Exercise 4-2: Elasticity and Revenue

This week's Exercise is about the relationship between demand elasticity and total revenue. I found an interesting article, about the demand elasticity of hotel rooms. See article on hotelnewsnow.com here.

A study conducted by the Hospitality Sales and Marketing Association International found that discounted hotel room rates do not stimulate enough additional demand to make up for the rate reduction.

In the article, there aren't too many actual numbers available, so I have made up some fictional numbers to graph and demonstrate the situation described in the article.

I have assumed that there are 1000 hotel rooms available at a certain location. As suggested in the article, if a hotel room would cost $1, everyone would suddenly want to stay in a hotel and demand would exceed the 1000 available rooms. Therefore, total revenue would be $1000 at a room price of $1, since every single room would be occupied.

The study found, that demand for hotel rooms is fairly inelastic. This means, as hotel room prices drop, demand doesn't raise significantly. Unless, of course, it comes to the $1 a room extreme. This conclusion tells us, that customers often don't have too many substitutes available. If a business men is on a business trip, chances are he doesn't know anybody in the city he has to stay in, and he probably doesn't want to sign a lease agreement or buy a house for just a couple of days... Most likely renting a camper or using a tent is also not a very convenient option either. So at the end of the day, a hotel room is his only option, at whatever rate the hotels currently charge.

I have assumed the following demand and prices:

Price: Demand:

$50 600

$100 590

$150 580

$200 560

$250 530

$300 490

$350 450

$400 410

$450 380

$500 10

These graphs show the total revenue at the different price and demand levels I have used above:

This graph shows us, that if my assumptions would be true, the hotels total revenue would increase as hotel rates increase, since demand is inelastic up to the point of around $450 per room. If hotels would be charging above the $450, demand drops.

A possible reason could be, that customers would rather rent a car and stay in a city a couple hours away from our "test region". Or now, customers rather sign an apartment lease agreement for a month, than staying in hotel for the price of $450 a night.