Question

Price Elasticity of Demand: Naturally Good Organics

Price Elasticity of Demand measurers how changed in a price affect the quantity of the product demanded. Specifically, it is the ratio of the percentage change in quantity demanded to the percentage change in price. In order to understand how to plan a successful pricing program, marketers must understand how elastic or inelastic the consumers are to changes in price. In other words, to what extent will a price increase or decrease result in changes in demand? For some products a price increase may in fact result in a drop in revenue if the quantity demanded declines. However, for that same product a price decrease may actually result in a revenue increase if the quantity demanded rises significantly.

% Change in Quantity Demanded

Price elasticity of Demand = -------------------------------------------------------------

% Change in Price

To calculate Percentage Change in Quantity Demanded:

Quantity Demanded at T2 − Quantity Demanded at T1

% Change in Quantity Demanded = -------------------------------------------------------------------------------------- × 100

Quantity Demanded at T1

To calculate Percentage Change in Price:

Price at T2 − Price at T1

% Change in Price = ------------------------------------------------------------------------------ × 100

Price at T1

Remember that markets are elastic if the Price Elasticity of Demand is less than -1. Thus, an elasticity of -5 would indicate that a 1% decrease in price produces a 5% increase in quantity sold. But it is important to remember that markets are not always elastic some marketing are inelastic.

In an inelastic demand market, price elasticity of demand is greater than -1. That means that if price elasticity of demand is -.50 then a 1% increase in price results in a ½ percent decrease in the quantity demanded. Inelastic demand markets allow marketers to raise price with fewer customers leaving the market than in elastic demand markets. However, a price decrease will not entice large groups of buyers into the market as they might in an elastic demand market.

In the following exercise, you’ll evaluate the Price Elasticity of Demand.

Read the fictional scenario below, you need to identify the price before the price/increase and quantity demanded before and after the price increase/decrease.

Case:

Tori Gilcrist was recently hired by Naturally Good Organics. Her firm is looking at starting a social entrepreneurship program were a portion of the proceeds from each sale would be donated to farmers who are converting to organic production. Naturally Good Organics owner, Anna Ruiz, is worried that consumers would see the price increase to cover the cost of the program and buy from other providers thus losing sales. Anna has asked Tori to conduct a pricing study to determine if the new program is feasible.

Anna has set up a test market in Iowa where the price for a gallon of milk would be increased so the firm would have real data to test the impact of the increase. Anna is hoping that the reason for the price increase would justify the consumer paying more for Naturally Fresh Organic’s products. Tori must now analyze the data from the test market and see what the impact on quantity demanded after the price increase was.

Time Period	Price/unit	Quantity Demanded
T1 (original Price)	$6.30	720
T2 (new Price)	$6.50	675

1. What is the percentage change in price”?

  (Click to select)   3.17%   -3.17%   5.17%   -5.17%   -2%

2. What is the percentage change in quantity demanded?

  (Click to select)   5.25%   -5.25%   6.25%   -6.25%   4.25%

3. What is the Price Elasticity of Demand?

  (Click to select)   1.97%   2.97%   3.97%   -1.97%   -2.97%

4. Is the market for Naturally Good Organics milk elastic or inelastic?

  (Click to select)   Elastic   Inelastic   Neither elastic nor inelastic   Cannot be determined from the data provided

5. Would this price increase result in a revenue increase or decrease for the firm?

  (Click to select)   Increase   Decrease   Remain the Same   Cannot be determined from the data provided.

6. Will all products in the Naturally Good Organics line have the same elasticities?

  (Click to select)   Yes, all products would have the same elasticities.   No, different products would have different elasticities.   Cannot be determined from the data provided

Answer 1

Given,

	Price	Quantity
T1	$ 6.30	720
T2	$ 6.50	675

1. $\large \% \triangle P = \frac{P_2-P_1}{P_1}*100$

$\large \% \triangle P = \frac{6.50-6.30}{6.30}*100$

$\large \% \triangle P =3.17 \%$

2. $\large \% \triangle Q = \frac{Q_2-Q_1}{Q_1}*100$

$\large \% \triangle Q = \frac{675-720}{720}*100$

$\large \% \triangle Q = -6.25 \%$

3. $\large Elasticity =\frac{\% \triangle Q}{\% \triangle P} = \frac{-6.25}{3.17} = -1.97$

4. Elastic (Since price elasticity of demand is greater than 1).

5. Decrease.

As in case of Elastic demand higher the price lower the revenue.

6. Cannot be determined using the data provided .

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