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Price Elasticity of Demand and an Optimal Cash Discount Rate in Credit Policy

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  • Rashid, Muhammad
  • Mitra, Devashis

Abstract

While the provision of a cash discount is equivalent to a reduction in price, the role of price elasticity of demand in determining credit terms has been neglected in the extant literature. In this paper, this role is investigated and it is shown that the optimal cash discount rate is affected by the price elasticity of demand for the firm's product. The comparative effects on the optimal cash discount rate with respect to exogenous changes in the fraction of credit sales paid after taking cash discount, the cost of short-term funds and the bad debt loss ratio are investigated. A trade-off between the time value gain and the price elasticity of demand is established. We find that firms which sell in locations having different price elasticities for their products, and/or which face various costs of short-term funds in different locations, should vary their cash discount terms accordingly. Copyright 1999 by MIT Press.

Suggested Citation

  • Rashid, Muhammad & Mitra, Devashis, 1999. "Price Elasticity of Demand and an Optimal Cash Discount Rate in Credit Policy," The Financial Review, Eastern Finance Association, vol. 34(3), pages 113-125, August.
    • Handle: RePEc:bla:finrev:v:34:y:1999:i:3:p:113-25
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    Cited by:

    1. Wahyu Jatmiko & M. Shahid Ebrahim & Abdullah Iqbal & Rafal M. Wojakowski, 2023. "Can trade credit rejuvenate Islamic banking?," Review of Quantitative Finance and Accounting, Springer, vol. 60(1), pages 111-146, January.
    2. M. Shahid Ebrahim & Seema Makhdoomi & Mustapha Sheikh, 2012. "The Political Economy and the Perennial Underdevelopment of the Muslim World," Working Papers 12011, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
    3. Stokes, Jeffrey R., 2005. "Dynamic cash discounts when sales volume is stochastic," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(1), pages 144-160, February.

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