Professional Documents
Culture Documents
N. Gregory Mankiw
A scenario…
You
You design
design websites
websites for
for local
local businesses.
businesses.
You
You charge
charge $200
$200 per
per website,
website,
and
and currently
currently sell
sell 12
12 websites
websites per per month.
month.
Your
Your costs
costs are
are rising
rising
(including
(including the
the opportunity
opportunity cost cost of
of your
your time),
time),
so
so you
you consider
consider raising
raising the
the price
price to
to $250.
$250.
The
The law
law of
of demand
demand says
says thatthat you
you won’t
won’t sell
sell as
as many
many
websites
websites ifif you
you raise
raise your
your price.
price.
How
How many
many fewer
fewer websites?
websites? How How much
much will
will your
your
revenue
revenue fall,
fall, or
or might
might itit increase?
increase?
2
Elasticity
• Basic idea:
Elasticity measures how much one variable responds
to changes in another variable.
• One type of elasticity measures how much demand for
your websites will fall if you raise your price.
• Definition:
Elasticity is a numerical measure of the
responsiveness of Qd or Qs to one of its
determinants.
$250 – $200
x 100% = 22.2%
$225
The % change in Q equals
12 – 8
x 100% = 40.0%
10
The price elasticity of demand equals
40/22.2 = 1.8
The
The price
price elasticity
elasticity of
of demand
demand depends
depends on:
on:
•• the
the extent
extent to
to which
which close
close substitutes
substitutes are
are available
available
•• whether
whether the
the good
good isis aa necessity
necessity or
or aa luxury
luxury
•• how
how broadly
broadly or
or narrowly
narrowly the the good
good isis defined
defined
•• the
the time
time horizon
horizon –– elasticity
elasticity isis higher
higher in
in the
the long
long
run
run than
than the
the short
short run
run
Revenue = P x Q
• If demand is elastic, then
price elast. of demand > 1
% change in Q > % change in P
• The fall in revenue from lower Q is greater
than the increase in revenue from higher P,
so revenue falls.
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.
P and Q fall.
P1 initial value
Result: of drug-
A decrease in P2 related
total spending crime
on drugs, and
in drug-related Q 2 Q1 Quantity
crime. of Drugs