Question

3. (12) Amazon had a public dispute with the book publisher Hachette regarding its prices for e-books. Amazon was trying convince Hachette to lower their price for e-books, arguing that doing so would benefit both consumers and the publisher; Hachette was refusing to cut their prices, countering that lower prices would hurt both the publisher and their authors. Amazon explained their objectives in terms of price elasticity on their discussion board which they recently discontinued. The full post was e-mailed to the class and is posted on Blackboard.

a.) Amazon states that "For every copy an e-book would sell at $14.99, it would sell 1.74 copies if priced at $9.99." Use this information to calculate the price elasticity of demand for e-books between these two prices. Show your work.

b.) Suppose Amazon was selling 7,000,000 Hachette e-books when the price was $14.99. If their above calculations are correct, how many would they sell after the price is cut to $9.99? What would the total revenue from e-books equal before and after the price cut?

c.) Amazon claims that “e-books are highly price elastic.” If this is the case, then why wouldn't Amazon want to cut prices even further? For example, why not cut the price of e-books to $0.99 instead of $9.99?

d.) Given that Amazon is arguing that cutting e-book prices to $9.99 would benefit Hachette through higher revenue, why do you think Hachette was against this price cut? Hachette obviously did not agree that this price cut would benefit them; but that does not mean they disputed what Amazon was saying. Briefly explain why Hachette may have been against the price cut, even if they did not dispute any of the estimates Amazon gives regarding the price elasticity of demand or revenue expectations.

Answer 1

a. Price elaticity of demand = Percentage change in quantity demanded/Percentage change in price

or, Price elaticity of demand = {(1.74-1)/1 * 100}/{($9.99-$14.99)/$14.99 * 100}

or, Price elaticity of demand = 74/(-500/14.99)

or, Price elaticity of demand = -74/33.36

or, Price elaticity of demand = -2.2

b. If price of e-books falls from $14.99 to $9.99,

number of e-books that will be sold = 7,000,000*1.74 = 12,180,000

Before the price-cut, Revenue = $14.99*7,000,000 = $104,930,000

After the price cut, Revenue = $9.99*12,180,000 = $121,678,200

c. Now, if e-books are sold at $0.99,

Percentage change in quantity demanded = Price elasticity of demand * Percentage change in price

or, Percentage change in quantity demanded = -2.2*{(0.99-14.99)/14.99 * 100}

or, Percentage change in quantity demanded = -2.2*(-1,400/14.99)

or, Percentage change in quantity demanded = -2.2*-93.4

or, Percentage change in quantity demanded = 205.48%

Thus, with a price fall of $14, quantity demanded will increase by 205.48%

Thus, quantity demanded may increase from 7,000,000 to 2,138,360,000 units. However, amazon won't be able to hold such a large stock. This is the reason why amazon donot further price cut.

d. Hachette do not want a price cut owing to lose the esteem of its publishers and authors by selling cheap. Price of a good are often related to its market value. Reducing price might result in losing its market value. This does not means that amazon are wrong in their concept of price elasticity and revenue expectations.