Question

The publisher of a magazine gives her staff the following information: $$ \begin{array}{l|l} \hline \text { Current price } & \$ 2 \text { per issue } \\ \hline \text { Current sales } & 150,000 \text { copies per month } \\ \hline \text { Current total costs } & \$ 450,000 \text { per month } \\ \hline \end{array} $$ The publisher tells the staff, “Our costs are currently \(\$ 150,000\) more than our revenues each month. I propose to eliminate this problem by raising the price of the magazine to \(\$ 3\) per issue. This will result in our revenue being exactly equal to our cost." Do you agree with the publisher's analysis? Explain. (Hint: Remember that a firm's revenue is calculated by multiplying the price of the product by the quantity sold.)

Short answer

Yes, the publisher's analysis is correct. By raising the price of the magazine to \$3 per issue, the revenue would be exactly equal to the cost, thereby eliminating the current monthly loss of \$150,000.

Step-by-step solution

Determine the current revenue

The current revenue can be calculated as the product of the current price and the number of copies sold monthly. So for the current scenario, it can be computed as: Revenue = Current Price * Current Sales = \$2 * 150,000 = \$300,000.

Analyze the current profit/loss situation

Once the revenue is calculated, the business' profitability can be determined by subtracting total costs from revenue. For the current situation, Profit/Loss = Revenue - Cost = \$300,000 - \$450,000 = -\$150,000. Therefore, there's indeed a loss as the publisher mentioned, of \$150,000 monthly.

Compute projected revenue with the new price

Should the price rise to \$3 per issue, the new revenue can be computed as: New Revenue = New Price * Current Sales = \$3 * 150,000 = \$450,000.

Compare the projected revenue with total costs

With the new pricing, the profit/loss would be: Profit/Loss = New Revenue - Cost = \$450,000 - \$450,000 = \$0. This means the publisher's analysis was correct – the new price would indeed make revenues equal to costs.

Key concepts

Revenue Calculation

Understanding revenue calculation is crucial in managing any business effectively. In the context of the magazine exercise, revenue is derived from multiplying the selling price of a product by the quantity sold. Specifically:\begin{align*}\text{Revenue} &= \text{Price per Issue} \times \text{Number of Copies Sold}\text{For the current price} &= \(2 \times 150,000 \text{ copies}\&= \)300,000\text{ per month}\text{Projecting the new revenue} &= \(3 \times 150,000 \text{ copies}\&= \)450,000 \text{ per month}\text{ This simple formula is an essential tool for planning and evaluating the financials of a company. It becomes particularly important when considering changes in the pricing strategy. The anticipated outcomes can be easily depicted by running these calculations.}

Profit and Loss Analysis

To conduct a profit and loss analysis, businesses subtract the total costs from generated revenues. Considering the original scenario provided, the magazine publisher is facing a loss:\begin{align*}\text{Profit/Loss} &= \text{Revenue} - \text{Total Costs}\text{For the current scenario} &= \(300,000 - \)450,000\&= -\(150,000 \text{ (which signifies a loss)}The possibility of reversing the loss relies on altering the factors controlling revenue and costs. By proposing an increase in the price per issue, the publisher projects a scenario where:\begin{align*}\text{New Profit/Loss} &= \text{New Revenue} - \text{Total Costs}\&= \)450,000 - \(450,000\&= \)0This analysis implies a break-even situation where the company no longer suffers losses. However, this does not consider potential changes in demand due to the price hike, which could lead to a different outcome.

Pricing Strategy

A pricing strategy is a complex consideration that goes beyond just matching costs with revenues. Price increases can lead to variations in consumer demand—a concept known as price elasticity of demand. In the example of the magazine publisher:

Before the Price Increase

• Price: \(2 per issue
• Demand: 150,000 copies sold per month

After the Price Increase

• Proposed Price: \)3 per issue
• Projected (but uncertain) Demand: 150,000 copies

While the publisher assumes that demand will remain constant, a price increase typically leads to a drop in quantity demanded. It is important to understand consumer sensitivity to price changes and anticipate the potential for decreased sales volume. The ideal pricing strategy would carefully weigh this alongside the objectives of revenue maximization and market competitiveness. An accurate profit and loss forecast relies on understanding the elasticity of the product, and the publisher's proposal might be over-simplistic if demand elasticity is not taken into account.