Question

Amasoon is a bookstore selling economic textbooks, and Booky is a bookstore selling mathematics textbooks. While Amasoon owns a physical shop located in Denver, Booky operates on the internet. Therefore, Amasoon has a fixed cost of $180,000 per year, while Booky has no fixed cost. Since Amasoon has a physical shop, the publisher is willing to sell the textbooks to Amasoon at a discounted price of $60 per copy. Booky has to buy the books for $100 per copy from the publisher, however. There is no other cost in their operations.

Currently, both bookstores set the price of textbooks at $200 per copy. At this price, the quantity demanded and the price elasticity of demand for both books are the same. Specifically, the amount required is 2,000 copies per year for each textbook, and the price elasticity of demand is -2.

1. What is the annual profit of Amasoon?

2. What is the annual profit of Booky?

3. To help improve profit, a business consultant suggests Amasoon reduce textbook prices by 10%. However, this consultant does not recommend Booky to adopt the same discount strategy. Show that while this price discount strategy helps improve the profit of Amasoon, this strategy reduces the benefit of Booky.

4. Based on your answer to part (c), briefly explain why discount pricing strategy is more common for products with the following two characteristics:

1. Price elasticity of demand is very elastic &
2. The total cost consists of a large portion of fixed costs.

Answer 1

Revenue for Amasoon=2000*200=$400000=Revenue for Booky

Fixed cost for Amasoon=180000 marginal cost for Amasoon =60 per copy ,Total variable cost for Amasoon=60*2000=120000, Marginal cost for booky=100, Total variable cost for booky=100*2000=200000

Annual profit for Amasoon=400000-180000-120000=$100000

Annual profit for Booky=400000-200000=$200000

If prices are reduced by 10% corresponding demand increase would be. -2= change in quantity demanded /-10%=20% hence, quantity increas would be2000*1.2=2400 at price=0.9*200=180

So new profit for Amasoon=180*2400-180000-60*2400=108000

For Booksy=180*2400-100*2400=192000

So pricing strategy increases the benefit for Amasoon by 8000(108000-100000) and reduce by 8000 for Booky

Pricing strategy works when elasticity is high with small drop in price leading to large increase in quantity demanded so elasticity should be high so as to benefit from pricing strategy also another factor is large fixed cost as if the firm have large fixed cost decrease in price will be offset by d mand increase and since variable cost is small proportion costing pressure wouldn't impact the bottom-line of the company on account of price decrease.