Question

When Netflix increased monthly subscription fees for the premium plan from $15 to $17, 16% of its subscribers switched to alternative providers.

1. Provide an estimate of Netflix demand elasticity using both the precent change and the log formula. Interpret whether the demand is elastic, inelastic, or unit-elastic.

2. Assuming that Netflix’s demand curve has constant elasticity, and assuming that the marginal cost of an additional subscribers is $2.20 (per month), determine Netflix' optimal price. In your calculation, use both elasticities obtained above.

Answer 1

a) Let the quamtity be 100

Price changed by $15 to $17 and thus quantity decreased by 16%

Which means [100- (16%of 100)]

= $[100 - 16] = $84

1) price elasticity through percentage change

= % change in quantity / % change in price

= [84-100 /100] / [ 17-15 / 15 ]

=[ -16 /100] / [2/15]

=| -1.2 |

=1.2

2) price elasticity through log formula

= [dQ/Q] / [ dP/P]

= [dQ/dP] x p/q

= (-16/2) x (15/100)

=| -1.2 |

= 1.2

*As the price elasticity of demand is greater than 1, then the demand is elastic. *

B) given -

1) assuming netflix demand curve is constant elasticity

2) assuming MC of subscriber = $2.20 per month.

We need to determine netflix optimal price

Ideal price depends upon a point where MR = MC or where additional revenue of extra unit of output equals to the additional cost of producing that unit .

Deriving MR from the demand

MR = P( 1 + 1/n ) = MC

therefore,  

P =[ MC / (1+ 1/n)]

P = MC ( n / n +1 )

Given :

a) company producing good at constant marginal cost of $ 2.20 .

Price elasticity of demand is 1.2

In order to determine the profit maximising price

Substitute $2.20 for MC and -1.2 for elasticity ( n)

P = mc ( n / n+1 )

P = 2.20 ( -1.2 / -1.2 + 1 )

P = 2.20 ( 6 )

P = $ 13.2