According to Real Time Economics (a Wall Street Journal blog), U.S. consumers are responding more quickly to price increases than they used to. In other words, the recession and continuing high unemployment are causing demand to become more elastic for a whole range of consumer goods.
Since nobody took up the elasticity challenge (see below) on their own, we solved it in class today. The original post says that “when Netflix raised its price from $10 to $16, it lost 1 million of its 25 million subscribers”. We googled the formula for price elasticity of demand:
E = % change in quantity / % change in price
And figured out that according to the midpoint formula, a “% change” is calculated as:
% change = [value 2 – value 1] / average of the two values
Keeping in mind that for price elasticity, we drop the negative sign, we calculated the price elasticity of demand to be:
[(25-24)/24.5] / [(10-16)/13] = .088
Since the coefficient of elasticity is less than 1, demand is inelastic, or not responsive to a change in price. This means that increasing the price was, in fact, a very good business decision, as it caused total revenue (Quantity x Price) to increase from $250 million to $384 million.
Somebody at Netflix remembered their microeconomics…
An article in the New York Times reported that when Netflix raised its price from $10 to $16, it lost 1 million of its 25 million subscribers, “a greater exodus than they expected”. Netflix shares fell 15%, and the company’s chief executive, Reed Hastings, ended up apologizing for the way he handled the changes.
CHALLENGE to ECON-3000 STUDENTS: If we put aside the temporary fluctuation in share price, was this, in fact, a bad business move? Why / why not? I will give 2 bonus marks to the first person who calculates the price elasticity of demand for Netflix subscriptions, and correctly describes the effect of the price increase on the company’s sales revenue. Please use the “Leave a Comment” link below to answer.
UPDATE ON CHALLENGE: If there is no reply by noon on Wednesday, Oct. 12, we will solve the riddle together in class. Timbits will be distributed in lieu of bonus marks.