General Information about Elasticity
Elasticity is the key economic concept that has a significant impact on companies’ profitability and overall performance. According to Hayes (2021), “in business and economics, elasticity refers to the degree to which individuals, consumers, or producers change their demand or the amount supplied in response to price or income changes” (para. 1). Price elasticity of demand may be defined as the connection between changes in the product’s price and its demanded quantity (Hutchinson, 2017). Generally, if a company increases the price of its goods or services, it may be expected that the demand reduces, and vice versa.
Researchers note that “when the value of elasticity is greater than 1.0, it suggests that the demand for the good or service is affected by the price” (Hayes, 2021, para. 3). At the same time, “a value that is less than 1.0 suggests that the demand is insensitive to price, or inelastic” (Hayes, 2021, para. 3). If a product’s demand changes significantly after its price fluctuates, this product is elastic. On the contrary, inelastic goods and services have their demand almost unchanged when the price decreases or grows.
General Information about the Markup Rule
The Markup rule is a special economic concept that explains particular pricing decisions made by companies. According to this rule, an organization that has market power charges a price that equals a markup over its marginal cost, which in turn is equal to one over one minus the price elasticity of demand inverse. When choosing output to sell quantity, firms that maximize their profits equalize their marginal costs to marginal revenues. As a result, the markup rule is applied – it states that the market power extent defines a company’s ability to price its products or services over their cost. At the same time, this rule has to consider the price elasticity of demand.
Analysis of Netflix Elasticity
Since 1997, Netflix, Inc. has been one of the most famous and successful American production companies and content platforms. However, now there are several rather quality substitutes for this company, which affects its profitability and performance. For example, Hulu, Amazon Prime, Time-Warner, Comcast, and AT&T compete for the same clients, and pricing is a significant component in this competition. Though Netflix’s services are not a necessity but a luxury, during the global pandemic, more and more people began using this platform as a primary source for entertainment. This had a significant influence on the company’s profitability.
In 2011, there was a tremendous increase in subscription prices – Netflix customers had to pay about sixty percent more every month (Wingfield & Stelter, 2011). Despite the fact that all clients were against such changes, the company made this risky choice because they needed money to expand and upgrade their library content. Although that decision resulted in a major loss of subscribers, it was temporary. After expanding their production of original movies and series, Netflix gained more customers, which means that this company perceives price elasticity as a prospect, not a risk. Thanks to increasing their prices, the platform gained an opportunity for development and expansion, as well as achieving increased earnings and stock.
From the data mentioned above, it is possible to suggest that the connection between price and demand for the platform’s services used to work both ways. For instance, if Netflix decided to increase subscription prices again, there would be another decrease in the number of its clients. People would go to other platforms that offer the same services at a lower price. Simultaneously, in case there was a reduction in prices, Netflix would attract more clients. Therefore, these actions would allow the company to make its elasticity of demand higher.
Nevertheless, the high elasticity of this platform’s services is likely to be left in the past. Nowadays, more and more customers make Netflix a monthly expense in their budget and stop paying attention to the price. During the lockdown, people started perceiving streaming services as the primary entertainment source, and Netflix became the choice of most of them. Therefore, even if the company decides to increase the price for a subscription again, it is unlikely to lose as many customers as it did in 2011. At the same time, if it reduces the prices, the demand will become higher. Thus, it is possible to say that the platform’s services and the price elasticity of demand became less elastic.
Applying the Markup Rule: Netflix
Netflix is a rather competitive and successful company that has great market power. That is why, according to the Markup rule, this platform can set its service quantity and price so that marginal cost is equal to marginal revenue (Lee, 2019). This company has a relatively high markup. Though it spends too much money on its content while also having modest subscription prices, it does not lose earnings but reports profit every quarter. For instance, on the movies and series produced by Netflix, there is a thirty to fifty percent markup (Lee, 2019).
Hayes, A. (2021). Elasticity. Investopedia. Web.
Hutchinson, E. (2017). Principles of microeconomics. University of Victoria.
Lee, E. (2019). Netflix is raising prices. Here’s why. The New York Times. Web.
Wingfield, N., & Stelter, B. (2011). How Netflix lost 800,000 members, and good will. The New York Times. Web.