Situation-1

• An estimated 80% increase in the retail price of cigarettes is necessary

to cause a 30% drop in the number of cigarettes sold. Would such a
price increase help or hurt tobacco industry profits? What would be
the likely effect on industry profits if this price boost was simply
caused by increase in cigarette taxes for Rs1.50 per cigarette?
Situation2
Surgical Systems, Inc., makes a patented line of disposable surgical stapling
instruments. The company grew rapidly during the 1990s as surgical stapling
procedures continued to gain wider hospital acceptance as an alternative to manual
stitching.
However, price competition in the medical supplies industry is growing rapidly in the
increasingly price-conscious new millennium. During the past year, Surgical Systems
sold 6000,000 units at a price of Rs14.50, for total revenues of Rs 87000000 . During
the current year, Surgical Systems' unit sales have fallen from 6000,000 units to
3600,000 units following a competitor price cut from Rs13.95 to Rs 10.85 per unit.  
Surgical Systems' director of marketing projects know that unit sales will recover
from 3600,000 units to 4800,000 units if Surgical Systems reduces its own price from
Rs14.50 to Rs13.50 per unit.
Determine the further price reduction necessary for Surgical Systems to fully
recover lost sales (i.e., regain a volume of 6000,000 units).
Elasticity of Demand
Session6
Chapter-6
Why understand Elasticity?
• From the managerial point of view, the knowledge of the nature of
relationship between product’s demand and its determinants is not
sufficient. What is more important is the degree of responsiveness of
demand to changes in its determinants.
• It allows us to analyze demand with greater precision.
• It is a measure of how much buyers and sellers respond to changes in
market conditions
Types of Elasticity
• Price Elasticity
• Income Elasticity
• Cross Price Elasticity
 Price Elasticity of Demand
(E)
• Measures responsiveness or sensitivity
of consumers to changes in the price of
a good
%Q
•
E
%P
• P & Q are inversely related by the law of demand so E is always
negative
• The larger the absolute value of E, the more sensitive buyers are to a
change in price
6
 Price Elasticity of Demand
(E)
Table 6.1
Elasticity Responsiveness E
Elastic %Q%P E 1
Unitary Elastic %Q%P E 1
Inelastic %Q%P E 1

7
Degree of Price Elasticity of Demand

• Inelastic Demand -Quantity demanded does not respond strongly to price

changes.
• Elastic Demand -Quantity demanded responds strongly to changes in price.
• Perfectly Inelastic -Quantity demanded does not respond to price changes.
• Perfectly Elastic -Quantity demanded changes infinitely with any change in
price.
• Unit Elastic -Quantity demanded changes by the same percentage as the
price. P
Perfectly Inelastic & Perfectly elastic
Inelastic Demand
Unit Elastic Demand
Elastic Demand
Price Elasticity of Demand (E)
• Percentage change in quantity demanded can be predicted for a
given percentage change in price as:
• %Qd = %P x E
• Percentage change in price required for a given change in
quantity demanded can be predicted as:
• %P = %Qd ÷ E

13
Price Elasticity & Total
Revenue
Table 6.2
Elastic Unitary elastic Inelastic
%Q%P %Q%P %Q%P
Q-effect No dominant P-effect
dominates effect dominates
Price
TR falls No change in TR TR rises
rises
Price TR rises No change in TR TR falls
falls

14
P-effect & Q-effect
• The effect on total revenue of changing price holding output
constant.- p effect
• The effect on total revenue of changing output , holding price
constant.- q effect
• Video

15
 Calculating Price Elasticity of
Demand
• Price elasticity can be calculated by multiplying the slope of demand
(Q/P) times the ratio of price to quantity (P/Q)

Q
 100
%Q Q Q P
E   
%P P P Q
 100
P
16
 Calculating Price Elasticity of
Demand
• Price elasticity can be measured at an interval (or arc) along demand,
or at a specific point on the demand curve
• If the price change is relatively small, a point calculation is suitable
• If the price change spans a sizable arc along the demand curve, the
interval calculation provides a better measure

17
 Computation of Elasticity Over an Interval
Or Mid Point Formula

• When calculating price elasticity of demand over an interval of

demand, use the interval or arc elasticity formula

Q Average P
E 
P Average Q

18
 Factors Affecting Price Elasticity of
Demand

• Availability of substitutes
• The better & more numerous the substitutes for a good, the more
elastic is demand
• Percentage of consumer’s budget
• The greater the percentage of the consumer’s budget spent on the
good, the more elastic is demand
• Time period of adjustment
• The longer the time period consumers have to adjust to price changes,
the more elastic is demand

