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Chapter 19 Elasticity of Demand
Affects Total Revenue
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I. Special Notes
A.
Math Review is a short dynamic review of basic math skills for
microeconomics from R. L. Reynolds of Boise St. University.
B. Some may want to review supply and demand principles explained
in
Chapter 4.
C.
McConnell Economics Books, including the 18th edition,
are one of many source of material included in this chapter.
D.
Our
Current Events Internet Library
has an interesting economics
section.
II. Elasticity of demand measures the responsiveness of quantity
demanded to changes in price, income, and the price of
related goods. |
III. Price elasticity of demand
A. Price elasticity of
demand measures the effect of price changes on
quantity demanded.
B. Sometimes a price increase causes quantity
bought to decrease significantly, other times not so much.
1. High airfares for a
luxury vacation may cause you to vacation locally.
2. High coffee prices
for people who think of coffee as a necessity may not change quantity demanded
very much.
C. The more quantity changes because of a price
change, the more elastic is demand.
1. Relative change will
be measured as a one dollar change at higher prices is not as significant as at
lower prices.
2. An easy way to measure
relative change is to use percent change.
D. Elasticity of demand is
important because it predicts what may happen to total revenue received when
a company
changes the price
of a product.
E.
Elasticity
from Samuel L. Baker, Ph.D. of the University of South
Carolina provides problems to help with the understanding of elasticity.
F. Elasticity can be measured
quantitatively.
1. The
Coefficient of elasticity of demand for product x
measures its price elasticity.
2. Delta,  ,
means change.
F. Elasticity can be measured
quantitatively.
1. The
Coefficient of elasticity of demand for product x
measures its price elasticity.
2. Delta, ,
means change.
Other Free
Business Stuff
|
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G. A demand schedule has more than one elasticity of demand. |
|
Demand Schedule |
| Price |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
| Quantity |
9 |
8 |
7 |
6 |
5 |
4 |
3 |
2 |
| Total Revenue |
18 |
24 |
28 |
30 |
30 |
28 |
24 |
1 |
|
P goes from 4 to 5 and Q from 7 to 6. |
P goes from 5 to 6 and Q from 6 to 5. |
P goes from 6 to 7 and Q from 5 to 4. |
|
Note: A down sloping demand curve is yields a negative ED.
Its sign is often ignored. |
|
|
|
H. Interpreting Elasticity of demand |
|
|
|
Relative Change in Quantity |
Terminology |
ED Parameters |
|
None, will pay anything, numerator is zero. |
Perfectly Inelastic |
ED = 0 |
|
Small |
Inelastic |
0 < ED < 1 |
|
Q demanded and P change same percentage |
Unitary Elasticity |
ED = 1 |
|
Large |
Elastic |
1 < ED <  |
|
Infinitely Large, price doesn't change,
denominator is zero |
Perfectly Elastic |
ED is undefined, can't divide by zero. |
|
1.
Virtual Economy
from
Buz\ed
has an elasticity calculator.
2.
Elasticity
II provides practice measuring ED.
From Samuel L. Baker, Ph.D. of the University
of South Carolina |
IV. Graphing and
Interpreting price elasticity of demand
| A. At the Extremes 
|
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contains practical real-world applications of breakthrough discoveries
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These Notes are from
Macro and Microeconomics Quick Notes which are now Free at the
Economics
Internet Library.
|
B. Total Revenue along a linear demand curve
 |
A. Moving from left to right on the bottom
graph indicates what happens to
total revenue
as price is lowered and the quantity sold increases.
B. At lower quantities (higher prices) demand is elastic.
Quantity increases
are relatively greater than price decreases
and total revenue increases as
more units are sold.
C. This means a company facing an elastic demand can increase revenue
by
decreasing price. An important question to be answered concerns
what happens
to costs when a lower price causes more units to be
sold.
D. When demand becomes inelastic, quantity increases are
now relatively less
than price decreases, and total
revenue falls.
E. This means a company could increase total revenue by
increasing price
and selling fewer units. This could
mean a very high profit. Important
questions to be answered concern
how competitors react to these
higher prices, can the
company produce lower quantities at reasonably
low
costs, exactly how much profit will the company
make, and how
will the government react to these higher
profits.
