Question

Recently, Verizon Wireless ran a pricing trial in order to estimate the elasticity of demand for its services. The manager selected three states that were representative of its entire service area and increased prices by 5 percent to customers in those areas. One week later, the number of customers enrolled in Verizon’s cellular plans declined 4 percent in those states, while enrollments in states where prices were not increased remained flat. The manager used this information to estimate the own price elasticity of demand and, based on her findings, immediately increased prices in all market areas by 5 percent in an attempt to boost the company’s 2012 annual revenues. One year later, the manager was perplexed because Verizon’s 2012 annual revenues were 10 percent lower than those in 2011—the price increase apparently led to a reduction in the company’s revenues. Did the manager make an error? Explain.

Answer 1

The manager failed to take into account the difference between long run price elasticity and short run price elasticity.

Own price elasticity is given by (% change in quantity/% change in price)  

=- 4%/5 %= -0.8

Which is less than one in absolute terms

Ie Eq,p is < 1 which means that the demand is inelastic.

Now when the same experiment and change was done for year , we get the following

Eq,p for long run = ( % change in quantity/% change in price)

= -10%/ 5% = -2

In absolute terms the elasticity in long run us greater than 1 ie | Eq,p| >1 so we have an elastic demand which means that a small change in price leads to a huge change in quantity demanded.

So from both long run and short run elasticity we conclude that the demand was less elastic in short run and more elastic in long run . This could be because in long run people had enough time and resources to change the cellular companies and get reasonable or cheaper cellular plans.