ECON 5003 Module 2 Pricing Analysis Example

Eight Dollars a Yard and Two Elasticities: Using Cost and Demand to Price a Standard Residential Concrete Mix

Student Name

American College of Education

ECON5003: Economics Analysis

Module 2 Assignment

Instructor Name

July 10, 2028

The Product and the Proposal

Bellwether Ready-Mix, the composite producer from Module 1, sells about 180,000 cubic yards a year of its standard 4,000 psi residential mix, used for foundations, slabs and driveways, at a delivered price of $158 per cubic yard. Module 1 found that Bellwether has moderate pricing power in the residential segment, where its dispatch reliability sets it apart, but that its largest rival acts as the market's price leader. The sales director proposes raising the residential price by $8, to $166, about 5.1 percent, ahead of the spring building season. The question is whether the increase would raise profit, and the answer requires both costs and demand. A price increase is profitable when the margin gained on every yard sold exceeds the margin lost on every yard not sold.

Variable Cost and Contribution

The relevant costs for a pricing decision are those that change with each additional yard. For a cubic yard of the standard mix, cement costs about $45, based on about 560 pounds of cement at Bellwether's current delivered cost; aggregates cost $24; admixtures cost $6; delivery costs that vary with loads, including driver wages paid by the hour, fuel and truck wear, cost $36; and plant costs that vary with output, mainly energy and water, cost $7. Variable cost is therefore about $118 per yard, and contribution margin at the current price is $40, or 25.3 percent of price. Fixed costs, such as plant depreciation, salaried dispatch staff and insurance, do not change with the price decision and are excluded.

Annual contribution from the residential mix is therefore about $7.2 million. At $166, contribution per yard would rise to $48.

How Much Volume Could Be Lost

The break-even volume change is the percentage of volume the company could lose and still earn the same total contribution. It equals the price change divided by the new contribution margin: $8 divided by $48, or 16.7 percent. If the increase costs Bellwether less than 16.7 percent of its residential volume, profit rises; if it costs more, profit falls. This single number turns the question from an abstract debate about demand into a specific test: is a 5.1 percent price increase likely to cost more or less than 16.7 percent of volume?

The answer depends on the price elasticity of demand Bellwether faces, the percentage change in quantity for a 1 percent change in price. At 5.1 percent, the increase would break even at an elasticity of about 3.3 in absolute value. Below that, it pays; above it, it does not.

Two Elasticities From the Company's Own History

The market elasticity for ready-mixed concrete is low. Concrete is a small share of a building's cost and has few substitutes for structural work, so a general rise in concrete prices barely changes how much concrete is used. But Bellwether does not face the market elasticity; it faces the elasticity of demand for its concrete, which depends on whether customers can switch to rivals. Bellwether's own history offers two estimates. Two years ago, it raised its residential price by about 3.9 percent while its rivals held their prices for three months; its residential volume in that period fell by about 14 percent against the prior year, adjusting roughly for housing starts, which implies a firm elasticity of about 3.6. Last year, the price leader announced a 5 percent increase and all producers followed within a month; Bellwether's volume fell about 2.5 percent, an elasticity of about 0.5.

Both estimates are rough. Each rests on one episode, and other things changed at the same time. But the difference between them is large and consistent with economic reasoning: when rivals do not follow, customers switch; when they do, customers have nowhere to go.

The Profit Effect Under Each

If rivals do not follow and Bellwether faces an elasticity of 3.6, a 5.1 percent increase would reduce volume by about 18.2 percent, to about 147,200 yards. Contribution would be about $7.07 million, roughly $135,000 less than today. If rivals follow and the elasticity is about 0.5, volume would fall about 2.5 percent, to about 175,400 yards, and contribution would rise to about $8.42 million, a gain of about $1.22 million.

The Lerner index offers a cross-check. Lerner (1934) showed that a profit-maximizing firm sets its markup over marginal cost so that the markup as a share of price equals one divided by the absolute value of the elasticity it faces. Bellwether's current margin of 25.3 percent corresponds to an elasticity of about 4.0; if its true firm elasticity when acting alone is about 3.6, the optimal margin would be about 27.8 percent, suggesting modest room to raise prices even without rivals following, but less than $8.

What the Numbers Leave Out

Three considerations sit outside the calculation. First, customer relationships. Residential builders who switch to a rival after a price increase may not return when prices equalize, because they build relationships with dispatchers and drivers. The 14 percent volume loss two years ago recovered only partly after rivals raised their prices, which suggests that some of the elasticity reflects lasting switching rather than a temporary shift. A one-period calculation understates the cost of losing customers.

Second, the cost side is moving. The integrated rival, which supplies most of Bellwether's cement, has told customers to expect a cement price increase of about $10 a ton in the spring, which would add about $2.80 to the variable cost of each yard of the residential mix and reduce contribution to about $37 at the current price. Part of any price increase would therefore only restore the current margin. Third, timing in the construction cycle matters. Collard-Wexler (2013) found that demand swings strongly influence the number of producers in local ready-mix markets, with entry following booms. Raising margins near the top of a strong building cycle invites an entrant; the residential market in Bellwether's area is currently growing, which is a further reason for caution about a large independent increase.

Recommendation

The analysis supports a conditional recommendation. Bellwether should not raise its residential price by $8 on its own initiative, because, if rivals hold their prices, the increase is likely to lose money. It should be prepared to follow promptly if the price leader raises prices, and it could justify a smaller independent increase of about $3 to $4, closer to the margin implied by its estimated firm elasticity, particularly in the eastern suburbs where Module 1 suggested its position is strongest. Whether rivals will follow a Bellwether-initiated increase is a question about strategic interaction, which the next module addresses directly. Syverson (2008) notes that prices of ready-mixed concrete vary considerably across local markets, which is consistent with local competitive conditions, not national costs, driving what producers can charge.

The sales director will also track residential volume weekly for eight weeks after any change, against housing permits, so the company learns its elasticity from better data than two episodes.

References

Collard-Wexler, A. (2013). Demand fluctuations in the ready-mix concrete industry. Econometrica, 81(3), 1003-1037. https://doi.org/10.3982/ECTA6877

Lerner, A. P. (1934). The concept of monopoly and the measurement of monopoly power. The Review of Economic Studies, 1(3), 157-175. https://doi.org/10.2307/2967480

Syverson, C. (2008). Markets: Ready-mixed concrete. Journal of Economic Perspectives, 22(1), 217-233. https://doi.org/10.1257/jep.22.1.217