Question

In 2010, Apple wanted to lower the price of down‐loading TV shows from iTunes from $ 1.99 to $ 0.99. But Apple had to get permission from, and convince, the management of the networks with whom they share the revenue from each download. Apple argued that lowering the price would benefit both Apple and the networks. Managers at the networks disagreed, and wanted the price kept at $ 1.99. a. What did Apple believe about the price elasticity of demand for downloaded shows? b. What did the networks believe about the price elasticity of demand for downloaded shows?

Answer 1

Price elasticity of demand is . The revenue can be depicted as . If, for a unit percent decrease in p, becomeing 0.99p, the increase in quantity is unit percent (approx 1.010101%), then the revenue is same for a change in price, and the price elasasticity of demand is unitary elastic. If demand is elastic, and , then for a unit percent change in price, the change in quantity will be more than a unit and the revenue increases. Vice-versa, if , then the revenue decreases.

(a) If Apple wanted to lower the price, they must have beleived that reducing the price would lead to increase in their total revenue as more consumers would be buying their product, so much that there would be an increase in the total revenue, ie price elasticity of demand would be elastic. In that case, for a unit percentage reduction in price, there would be more than a unit percentage increase in quantity. Hence, Apple beleived that price elasticity of demand would be elastic and greater than 1.

(b) If Networks didn't wanted to lower the price, they must have beleived that reducing the price would lead to decrease in their total revenue as yet more consumers would be buying their product, the increment wouldn't be so much that there would be an increase in the total revenue, ie price elasticity of demand would be inelastic. In that case, for a unit percentage reduction in price, there would be less than a unit percentage increase in quantity. Hence, Networks beleived that price elasticity of demand would be inelastic and less than 1.