Question

1. A) Based on this survey, suppose Netflix decided to double the price of its service from $8 to $16. As a result, the number of Netflix subscribers falls from 60 million to 40 million. Use the mid-point formula to calculate the price elasticity of demand for Netflix between these two price points.

B) Based on your calculation, is demand for Netflix elastic, inelastic, or unit elastic? Explain your answer.

C) Would Netflix generate more revenue if they increased their price from $8 to $16? Explain your answer.

Answer 1

Answer

1. A) The Netflix doubles the price of its service from $8 to $16 and as a result, the number of Netflix subscribers falls from 60 million to 40 million.

The price elasticity of demand(_d) for a product is the responsiveness of the change in quantity demanded for the product for the change in its price.

Or ,  _d = percentage change in quantity demanded for a good / percentage change in its price

Now, let us assume for a good, when its price is P₁ , then its quantity demanded is Q₁ , and when its price is P₂, then its quantity demanded is Q₂. Then the price elasticity of demand by mid-point formula would be as follows;

_d = [(Q₂ - Q₁) / (Q₂ + Q₁) / 2] / [(P₂ - P₁) / (P₂ + P₁) / 2]

In case of Netflix, if P denotes the price, and Q denotes the Netflix subscribers, then,

When P₁ = $8 , Q₁ = 60 million ;

When P₂ = $16 , Q₂ = 40 million

Now using the mid-point formula, we get the elasticity of demand for Netflix between these two price points P₁, and P₂, as follows,

_d =  [(40 - 60) / (40 + 60) / 2] / [(16 - 8) / (16 + 8) / 2]

Or, _d = [( - 20) / (100 / 2)] / [(8) / (24 / 2)]

Or, _d = ( - 20 / 50) / (8 / 12)

Or, _d = ( - 2/ 5) / (2 / 3)

Or, _d = (- 0.4) / (0.66)

Or, _d = - 0.6 ( approx.)

Taking modulus in both sides, we get,

| _d | = | - 0.6 |

Or, _d = 0.6 ( approx.)

The price elasticity of demand for Netflix between these two price points is 0.6.

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B) Demand for Netflix is inelastic.

If the price elasticity of demand for a product is greater than 1, the demand is then called elastic.

   If the price elasticity of demand for a product is less than 1, the demand is then called inelastic.

   If the price elasticity of demand for a product is equal to 1, the demand is then called unit elastic.

From the above calculation, we see that the price elasticity of demand for Netflix between the given price points is 0.6, which is less than 1. So the demand for Netflix is inelastic.

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C)  Yes, the Netflix would generate more revenue if they increased their price from $8 to $16.

Revenue = price * Quantity

When price of Netflix = $8, the quantity or number of subscribers = 60 million ;

When price of Netflix = $16, the quantity or number of subscribers = 40 million

So, when price is $8, revenue (R₁) = $8 * 60 = $480

when price is $16, revenue(R₂) = $16 * 40 = $640

From above, we see R₂ R₁ .

The Netflix would generate more revenue if they increased their price from $8 to $16.

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