Unformatted Attachment Preview
Will Bury’s Price Elasticity Scenario
ECO/561 Version 9
1
Will Bury’s Price Elasticity Scenario
Will Bury, an enterprising inventor, is convinced that soon everyone will be reading or listening to
everything digitally, including books that have been mostly available in hard copy. He knows that
there are books on CD, but these are relatively expensive and have been recorded using human
readers. He also knows that there is technology that can transform the printed word into audio,
but the sound is somewhat inhuman. Will plans on speeding up the transformation with a
proprietary technology he has developed and patented. This technology takes the printed word
for text materials and creates a file with the option of reading it digitally or listening to it with a
realistic synthetic voice. Will knows that he has free access to books no longer under copyright
protection, and he figures he can pay a royalty fee of $5 per title for copyrighted books that will
greatly expand his catalog. So far, he has limited himself to English-language books but is
working on a language translation option as well.
To date, Will’s technical skills outpace his business acumen. He is struggling with some basic
decisions. He has been working on his invention as a garage operation for the last few years and
has missed many of his daughter’s soccer games while working at High Tech Digital Industries to
keep his family comfortable on his $200,000 annual salary and benefits package. Will may
eventually have to decide whether to devote most of his time to his invention. Moreover, he is not
sure how to determine all the applications for his technology, who would want it, how it would be
delivered to customers, how many books would be bought at what price, and so forth. Even after
he has secured the rights to copyrighted material, he needs some help acquiring the books he
wants to digitally transform and scanning them into his digitizer. It is not difficult to train others to
do this, but the process takes about an hour per 500 pages to complete. To make sure the
process works well, Will has been doing this himself, but he realizes this is neither a good use of
his time nor will it get many books digitized. Fortunately, the digitizer Will uses is inexpensive to
reproduce for others to use, and Will is certain that the security he has encoded into it will prevent
others from unauthorized replication of the device. Where are the people Will can hire to do the
work, and how much should he pay them? If it is easy to train workers in the United States to do
this, could Will pay $10 an hour for someone with the skills of a high school graduate? If this is
the skill level, could he pay a worker overseas $2 an hour for the same service?
To address some of these issues, Will has been doing some research. First, he checked online to
discover that a 500-page book on CD costs approximately $20. This is a good substitute for his
audio files, and further research suggests that he could apply his digitizing process to more
recent copyright-protected books for a royalty fee of $5 per book. He would still incur the labor
charge of scanning the book. Will continues to wonder whether people want to read digitally or
listen to audio books, or whether they still prefer a physical book to read. Will found an article
from a reputable source that suggests customers of digital and audio books are relatively affluent,
their household incomes are above average, and acceptance of digital reading for pleasure is
lagging behind acceptance of digital reading for business. The article found that digital listening is
attracting the same audience who download music to digital devices.
Further research has suggested that price is an important feature driving the appeal of digital
book files. Will is trying to apply some earlier experiences in movie distribution to his digital book
project. When movies were first released for general consumer distribution as videotapes, they
were expensive—about $80 per title. When the price was lowered to $20 per title, evidence
suggests that volume sales typically went up 600%. Of course, not everything stayed the same.
In recent years, movie titles have been released more quickly following their showing in theaters,
there have been more extra features on the DVDs because of greater storage capacity, and the
format changed from videotape to disk. Some have hinted that although there are fewer
blockbuster hits now, there are more titles appealing to a broader audience. Will is trying to find
more evidence of the effect of price on volume demand, but this is all he has discovered so far.
Will Bury’s Price Elasticity Scenario
ECO/561 Version 9
2
Nevertheless, Will must determine a launch price for when he first introduces his digital titles to
the market. He set up a website offering his small catalog of books. He set the price at $10 for a
title on which copyright has lapsed and $15 for a title that includes a royalty fee. He is a little
disappointed in his sales in the first 6 months of operation, having sold only 1,000 of the older
books with a lapsed copyright and 2,000 of the newer books. Moreover, he is confused as to why
he sold twice as many of the more expensive books. He wonders whether he should lower or
raise prices to increase his revenues. What might he expect to happen to his volume sales if he
does change prices? If he decides to increase or decrease prices, is it better to make a small
change and observe the effects on quantity, or will customers more likely react to a change in
price of at least $1 per title? If he changes his prices, will this have any effect on the prices
charged by big-volume sellers for conventional hard-copy books?
While Will is pondering his pricing strategy, he visits a friend, Elsa Budley, who has had
experience selling online. Elsa started an online business selling her artwork. Although her initial
sales were a bit disappointing, she offered some shocking advice. She discovered that she sold
more artwork when she raised her prices at the same time that she expanded her online
advertising budget. Elsa thinks Will’s key to success is to raise prices and sell more books!
