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?

Answer 1

Manager definitely made an error by assuming that the calculations for the price elasticity of demand for a week will be consistent over an year. note that long run price elasticity of demand has a greater value than the short run.

In this case the short run price elasticity of demand was 0.04/0.05 = 0.8 which implied that demand was inelastic and hence price increase would have increased revenue. But the trials were run for a week and in contrast revenues were measured over an year. One year is a pretty long period for price elasticity of demand to go from being inelastic to elastic.

due to this reason the price increase resulted in a decline in revenues because in the long run the price elasticity of demand increased as people were able to change their preferences. This shows that manager definitely made an error.