Chapter 3

Demand EIasticities
S4:Id Managers St:d
EIasticit
3price elasticity helps ma3agers
u3/ersta3/ the impact that price cha3ges ill
have o3 their reve3ue.
3come elasticity ca3 help ma3agers
u3/ersta3/ hat i3come groups to target their
pro/uct to.
Crossprice elasticity ca3 help ma3agers
u3/ersta3/ ho their closest competitors are.
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
Demand EIasticit
ema3/ elasticity is the respo3sive3ess of
qua3tity /ema3/e/ to cha3ges i3 the factors
that i3flue3ce /ema3/ pro/uct price i3come
or prices of relate/ pro/ucts.
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
n Price EIasticit 41 Demand
easure/ as the
perce3tage cha3ge
i3 qua3tity
/ema3/e/ of a give3
goo/ relative to a
perce3tage cha3ge
i3 its price all else
co3sta3t.
e
p
= %AQ
x
%AP
x
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
n Price EIasticit 41 Demand -
GrapicaI Representati4n
5 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
P
Q
P
1
P
2
Q
1
Q
2
%AP
%AQ
A
B
ExampIes 41 n-Price EIasticit
Cereal: 0.55
Fish: 0.29
Neuma3s 3 Pasta Sauce: 2.32
ra3ge juice: 1.39
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
n Price EIasticit and T4taI
Reven:e
Va|ue of pr|ce
e|ast|c|ty
coeff|c|ent
L|ast|c|ty
def|n|t|on
ke|at|onsh|p among
var|ab|es
Impact on revenue
|e
p
| 1
LlasLlc
demand C
d

x
Price i3crease results i3 loer
total reve3ue.
Price /ecrease results i3 higher
total reve3ue.
|e
p
| 1
lnelasLlc
demand C
d

x
Price i3crease results i3 higher
total reve3ue.
Price /ecrease results i3 loer
total reve3ue.
|e
p
| 1
unlL or
unlLary
elasLlc
C
d

x
Price i3crease or /ecrease has
3o impact o3 total reve3ue.
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
GrapicaI Representati4n 41 ReIati4nsip
Beteen Price EIasticit and T4taI Reven:e
8
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
P
Q
P
1
P
2
Q
1
Q
2
A
B
Y
X
If demand is elastic,a decrease
in price results in an increase
in total revenue, and an increase
in price results in a decrease in
total revenue.
P
Q
P
1
P
2
Q
1
Q
2
A
B Y
X
If demand is inelastic,a decrease
In price results in a decrease in
total revenue, and an increase
in price results in a increase in
total revenue.
Determinants 41 n Price
EIasticit
%he 3umber of
substitute goo/s.
%he perce3t of a
co3sumers i3come
that is spe3t o3 the
pro/uct.
%he time perio/
u3/er co3si/eratio3.
ema3/ is ge3erally more
i3elastic:
%he feer the 3umber of
substitutes or perceive/
substitutes available.
%he smaller the perce3t of
the co3sumers i3come
that is spe3t o3 the
pro/uct.
%he shorter the time perio/
u3/er co3si/eratio3.
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
Per1ectI EIastic and IneIastic
Demand
10 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
Inc4me EIasticit 41 Demand
%he perce3tage
cha3ge i3 the
qua3tity /ema3/e/
of a give3 goo/ ,
relative to a
percentage cha3ge
i3 co3sumer i3come
assumi3g all other
factors co3sta3t.
e
i
= %AQ
x
%A
11 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
4rmaI G44d
oo/ X is a 3ormal
goo/ if the /ema3/
for goo/ X moves i3
the same /irectio3 as
a cha3ge i3 i3come.
Cream
e
i
= 1.72
Apples
e
i
= 1.32
Potatoes
e
i
= 0.15
1 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
In1eri4r G44d
oo/ X is a3 i3ferior
goo/ if the /ema3/
for goo/ X moves i3
the opposite /irectio3
of a cha3ge i3
i3come.
Chicke3
e
i
= 0.106
1 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
r4ss-Price EIasticit 41 Demand
%he perce3tage
cha3ge i3 the
qua3tity /ema3/e/
of a give3 goo/ ,
relative to a
percentage cha3ge
i3 the price of goo/
Y assumi3g all other
factors co3sta3t.
e
xy
= %AQ
x
%AP
y
1 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
S:-stit:tes
%o goo/s ith a
positive cross-price
elasticity of demand
coefficient are said to
be substitute goods.
Boiler chicke3s a3/
beef
e
xy
= 0.20
Boiler chicke3s a3/
pork
e
xy
= 0.28
15 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
4mpIements
f to goo/s have a
negative crossprice
elasticity of /ema3/
coefficie3t they are
calle/
complementary
goods.
Brea/ a3/ eggs
e
xy
= 0.03
1 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
Appe3/ix 3A
Demand EIasticities
4ns:mer Tastes and Pre1erences
Prefere3ce or/eri3gs are complete.
ore of the goo/s are preferre/ to less of the
goo/s.
Co3sumers are selfish.
%he goo/s are co3ti3uously /ivisible so that
co3sumers ca3 alays purchase o3e more or
o3e less u3it of the goo/s.
18 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
Indi11erence :rves
A co3sumers
indifference curve
that shos
alter3ative
combi3atio3s of the
to goo/s that
provi/e the same
level of satisfactio3
or utility.
1

Y
1
Y
2
X
1
X
2
U
2
U
1
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
MarginaI Rate 41 S:-stit:ti4n
%he ratio A, hich shos the rate at
hich the co3sumer is illi3g to tra/e off o3e
goo/ for a3other a3/ still mai3tai3 a co3sta3t
utility level is calle/ the marginal rate of
substitution (MRS
xy
).
0 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
Te B:dget 4nstraint
%he co3sumers
bu/get co3strai3t
shos all the
combi3atio3s of to
goo/s that ca3 be
purchase/ ith a
give3 i3come a3/
give3 the prevaili3g
prices of the to
goo/s.
1 Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
Si1ts in te B:dget 4nstraint
Increase in inc4me Increase in price 41 g44d X

Y
1
B
1
B
2
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
4ns:mer 4ice
%he co3sumer
maximizes utility by
choosi3g a
combi3atio3 of goo/ X
a3/ Y lyi3g o3 the
bu/get co3strai3t a3/
simulta3eously lyi3g
o3 the i3/iffere3ce
curve furthest from the
origi3.
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall
anges in 4ns:mer 4ice
Increase in inc4me Increase in price

B
Copyright 2010 Pearso3 E/ucatio3 3c.
Publishi3g as Pre3tice Hall