 1). If the demand of a product is deemed price inelastic, then a cash discount will lower sales (Rashid 1). “Frantz Viscione (1976), in a survey of over 100 U.S. manufacturing firms, show that the introduction (and in some cases the elimination) of a cash discount led to more (or less) profits for some firms, less (or more) profits for some other firms and no change in profitability for the remaining firms. These findings are consistent with the differential effects of the cash discount in situations of elastic, inelastic, and unitary elastic demand (Rashid 1).” When looking at the case of either elastic or inelastic demand, the provision a cash discount adds another benefit (cost) to be considered during the analysis of the determination of an optimal cash discount rate (Rashid 1). Regardless, there is still a level of inelasticity where all the marginal gains from a cash discount are exactly outweighed (Rashid 1). Price elasticity may differ from one geographical location to the next. Hotch, Kim, Montgomery, and Rossi (1995) did a study that estimated the “store specific price elasticities of demand” for a chain of nearly 85 supermarkets (Rashid 1). Among the findings of this study was that they found eleven demographic and competitive variables. These eleven variables helped to explain around sixty seven percent of the variations in elasticity (Rashid 2). From these it finding it is said that if a store is having different price elasticities for a product in different locations, that it should set different cash discounts accordingly.Estimating Price Elasticities with Theory-Based PriorsPrice elasticity can be improved in de...
