Bellsouth Mobility (BM) ran a pricing trial in order to estimate the elasticity

Question

Bellsouth Mobility (BM) ran a pricing trial in order to estimate the elasticity of demand for its services. The manager selected 4 states that were representative of its entire service area and increased prices by 5% to subscribers in those areas. One month later, the number of its customers enrolled in BM's plans declined 4% in those states, while enrollments in states where prices were not increased remained flat. Based on this information, the manager estimated the own price elasticity of demand and based on her findings immediately increased prices in all markets by 5% in an attempt to boost the company's revenues. One year later, the manager was confused because BM's revenues were down 10%. Apparently, the price increase led to a reduction in the company's revenues.

Did the manager make a mistake? Explain.

Explanation / Answer

The elasticity of demand states that when a (% change in quantity/% change in price) is less than 1, then it indicates that the demand is inelastic. And the same case happened with the problem above

The manager estimated the price elasticity of demand by taking the resulted change in current/previous price and quantity.

Price Elasticity of demand = ((960-1000) / (960+1000))/ ((262.5-250)/   (262.5+250)) = -0.83673

For the problem above we have assumed that BM had 1000 subscribers and the cost of subscription was 250.

The above price elasticity is showing a negative value of 0.83673, which indicates the demand is inversely related with the price. In other words, for a percentage increase in price, the quantity demand will decline by 0.83%. However, in the problem above, the situation has gotten worse, where the total revenues declined by 10%.

I believe the manager did the right thing by increasing the price by 5%, but the decline in revenues could be a result of other market force such as consumer income or any close substitute.

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