Price Elasticity of Demand and Total Revenue - Assignment Example

Price elasti of demand and Total Revenue Number Price elasti of demand and Total Revenue Demandand supply are at the center of the decision by Nobody University to increase the tuition fee. Assessing the two factors shows that the university prefers to change its pricing policy in order to reclaim the resources spent in the investment. Although, supply and demand can be tracked by observing price elasticity, that is not always the case. In the unique case of Nobody University, increasing the tuition has been arrived at despite the pointers showing the demand for the services is at its low of 1:2 possibly because the price skimming strategy would provide more attractive returns on investment. This implies the university wants to obtain as much finances as it can (total revenue) from the fewer students who are expected to enroll for the services. By doing so, the university would have settled all the expenses it incurred to provide the services in the first place. Price elasticity and total revenue As Beattie and LaFrance (2006) suggested, by choosing to increase the tuition fees, the university is likely to be engaging in price skimming in order to obtain maximum revenue. This is a pricing policy in which an organization sets a fairly high price for a good or service at its inception then reduces it over time (Bailey, Olson, & Wonnacott, 1980). It is a transient strategy of price discrimination quicker offsetting of potential losses. The strategy would allow Nobody University to reclaim its lost expenditure faster before competition from other similar institutions sets in and forces the market price downward for tuition services. Feess and Schumacher (2013) noted that price skimming may be used interchangeably with scaling down the demand curve. The institution’s main objective of implementing the strategy is to capitalize on the consumer surplus ahead of time so as to reap major benefits of the monopoly or the innovators’ poor price sensitivity. As such, Nobody University is likely to be a new institution that seeks to obtain the highest return on investment through its higher price strategy at its inception before normalizing the fee for a higher demand for learning. As Bailey, Olson and Wonnacott (1980) argued, meeting the demand of the first group of students will likely trigger the university to reduce the fee to entice another segment that is more concerned about fairer pricing. As Feess and Schumacher (2013) suggested, the university pricing strategy is theoretical in the sense that it is almost unlikely for the approach to turn the entire surplus of students into clients, despite its major potential impact on market segmentation. The pricing strategy is likely to work for Nobody University when the tuition services are dictated by inelastic demand, which implies that the quantity of the services demanded does not increase or decline sharply in response to varying tuition fees levied by other universities operating in the same market area. While the changes in the tuition fee could be inelastic if the university was new in the market and thus enjoys a monopoly of similar services, a reputable university can potentially maintain an inelastic demand for the services it offers despite the existence of lesser competitors (Feess, & Schumacher, 2013). Greater return on investment In such a scenario, Nobody University would still earn fewer but, a consistent number of new enrolments, irrespective of its high tuition charges. In this case, the price elasticity of demand and total revenue is dependent on several factors: firstly, the pricing strategy is mainly guided by the need for greater returns on the resources allocated to ensure the success of the tuition program. Charging more as the university rolls out the services would help it recoup any expenditures on research and development (R&D) as well as costs of advertisement (Feess, & Schumacher, 2013). Although the strategy is common in technology firms like Apple where a new product is delivered in the market at a higher price to generate high profits in the short term, the university’s initial higher tuition fees may be justified by the major leaps which the institution has made in equipping the lecture halls with high technologies, for instance, to aid easier learning. Beattie and LaFrance (2006) noted that the benchmark for high pricing for commodities any organization is triggered by the heavy investment in the development of a quality service or product that outshines competitors. The competitive edge then enables the innovator to enjoy the freedom to attach a higher price tag to it so as to reclaim the bulk of resources invested to generate it. Secondly, the higher pricing despite fewer enrolments for tuition would help in establishing and keeping the brand reputation of the university high (Feess, & Schumacher, 2013). This way, the university would also create the impression that the tuition services are of a high quality and the lucky few who are enrolled already would be better placed to enjoy a higher social status in society. As such, the higher tuition fees, especially for new services would enable the university to create a vital brand reputation that really attracts status weary students, and consequently give the university management team the opportunity they need to reduce tuition fees as market rivals prepare for competition. By contrast, Nobody University may have opted to raise the tuition fees because economic indicators show that any upward adjustments of the same may be impossible in future, without ceding sufficient enrolments. As such, the likelihood of obtaining total revenue would be lost, hence the need to reclaim the cost early enough. Third, the pricing strategy is likely to work for the university by segmenting the education market and thus attract sustainable demand and supply of the services. Feess and Schumacher (2013) said high pricing works effectively to segment virtually any customer base. This would technically allow the organization to generate the highest possible gains from various categories of clients as the prices come down. By beginning with a higher tuition fee, the early students will be more willing to pay higher for potentially quality services and as the university lowers the fee over time it will be more attractive to lesser-endowed segments of the society, who mainly constitute price sensitive clientele. As Beattie and LaFrance (2006) noted, when the university strategy subsequently creates lower prices in response to the demand curve of the product, but keep it at the highest level where many students are ready to pay, the institution could capture a substantial chunk of the student surplus and thus generate total revenue following the positive externality. Lastly, early enrollments would enable the students to test the quality of the services and act as marketing agents. Bailey, Olson and Wonnacott (1980) noted that early adopter students are important to the organization as they would provide the testing ground for the new services. Granted, the first status conscious students that enroll for the innovative classes could provide important feedback and assist the university to correct potential areas of weakness before the subsequent update and thus capture the interests of a broader client base. This would make future clients less vulnerable to swaying, which the organization would consider as a negative externality. Aside from being important testers, early students who prefer the services can play the role of brand marketers that create an impression of quality through their physical interactions with potential clients in the market. The resulting free advertisement would persuade the new clients to enroll for the tuition services when the price comes down. Despite the benefits of price skimming for Nobody University, there are potential pitfalls that could push the institution out of the market. Firstly, the strategy may not be as useful in an environment where there is elasticity of demand. Secondly, the strategy may not be so effective in an environment where there are many other universities offering similar services. This is because having too many rivals in the market implies the demand curve is relatively elastic, and higher opening prices would send clients and prospects running in the direction of other universities providing more competitive pricing for similar services. Lastly, the strategy would attract and or embolden competitors in an already established market and thus limit the chances of the university to gain total revenue from the business (Feess, & Schumacher, 2013). Conclusion Generally, by increasing its tuition pricing, Nobody University may benefit or lose a substantial chunk of its return on investment to positive or negative externalities respectively. While raising the tuition fee could enable the university to obtain total income and hence recoup its investment in the services, the impacts are dependent on positive externalities including consumer impression of a quality services, a strong brand and low competition. By contrast, negative externalities such as stiff competition and the impression of a lack of value for the money may conspire with the fewer enrolments to prevent the effective realization of maximum returns on investment for the university. As such, the university should conduct a proper market research to establish the negative externalities and find appropriate ways of dealing with them before skimming the tuition fees. References Bailey, M. J., Olson, M., & Wonnacott, P. (1980). The marginal utility of income does not increase: Borrowing, lending, and Friedman-savage gambles. The American Economic Review, 70(3), 372. Beattie, B. R. & LaFrance, J. T. (2006). The law of demand versus diminishing marginal utility. Review of Agricultural Economics, 28(2), 262-271. Feess, E., & Schumacher, C. R., (2013). The elasticity of demand for wagering in an unregulated market. Applied Economics, 45(15), 2083-2090. Read More