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% to customers in those areas. One week later, the number of customers enrolled in Verizon's cellular plans declined 4% 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% 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% lower than those in 2015. The price increase apparently led to a reduction in the company's revenues. Did the manager make an error?
A) Yes: The one-week measures show demand is inelastic, so a price increase will decrease revenues.

B) No: The cell phone market must have changed between 2011 and 2012 for this price increase to lower revenues.

C) Yes: The one-week measures show demand is elastic, so a price increase will reduce revenues.

D) Yes: Cell phone elasticity is likely much larger in the long-run than the short-run.

Answer 1

Answer:

C) Yes: The one-week measures show demand is elastic, so a price increase will reduce revenues.

Explanation:

The error that the Manager did was to under-estimate the principles of elasticity of demand that posits that increase in price is inversely proprtional to demand. Perhaps, she also overrated the quality of their services without given thoughts to the presence of competition and customers’ decisions in a competitive market.

The survey carried out was a proof of the fact that price increase had an inverse effect on the demand for the services, as was shown by the rate of decline in the number of customers who enrolled in Verizon's cellular plans especially in those states where they had the best of customers’ loyalty.  

Answer 2

Answer:

D) Yes: Cell phone elasticity is likely much larger in the long-run than in the short-run.

Explanation:

Elasticity measures the relative responsiveness of the change in quantity demanded to the change in the price. A 5% increase in price caused a decline in Verizon's cellular plan enrollment by 4%. The price elasticity is 0.8 which is less than 1. This means that Verizon's customers' demand is price inelastic. The manager made an error in thinking that a very short term one week elasticity could predict the longer term one year elasticity. The annual results very clearly indicate that the pricing trial was not predictive.