Question

Imagine that you are part of the management team for Econsoft, a computer software company. You are discussing one of your products, “Econblaster,” with the company’s CEO and the other managers. You have made the software available for download on your firm’s website for download for $9.99 and you are trying to figure out how to generate more revenue from the product. Half of the management team suggests increasing the price to $11.99. The other half advocates cutting the price to $7.99. Both sides claim that their idea will increase total revenue generated from the product.

The CEO turns to you to help explain what’s going on. “How can half of the team suggest one thing, and the other half the exact opposite? Who is right? What should we do?”

What do you think? What does the right answer depend on?

Answer 1

To understand whether we should increase or decrease the price, we must decide the nature of the demand curve that is facing the firm. The elasticity of demand curve reflects the competitiveness of the market structure, tastes and preferences and presence of substitutes.
Those who are advocating that the price must be raised to $11.99 believe that the demand for the product is inelastic. That is, an increase in price level will not affect the quantity demanded of the product. Those who want to cut the price probably believe that the demand curve is elastic and hence cutting the price level will lead to an increase in quantity demanded and hence improve the revenue of the firm.
The firm must assess the nature of the demand curve by estimating the elasticity of the product over a considerable period of time. The elasticity measure can help in determining which group is correct and appropriate decision can then be taken.