19
Use midpoint formula to calculate
elasticity
 Income Elasticity
• Income elasticity (EM) measures the responsiveness of quantity
demanded to changes in income, holding the price of the good &
all other demand determinants constant
• Positive for a normal good
• Negative for an inferior good

%Qd Qd M
EM   
%M M Qd
24
 Cross-Price Elasticity
• Cross-price elasticity (EXY) measures the responsiveness of quantity
demanded of good X to changes in the price of related good Y,
holding the price of good X & all other demand determinants for
good X constant
• Positive when the two goods are substitutes
• Negative when the two goods are complements

%Q X Q X PY
E XY   
%PY PY QX
25
 Interval Elasticity
Measures
• To calculate interval measures of income & cross-price
elasticities, the following formulas can be employed

Q Average M
EM  
M Average Q

Q Average PR
E XR  
PR Average Q

26
 Point Elasticity Measures
 For the linear demand function
Q X  a  bPX  cM  dPY , point
measures of income & cross-price
elasticities can be calculated as
M
EM c
Q

PR
E XR d
Q
27
Use midpoint formula to calculate
elasticity
Based on your answer to the previous question the
price elasticity of demand would be considered:

A. Perfectly Elastic
B. Elastic
C. Inelastic
D. Perfectly Inelastic
The price elasticity of demand
measures:
A. The responsiveness of demand to changes in price
B. How likely a person is to buy a product when the budget increases
C. The number of units that consumers would give up if the price
decreased
D. All of the above
When demand is elastic that would indicate that:

• consumers will increase the quantity demanded in response to a

decrease in price.
• the demand curve will be flatter than an inelastic demand curve
over the same price range.
• the percentage change in quantity will be bigger than the
percentage change in price.
• all of the above. 
The midpoint formula
uses percentage changes:
• because people change their behavior when using US Dollars instead
of Euros.
• because the result can be interpreted easier as a negative value.
• so that it matches the consumers' desire have prices listed as
percentages instead of dollars
• in order to be independent of the units used when measuring
elasticity.
Price Elasticity
The South Beach Cafe recently reduced appetizer prices from $10 to $6
for afternoon for early bird customers and enjoyed a resulting increase
in sales from 60 to 180 orders per day. Beverage sales also increased
from 30 to 150 units per day.
A. Calculate the price elasticity of demand for appetizers.
B. Calculate the cross-price elasticity of demand between beverage
sales and appetizer prices.
C. Holding all else equal, would you expect an additional appetizer
price decrease to $5 to cause both appetizer and beverage revenues to
rise? Explain.
Income Elasticity
Ironside Industries, Inc., is a leading manufacturer of tufted carpeting under the Ironside brand.
Demand for Ironside's products is closely tied to the overall pace of building and remodeling activity
and, therefore, is highly sensitive to changes in national income. The carpet manufacturing industry
is highly competitive, so Ironside's demand is also very price-sensitive.
• During the past year, Ironside sold 30 million square yards (units) of carpeting at an average
wholesale price of $15.50 per unit. This year, household income is expected to expected to surge
from $55,500 to $58,500 per year in a booming economic recovery.
•
A.Without any price change, Ironside's marketing director expects current-year sales to soar to 50
million units because of rising income. Calculate the implied income arc elasticity of demand.
• B.Given the projected rise in income, the marketing director believes that a volume of 30 million
units could be maintained despite an increase in price of $1 per unit. On this basis, calculate the
implied arc price elasticity of demand.
• C.Holding all else equal, would a further increase in price result in higher or lower total revenue?
Demand Curves
KRMY-TV is contemplating a T shirt advertising promotion. Monthly sales data
from T shirt shops marketing the KRMY TV@ design indicate that
Q = 1,500 - 200P
where Q is T shirt sales and P is price.

A. How many T-shirts could KRMY-TV sell at $4.50 each?

B. What price would KRMY TV have to charge to sell 900 T shirts?
C. At what price would T shirt sales equal zero?How many T shirts could be
given away?
E. Calculate the point price elasticity of demand at a price of $5.
Agriculture Commodities are known to have a price inelastic demand
and to be necessities. How can this information explain why income of
farmers falls a) after a good harvest b)in relation to the incomes in other
sectors of the economy
Answer
• A good harvest increases the supply of agricultural commodities. Given
the demand for agricultural commodities, this results in lower prices for
farm products. Since the demand for agricultural commodities is price
inelastic, the reduction in prices after a good harvest leads to a decline in
the total revenues (income) of farmers.
• Since agricultural commodities are necessities (i.e., their income
elasticity of demand is positive but has a value below one), the increase
in consumers’ income in the process of economic growth leads to a
smaller than proportional increase in the demand for agricultural
commodities. As a result, farmers’ incomes rise less than proportionately
in comparison to the rise in income in other sectors of the economy.