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.
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Answer 1

The sequence of events can be observed as follows. Each decision by the producer has been analyzed:

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A producer of a new range of energy drink introduces their product at R25 per can.

At this stage, the producer doesn't know whether this price will be suitable for the consumers. Some analysis of existing products may have been useful.

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After a month of sales, they introduce a special of R40 for two cans.

The producer feels that R25 per can is a bit high, and thus offers a discount. With the discount, the price is R20 per can.

This implies that the demand for the good is price elastic, and consumers have a lot of choice. They are not willing to pay a higher price, as they compare all the options.

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A month later they sell the product at the original introductory price.

The producer witnesses loss in profits due to the lower price, and attempts to raise the price again. This doesn't work. The producer has to come back down to the original price.

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They subsequently introduce another special after another month of R45 for two.

Since demand is price elastic, the producer should not raise price again.

But, they decide to keep it slightly higher, than the original R20 for two cans. This may not work again, as consumers are price sensitive.

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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.

The producer's attempts to raise the price have failed completely. From R45 to R50 for two, it has come back to R40 for two. This happens in a competitive market (not to be confused with perfect competition).

In a competitive market, demand is highly elastic with respect to price. There are many sellers, and they have less control over prices. Consumers have a lot of choice, and profit margins for producers are low.

In case demand for a product is elastic, then the only option that producers have is to offer more discounts. If they attempt to raise prices, they lose their customers.