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16
Price Elasticity of Demand
Q = aP-b
• Categories of elasticity
• Elasticity examples
$11 0
10 2
9 4
8 6
7 8
6 10
5 12
4 14
3 16
2 18
1 20
0 22 FIGURE 5.3 Demand Curve for
Lunch at the Office Dining Room
Between points A and B, demand is quite elastic at -6.4.
Between points C and D, demand is quite inelastic at -.294.
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Refer to the figure. Using the midpoint
formula, calculate the values of
elasticity between points A and B,
and then between points C and D.
Those values are, respectively:
a. –6.4 and –0.294
b. –0.1 and –4.54
c. –0.15 and –3.40
d. –0.5 and –0.5. Elasticity is the same
for both sets of points because the
demand curve is linear; thus, the
slope of the line remains constant.
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ELASTICITY AND ITS APPLICATION 29
Cross-price Elasticity of Demand
• Categories of income
elasticity
– superior goods:
EY > 1
– normal goods:
0 ≤ EY ≤ 1
– inferior goods:
EY < 0
Availability of Substitutes
Types of Elasticity
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Price Elasticity of Demand
Types of Elasticity
Types of Elasticity
Types of Elasticity
unitary elasticity A demand relationship in which the
percentage change in quantity of a product demanded
is the same as the percentage change in price in
absolute value (a demand elasticity of -1).
D curve: P
D
vertical
P1
Consumers’
price sensitivity: P2
none
P falls Q
Elasticity: by 10% Q1
0 Q changes
by 0%
ELASTICITY AND ITS APPLICATION 57
“Inelastic demand”
Price elasticity % change in Q < 10%
= = <1
of demand % change in P 10%
D curve: P
relatively steep
P1
Consumers’
price sensitivity: P2
relatively low D
P falls Q
Elasticity: by 10% Q1 Q2
<1
Q rises less
than 10%
ELASTICITY AND ITS APPLICATION 58
“Unit elastic demand”
Price elasticity % change in Q 10%
= = =1
of demand % change in P 10%
D curve: P
intermediate slope
P1
Consumers’
price sensitivity: P2
intermediate D
P falls Q
Elasticity: by 10% Q1 Q2
1
Q rises by 10%
D curve: P
relatively flat
P1
Consumers’
price sensitivity: P2 D
relatively high
P falls Q
Elasticity: by 10% Q1 Q2
>1
Q rises more
than 10%
ELASTICITY AND ITS APPLICATION 60
“Perfectly elastic demand” (the other extreme)
Price elasticity % change in Q any %
= = = infinity
of demand % change in P 0%
D curve: P
horizontal
P2 = P1 D
Consumers’
price sensitivity:
extreme
P changes Q
Elasticity: by 0% Q1 Q2
infinity
Q changes
by any %
ELASTICITY AND ITS APPLICATION 61
ELASTICITY AND ITS APPLICATION 62
ELASTICITY AND ITS APPLICATION 63
Price Elasticity of Demand
• As price decreases
– revenue rises when
demand is elastic
– revenue falls when it
is inelastic
– revenue reaches its
peak if elasticity =1
Revenue = P x Q
Revenue = P x Q
▪ If demand is inelastic, then
price elast. of demand < 1
% change in Q < % change in P
▪ The fall in revenue from lower Q is smaller
than the increase in revenue from higher P,
so revenue rises.
▪ In our example, suppose that Q only falls to 10
(instead of 8) when you raise your price to $250.
ELASTICITY AND ITS APPLICATION 73
Price Elasticity and Total Revenue
Now, demand is Demand for
inelastic: your websites
elasticity = 0.82 P lost
If P = $200, revenue
due to
Q = 12 and
$250 lower Q
revenue = $2400.
$200
If P = $250,
Q = 10 and D
revenue = $2500.
When D is inelastic, Q
a price increase 10 12
causes revenue to rise.
ELASTICITY AND ITS APPLICATION 74
Calculating Elasticities
TR = P x Q
total revenue = price x quantity
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Calculating Elasticities
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Calculating Elasticities
77
Summary
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