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

In 4 states selected as representative of entire service area, proportionate change in quantity demanded is less than the change in price.

When percentage change in quantity demanded is less than the percentage change in price, demand is said to be inelastic.

So, based on above observation (percentage change in quantity demanded being less than the percentage change in price) manager would have concluded that demand for BM’s service is inelastic.

In case of inelastic demand, increase in price increases the total revenue and vice-versa.

So, based on her conclusion of demand being inelastic, manager has gone for price increase in order to boost revenue.

However, results show that revenue has indeed declined.

This implies that manager had made the mistake in assessing the nature of demand. In other words, she has incorrectly recognized the demand being inelastic. On the contrary, in reality, demand for BM’s service is elastic.

It is only in case of elastic demand that increase in price results in fall in total revenue.

Representative area has thrown the wrong notion with respect to nature of demand for BM’s service.

Thus, it can be said that manager has made the mistake of wrongly assessing the nature of demand and therefore has got the totally opposite result.

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