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Price Elasticity

By icedog114 Nov 09, 2008 1390 Words
Many companies in today’s business world face tremendous pressure from its shareholders to maximize profits. Those companies are forced to find ways to maximize revenues from sales and minimize the costs of doing business. One way to determine the correct pricing for a product would be to use the concept of elasticity of demand. This paper will look at elasticity and the factors that go into calculating it, and describe how using elasticity could help Apple Inc. (Apple) maximize its revenue from the iPod. Finally, this paper will describe how a change in consumer income will affect the overall demand for iPods. Price elasticity is a tool designed to identify the overall change in demand or supply of a product compared to the overall movement of price. For the sake of this paper, we will focus on the overall change in demand from consumers. Elasticity is calculated by creating a ratio of the percentage change in demand of a good compared to the percentage change in price. If the percentage change in demand is greater than the percentage change in price, the product would have a ratio of more than 1, and would therefore be considered elastic. If the ratio were greater than 1, that product would then be considered inelastic, as the percentage change in demand was less than that of the percentage change in price. For example, if a product were to increase in price by 10%, and the overall demand fell by only 5%, then the good would be considered inelastic. If a 10% rise in price caused a 20% fall in demand that same good is elastic (McConnell & Brue, 2004). Since Apple released the first iPod in 2001, the product has served as one of its iconic products (Hormby & Knight, 2005). Facing the ultimate objective of increasing revenue, Apple continually addresses option of changing the price of the current generation iPod. Elasticity of demand helps Apple evaluate whether or not the iPod would increase or decrease revenue if Apple were to change its price. If the iPod was elastic, then a decrease in price would produce a relatively larger increase in demand. This would lead to increased revenue. If Apple were to raise the iPod’s price, then a higher percentage of customers would not purchase the product, leading to less revenue. Conversely, if the iPod was inelastic, it would be a rise in price that would create more revenue, as the price increase would overcome the relative decrease in demand. A decrease in its price would lead to an increase in demand but not enough to overcome the revenue from a lower price. For Apple, the use of price elasticity of the iPod could help realize a potential increase in revenue by changing its price, assuming that the iPod is incorrectly priced at the moment. Before Apple decides whether or not to change the iPod’s price, the company needs to consider its place in the market through market research. Apple must survey the market by having direct interaction with the people they believe will buy the product. Proper market research should include a survey of prospective customers, plenty of government data about consumer trends, and research of the equilibrium price (Tozzi, 2008). Because Apple offers “innovative integrated digital lifestyle solutions” and is the only company in the personal computer industry that completely controls the designs and development of its products, the company is often identified by consumers as a company at the leading edge of technology (Apple Computer, Inc. Overview, 2008, p. 21). By creating this reputation, Apple was able to establish itself as the preferred brand by many consumers. Apple is holding the position of the market leader in a market of monopolistic competition, which makes the iPod more inelastic, as few people would switch to another producer in the event of a price increase. Therefore, raising price successfully is easier for Apple than for the competition in this market environment (Apple Computer, Inc. Overview, 2008). However, risk factors must also be taken into consideration when deciding whether or not to change prices. Just because a company raises or lowers its prices, it cannot assume that the demand would perfectly correspond to the estimated elasticity and anticipated results. These risks include business risks, competition, and the economy in general. If Apple considered the iPod to be elastic and lowered its price to gain a larger increase in demand the state of the economy and consumers’ disposable income could lead to a less-than-expected rise in demand for the iPod. The price change would then decrease overall revenue rather than increase it. Competition plays a huge role in demand. Demand for the iPod is continuously influenced by the introduction of new competing products. Knowing what competing products are in the market, the prices of competitors’ products, and the current supply and production capabilities of its competitors can all be used to make a quality decision regarding price-setting and changes. Many producers currently exist in today’s digital music industry. These producers have introduced much lower prices, with some as low as $39 in newspaper ads. To respond, Apple has recently decreased the price of its most simple iPod version, the Shuffle, to just $47.99 (, 2008). If Apple were to introduce new, innovative changes to the iPod that exceeded the competition’s products, Apple could potentially entice the competition’s consumers to switch to the iPod, and maybe even pay a higher price (if the benefit of the upgraded performance were to outweigh the increased cost). One compelling feature that iPod consumers are currently missing is the integrated Bluetooth connectivity. In the past, Apple already released new iPod models successfully by customizing the product to meet customer needs, for example, by introducing the iPod nano. Apple could use a similar approach to improve the original iPod by adding Bluetooth features and raising the price respectively. Although other companies are already offering Bluetooth periphery for the iPod, Apple consumers usually prefer to use original Apple products when available. Apple could use this high level of brand loyalty to its advantage (Reppel, Szmigin, & Gruber, 2006). Competitor innovations, such as the introduction of a new music download model (Associated Press, 2006), and price changes could also impact the price level for Apple. If a new product were introduced that clearly outperforms the iPod, and is competitively priced to the iPod, Apple would need to consider lowering its iPod prices in an attempt to keep its customers. The same situation would exist if a competitor used an innovative technology to reduce manufacturing costs, which would lower the price the competitor charged. With all these factors taken into consideration, we believe that the iPod is in a very stable, somewhat inelastic position in the market. With its product diversity and leading technology, and its large, loyal customer base, we foresee that an increase in consumer income would produce a relatively larger increase in demand for the iPod. In other words, if consumer income rose by 10%, disposable income would also rise, shifting the demand curve out. Because the demand curve is inelastic, a 10% shift in income would create a shift in demand greater than 10% (McConnell & Brue, 2004).

Apple Computer, Inc. Overview. (2008). Retrieved July 17, 2008 from MarketLine Business Information Center database. (2008). iPod Classic. Retrieved July 17, 2008, from
Associated Press (2006, September 29). Zune gives iPod competition. Chicago Tribune, 68. Retrieved July 17, 2008, from Chicago Tribune database. Hormby T., & Knight, D. (2005). A History of the iPod: 2000 to 2004. Orchard.

Retrieved July 17, 2008, from
McConnell, C.R., & Brue, S.L. (2004). Economics: Principles, problems, and policies
(16th ed.). [University of Phoenix Custom Edition e-text]. New York: McGraw-Hill. Retrieved July 17, 2008, from University of Phoenix, MBA/501 – Forces Influencing Business in the 21st Century website.

Reppel, A. E., Szmigin, I., & Gruber, T. (2006). The iPod phenomenon: identifying a market leader’s secrets through qualitative marketing research. Journal of Product & Brand Management , 15(4), 239-249. Retrieved July 17, 2008, from Emerald database. Tozzi, J. (2008, Januar 10). Market Research on the Cheap;

Business Week Online, p.NA. Retrieved July 18, 2008, from General OneFile via Gale.

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