Consider a retailer selling blenders currently priced at $54. Suppose it pays $29 per blender from the manufacturer.
(a) Suppose the retailer’s market research team determines that the elasticity of demand for consumers of blenders is – 1.5. What does this imply about the actual demand for blenders in case of the two situations: a 33% price cut or a price increase to $59?
(b) Can you make recommendations to the retailer regarding which strategy makes more sense: a 33% price cut or a price rise to $59 from its current price level of $54?
Current profit per blender = $54 – $29 = $25
Price elasticity of demand is usually negative due to the inverse relation of price and demand. It is given by –
Price elasticity = %change in qty / %change in price
Or, %change in qty = %change in price x price elasticity
a) in case price is lowerd by 33%, qty should increase.
% change in qty = (-)33% x (-)1.5 = 49.5%
If the original qty is 100 units, then the new qty would be 149.50 units. New price would be 36.18. New profit per unit 7.18.
Old profit (100 units) = 25 x 100 = 2500
New profit (149.50 units) = 149.50 x (36.18 – 29) = 1073.41
Reduction in profit = (-)1426.59
Now, in case Price is increased, the quantity demanded should decrease.
%change in price = ($59-$54)/ $54 = 9.2593%
%change in qty = (-)1.5 x 9.2593% = (-)13.88895%
If the original qty is 100 units, new qty would be 86.11105 units.
New profit = 86.11105 x (59 -29) = 2583.3315
Increase in profit = 2583.3315 – 2500 = 83.3315
b) Increasing the price makes more sense as profit is increased slightly even though qty is reduced. When price is reduced by 33%, the increase in qty does not take care of the reduced price in terms of profit.