F. The Total Revenue Test
1. When demand is elastic, price and total revenue move
in the opposite direction.
2. When demand is inelastic, price and total revenue
move in the same direction.
3.
Econ Concepts in 60 Seconds Video has a graphic explanation. |
|
Summary Elasticity of Demand and Total Revenue |
|
|
|
When Price Increases |
Total Revenue |
|
ED >1 |
Somewhat
Elastic |
Quantity Changing a Lot so you could
lose lots of money. |
decreases |
|
ED = 1 |
Unitary
Elasticity |
Quantity/Price Changing Same % |
no change |
|
ED <1 |
Somewhat Inelastic |
Quantity Doesn't Change Much, so you
could make lots of money |
increases |
|
We need to understand cost production to understand making a profit. |
|
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V. What Determines Elasticity of Demand
|
Product Characteristics |
Elastic Demand |
Inelastic Demand |
Read Business Book Summaries to Save Time
 |
|
Number of substitutes |
Many |
Few or none |
|
% of purchaser's budget |
High |
Low |
|
Type of good |
Luxury |
Necessity, Emergency |
|
Time until purchase |
No hurry |
Required quickly |
|
Examples |
Steak, Vacations |
Salt, Bread |
VI. Application
A. Various research methods are used
to calculate price elasticity:
1.
Test markets
2.
Analysis of historical sales data
B.
Selected income
elasticity's
1.
Automobiles 2.46[40]
Books 1.44 Restaurant Meals 1.40
Tobacco 0.64 Margarine -0.20
2.
View
a table containing elasticity of demand approximations presented by the
MACKINAC CENTER FOR PUBLIC POLICY.
3. Income
elasticity's are notably stable over time and across countries.[41]
C. Price Elasticity and Government
Actions
1. High
farm yields for crops with an inelastic demand cause farmers to lose money as
people don't eat a lot more so we have a federal farm program.
2.
Excises taxes increase price so the governments puts them on inelastic goods
like tobacco, alcohol, and jewelry.
a) Drugs could be next and profit will be determined by price elasticity of demand
for drugs (How Inelastic is it?),
law enforcement savings, and the cost of helping new addicts?
b)
Econ Concepts in
60 Seconds Video on Analyzing Taxes Practice
VII. Income elasticity of demand
is the % change in quantity demanded divided by the %
change in income.
A. Income elasticity is positive for normal (superior)
goods such as steak and vacations - more is
purchased as income
increases.
B. Income elasticity is negative for
inferior
goods such as bread and hamburger - less is purchased
as
income increases.
C. In times of recession,
income elasticity determines loss in revenue by producing firms.
D.
YouTube - Income Elasticity of Demand
E. Visit
Income
Elasticity of Demand from tutor2u for more information.
IX. Cross elasticity of demand is the % change in quantity demanded
divided by the % change in the price of a substitute or complement.
A. Cross elasticity is positive
for goods that are substitutes (price of hot dogs up,
quantity of hamburger sold up).
B. It is negative for goods
that are complements (price of hot dogs up, quantity of hot
dog rolls sold down).
C Near zero for independent
goods (peanuts and grapefruit)
C. Visit
Cross
Price Elasticity of Demand from tutor2u for more information.
X. Price elasticity of supply
is the % change in quantity supplied divided by the %
change in price.
A. It is a function of how factor costs
change as more is produced and the passage of time.
B. If costs (factor prices such as wages
and rent) change little as more is offered for sale at higher selling prices
then profit potential is high and supply will be
elastic.
C. Supply elasticity also increases with
time as companies have more time to adjust to higher costs.
1. Unusually high
demand for tomato's or the Chrysler PT Cruiser take time to produce and supply is
inelastic.
2. Gateway may be
able to increase the number of a new popular model computer quickly and supply
is more elastic.
D. Gold production is costly and takes time so
price is volatile because of frequent demand changes.
E. Visit
Price
Elasticity of
Supply
from tutor2u for more information.
XI. Economic Surplus of consumers and producers
is explored in the next chapter.
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