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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.



 

 

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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

E Parameters

None, will pay anything, numerator is  zero.

Perfectly Inelastic

E = 0

Small

Inelastic

0 < ED < 1

Q demanded and P change same percentage

Unitary Elasticity

ED = 1

Large

Elastic

1 < E <

Infinitely Large, price doesn't change, denominator is zero

Perfectly Elastic

E 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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       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

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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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