Recently, Pacific Cellular ran a pricing trial in order to estimate the elastici

Question

Recently, Pacific Cellular ran a pricing trial in order to estimate the elasticity of demand for its services. The manager selected three states that were representative of its entire service area and increased prices by 5% to customers in those areas. One week later, the number of customers enrolled in Pacific’s cellular plan declined 4% in those states, while enrolments in states where prices were not increased remained flat. The manager used this information to estimate the own-price elasticity of demand and, based on her findings, immediately increased prices in all market areas by 5% in an attempt to boost the company’s 2007 annual revenues. One year later, the manager was perplexed because Pacific Cellular’s 2007 annual revenues
were 10% lower than those in 2006 – the price increase apparently led to a reduction in the company’s revenues. Did the manager make an error? Explain.

Explanation / Answer

Price elasticities of demand vary among groups and areas. They also can change with time (they become more elastic with time). The manager probably selected three states that were not representative of the country as a whole. The sample size should have been increased, or the states selected more carefully to ensure they were a representative sample.

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