In an article about the financial problems of USA Today, Newsweek reported that the paper was losing about $20 million a year. A Wall Street analyst said that the paper should raise its price from 50 cents t o75 cents, which he estimates would bring in an additional $65 million a year. The paper's publisher rejected the idea, saying that circulation could drop sharply after a price increase; citing The Wall Street Journal's experience after it increased its price to 75 cents. What implicit assumptions are the publisher and the analyst making about price elasticity?
The publisher and the analyst are making implicit assumptions about price elasticity.
The analyst assumes that the demand for USA Today is relatively inelastic, meaning that an increase in price from 50 cents to 75 cents would not significantly affect the quantity demanded. This assumption is based on the belief that even with the price increase, readers would still be willing to pay for the newspaper, resulting in a significant increase in revenue.
On the other hand, the publisher assumes that the demand for USA Today is relatively elastic, meaning that an increase in price would result in a proportionally larger decrease in the quantity demanded. The publisher bases this assumption on The Wall Street Journal's experience, where circulation dropped sharply after increasing the price to 75 cents.
Both assumptions are plausible interpretations of price elasticity, with the analyst assuming relatively inelastic demand and the publisher assuming relatively elastic demand.
To understand the implicit assumptions made by the publisher and the analyst about price elasticity, let's first define price elasticity:
Price elasticity of demand measures how sensitive the demand for a product is to changes in its price. If the demand is highly responsive to price changes, it is said to be elastic. If the demand is less responsive, it is considered inelastic.
Now let's examine the assumptions made by both the publisher and the analyst:
1. The analyst's assumption: The analyst assumes that increasing the price of USA Today from 50 cents to 75 cents will generate an additional $65 million a year. This suggests that the analyst believes the demand for USA Today is relatively inelastic. In other words, the analyst expects that even with a price increase, the majority of existing customers will continue buying the newspaper.
2. The publisher's assumption: The publisher rejects the idea of raising the price, citing The Wall Street Journal's experience after it increased its price to 75 cents. This assumption implies that the publisher believes the demand for USA Today is more elastic. The publisher suggests that a price increase could result in a sharp drop in circulation, potentially leading to a net loss in revenue.
In summary, the analyst assumes that USA Today's demand is relatively inelastic and will not be significantly affected by a price increase. Conversely, the publisher assumes that USA Today's demand is more elastic, and a price increase may result in a notable decline in circulation.