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 2016 annual revenues. One year later, the manager was perplexed because Verizon's 2016 annual revenues were 10 percent lower than those in 2015—the price increase apparently led to a reduction in the company’s revenues.

Did the manager make an error? Explain.

Answer 1

Answer :

Price elasticities of demand vary among groups and areas. They also can change with time (they become more elastic with time). The manager probably selected three states that were not representative of the country as a whole. The sample size should have been increased, or the states selected more carefully to ensure they were a representative sample.

Demand is price inelastic if a change in price causes a smaller % change in demand. This gives a low PED <1.
Demand is price elastic if a change in price causes a bigger % change in demand. This gives a high PED >1
Elasticity of Demand in Short Run

In the short run demand is likely to be more inelastic (low = less than 1).

If people are used to buying a good, then when the price goes up, they will tend to keep buying it out of habit. However, when they realise the price rise is permanent they will expend more energy and time in looking for alternatives. Therefore, over time, people are more likely to find alternatives.

So it seen that initially PED found to be less than 1

4%/5% = 0.8

However, over the period of time customers has shifted to other providers.