Impact of Elasticity of Demand on Price in the Earphone Market

Impact of Elasticity of Demand on Price in the Earphone Market

Introduction

There are an estimated 1.5 million persons in China who experience some form of a broken earphone (mobile phone, MP3, MP4, etc), yet only 8000 opt to change a new and high quality earphone. The market penetration for earphone-calculated as the number of earphone users divided by the number of persons with a broken earphone—is about 53.3% (0.8/1.5).

Why people don't want to have a new or high quality earphone? The answer is the price, people usually think that high quality equals to a high price. Price represents one attribute that consumers evaluate when purchasing a product or service. In fact, price plays one of two roles in the purchase decision process for consumers. First, consumers might use price as a measure of product quality. That is, when quality is associated with higher prices, price can become an incentive to buy (like Ferrari). Alternatively, consumers might buy more of a product at lower prices and less at higher prices, all other things being equal. The purpose of this paper is to take a company (which sell earphones) as an example to introduce the concept of price elasticity of demand to the readers.

The earphone company is one of biggest earphone manufacturers in China. Their main product concept is selling a high quality and well design earphone, including mobile earphone, Mp3 (or Mp4) musical earphone and other kinds of earphones.

Elasticity and Its Characteristics

Price elasticity of demand measures the sensitivity of consumer purchasing behavior when price is raised (or lowered) by some percentage and the corresponding percentage decrease (or increase) in quantity demanded. The relationship between price and quantity is shown in Figure 1.

Figure 1.Price and quantity are inversely related.

Elasticity is calculated as:

As a rule, when the absolute value is bigger than 1, the demand curve is elastic, suggesting that consumers are more responsive to price changes. On the other hand, when the absolute value is less than 1, the demand curve is inelastic, indicating that consumers are less responsive to price changes. An example of how this equation can be used in earphone pricing is given in the next section.

Figure 2 and 3 are examples of price elasticity of demand functions. Point A, in Figure 2, shows that this business is dispensing 150 earphones monthly and yielding total revenue of $40,000. The company wants to increase revenue by $2,500—resulting in total revenue of $42,500 (Point B) —by reducing the number of units sold by 25 to 125 units. The percentage changed in price (%⊿P)