Question

A producer of a new range of energy drink introduces their product at R25 per can. After a month of sales, they introduce a special of R 40 for two cans. A month later they sell the product at the original introductory price. They subsequently introduce another special after another month of R 45 for two. After a month of sales, they re-introduce the original special of R40 for two and this special is kept on-going for numerous months thereafter. Use price elasticity theory to show why, ceteris paribus, the producer settles at the initial special of R 40 for two. In your discussion, include a comment on the type of price elasticity observed with the demand for this energy drink at these prices.

Answer 1

The price elasticity measure the response of quantity demanded as price changes, => it measure the percentage change in quantity demanded as price increases by 1%. For an elastic demand the percentage change in quantity demanded is more than percentage change in price, => if the producer reduces the price the total revenue from the sale of the good increases.

For an inelastic demand the percentage change in quantity demanded is less than percentage change in price, => if the producer increases the price the total revenue from the sale of the good increases.

Here the price elasticity of energy drink is elastic in nature, => if the producer decreases the price by 1% then quantity demanded will increase by more than 1%, => the producer should reduce the price in order to increase total revenue, that’s why the producer get back to the original special price of R40 for two cans.