Will senses that he is on the brink of great success with a proprietary technology that transforms
the way people access books and other materials currently offered only in print. He is also on the
verge of making some fundamental business mistakes, however, that could rob him of his
success. He may be more successful if he observes some basic concepts included in the early
part of this course.
Thomas Money Service Inc. Scenario
ECO/561 Version 9
1
Thomas Money Service Inc. Scenario
Thomas Money Service Inc. has been in business since 1940. It started out as a consumer finance company granting small loans for household
needs. Over the following 5 years, the company expanded its services by issuing business loans, business acquisition financing, and commercial
real estate loans.
In 1946, the decision was made to branch out into equipment financing. A subsidiary named Future Growth Inc. (FGI) was established. This
decision turned out to be very lucrative. Because of the end of World War II, society had a huge demand for construction and forestry equipment.
Because of increasing demand for this type of equipment, FGI decided to make a very daring move in 1951 and purchased an equipment
manufacturing company. Now they could build, sell, and finance their own brand of building and forestry equipment. FGI discontinued financing
other brands of equipment.
For 67 years, FGI had been able to truthfully state that they have continuously increased profits year after year, even during economic downturns,
and have never laid off workers. This track record has allowed their stock to grow from $5.00 to $85.60 with six stock splits from 1975 to 1998. FGI
has never issued bonds, and the present stock value is $35
The current global downturn has caused the American economy to suffer. Oregon, Washington, and several other forestry states have
encountered flooding, massive fires, and protest from animal activists. For the first time in FGI history, profits declined—down 30% from last
year—and they had to lay off one-third of their workforce.
The falling economy has also caused a drop in new-home sales: sales dropped 30% from the prior year and additional declines are expected. This
has caused a domino effect throughout the entire construction industry. Not all sectors, however, are being hit equally by the economy. Hospitals
and nursing homes still have a demand for new buildings.
Data
•
•
There are currently many domestic and international companies manufacturing construction and forestry equipment. Each company’s
equipment offers slightly different features and functions, which allows the market to supply many substitutes.
FGI has repossessed over 500 pieces of equipment during the past year. They have bundled the pieces together and determined an average
price for each piece. The present selling price is $1,732. Below are the demand figures for each price.
Demand data in millions in the past years
Thomas Money Service Inc. Scenario
ECO/561 Version 9
•
Price
Demand
1,990.1
1,732.0
1,634.3
1,252.0
732.1
622.3
123
182
350
380
400
456
2
In recent years, FGI had decreased its advertisement revenue, selecting to have a commercial during the Super Bowl and a few other
sporting events.
FGI has cut down on manufacturing because of lack of demand. Below is the combined production cost for construction and forestry equipment.
What level of demand generates the greatest net income?
OUTPUT
PRICE
MARGINAL
REVENUE
TOTAL
REVENUE
TOTAL
COST
0
FIXED
COST
VARIABLE
COST
MARGINAL
COST
AVERAGE
FIXED
COST
AVERAGE
VARIABLE
COST
AVERAGE
TOTAL
COST
$990.0
1
$2,600.0
$2,600.0
$2,600.0
$1,050.0
$990.0
$60.0
$60.0
$990.0
$60.0
$1,050.0
2
$2,500.0
$2,400.0
$5,000.0
$1,100.0
$990.0
$110.0
$50.0
$495.0
$55.0
$550.0
3
$2,400.0
$2,200.0
$7,200.0
$1,145.0
$990.0
$155.0
$45.0
$330.0
$51.7
$381.7
4
$2,300.0
$2,000.0
$9,200.0
$1,200.0
$990.0
$210.0
$55.0
$247.5
$52.5
$300.0
5
$2,200.0
$1,800.0
$11,000.0
$1,262.0
$990.0
$272.0
$62.0
$198.0
$54.4
$252.4
6
$2,100.0
$1,600.0
$12,600.0
$1,335.0
$990.0
$345.0
$73.0
$165.0
$57.5
$222.5
7
$2,000.0
$1,400.0
$14,000.0
$1,423.0
$990.0
$433.0
$88.0
$141.4
$61.9
$203.3
8
$1,900.0
$1,200.0
$15,200.0
$1,517.0
$990.0
$527.0
$94.0
$123.8
$65.9
$189.6
9
$1,800.0
$1,000.0
$16,200.0
$1,637.0
$990.0
$647.0
$120.0
$110.0
$71.9
$181.9
Thomas Money Service Inc. Scenario
ECO/561 Version 9
3
10
$1,700.0
$800.0
$17,000.0
$1,772.0
$990.0
$782.0
$135.0
$99.0
$78.2
$177.2
11
$1,600.0
$600.0
$17,600.0
$1,917.0
$990.0
$927.0
$145.0
$90.0
$84.3
$174.3
12
$1,500.0
$400.0
$18,000.0
$2,091.0
$990.0
$1,101.0
$174.0
$82.5
$91.8
$174.3