Question

Applying Economic Concepts Suppose the company that runs concession stands at a local sports arena wants to increase revenue on sales of soft drinks. The manager believes the only solution is to charge higher prices. As a business consultant, what advice would you give the manager? Use economic thinking to support your answer.

Short answer

Consider price elasticity; raising prices might reduce demand. Explore strategies like bundling instead.

Step-by-step solution

Define the Economic Problem

The company's goal is to increase revenue from soft drink sales. The manager believes raising prices might solve this.

Understand Price Elasticity of Demand

Price elasticity of demand refers to how sensitive the quantity demanded is to a price change. This concept is key because it affects how a change in price will impact revenue.

Analyze Price Elasticity Impact

If soft drinks are elastic (a large change in demand with a small change in price), raising prices could lead to a decrease in total revenue. If they're inelastic (little change in demand with large price changes), revenue might increase.

Consider Substitution Effect

People might switch to cheaper alternatives, like water or non-soft drink options, if the price of soft drinks rises, impacting expected revenue increases.

Suggest Possible Strategies

Advise the manager to conduct market research to gauge elasticity. Other strategies could include bundling deals or promotions to increase sales volume without changing prices.

Key concepts

Economic Problem

The economic problem faced by the concession stand company is centered on their desire to enhance revenue from soft drink sales at a local sports arena. This is a classic economic problem where the business must decide the most effective approach to increase income.

The manager initially considers the straightforward solution of raising prices. However, economic thinking suggests that the relationship between price changes and revenue is more complex. Price elasticity of demand helps in understanding this relationship as it measures how the quantity demanded of a good responds to changes in price.

To address this economic problem, it is essential for the company to gather data on consumer preferences and behavior. This data can help determine whether their product has elastic or inelastic demand, thus guiding them towards a more informed pricing strategy.

Substitution Effect

The substitution effect plays a crucial role in consumer decision-making. It's essential for the manager to understand how price changes might push customers towards alternative goods.

When prices for soft drinks increase, consumers may look for cheaper substitutes like bottled water, juice, or other non-carbonated beverages available at the arena. This shift in consumption can significantly impact sales, leading to an unintended decrease in revenue despite higher pricing.

Therefore, understanding customer preferences and potential substitution trends is crucial for making informed pricing decisions. The company might consider diversifying their product offerings to include popular substitutes at competitive prices or enhance the value proposition of their current offerings to minimize the impact of the substitution effect.

Revenue Strategy

Developing a revenue strategy requires a balanced consideration of price elasticity and the substitution effect. Here are some strategic steps:

• Market Research: Conduct in-depth research to understand the elasticity of demand for soft drinks. This involves collecting data on past sales reactions to price changes.
• Promotional Tactics: Explore options like bundling soft drinks with snacks or offering promotions such as 'buy one get one free' deals. These tactics can boost volume sales.
• Value Addition: Enhance the attractiveness of soft drinks through added value, such as offering exclusive collectible cups or tied experiences with the purchase.

By integrating these strategies, the company can aim to maximize revenue while maintaining a loyal customer base. Applying such comprehensive strategies allows for effective revenue optimization beyond mere price adjustments.