Question

Amazon.com, the online bookseller, wants to increase its total revenue. One strategy is to offer a 10% discount on every book it sells. Amazon.com knows that its customers can be divided into two distinct groups according to their likely responses to the discount. The accompanying table shows how the two groups respond to the discount.

	Group A (sales per week)	Group B ( sales per week)
Volume of sales before the 10% discount	1.55 million	1.50 million
Volume of sales after the 10% discount	1.65 million	1.70 million

1. Using the midpoint method, calculate the price elasticities of demand for group A and group B. (10 marks)

2. Explain how the discount will affect total revenue from each group. (5 marks)

3. Suppose Amazon.com knows which group each customer belongs to when he logs on and can choose whether or not to offer the 10% discount. If Amazon.com wants to increase its total revenue, should discounts be offered to group A or to group B, to neither group, or to both groups? (5 marks)

Answer 1

Answer:

Price elasticity (Ed) with midpoint method:
Formula: Ed = [(%change in quantity demanded)/ (% change in price)] * 100

Group A: Ed = 6.45%/-10% = -0.65
Group B: Ed = 13.33%/-10% = -1.33

Calculation of %change in quantity demanded:
Group A: ((1.65 - 1.55)/ 1.55)*100 = 6.45%
Group B: ((1.70 - 1.50)/ 1.50)*100 = 13.33%

2. Group A has inelastic demand (absolute value less than 1). So, discount will not make much difference in the quantity demanded. Quantity will increase by less than proportionate amount. While Group B has elastic demand (absolute value more than 1), so discount will be effective for this group. Quantity demanded will increase by more than proportionate amount.

3. Group B.
If Amazon.com knows the ealsticity of both the groups, and which group each customer belongs to, and also and can choose whether or not to offer the 10% discount, then in order to increase revenue, it should offer discount to Group B.

Reason: According to the properties of elasticity, when the deamnd is elastic, with a decrease in price, total revenue will increase, but total revenue will decrease if the demand is inelastic. So discount should be offerred to the group with elastic demand, that is Group B.