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Demand and Elasticity
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Consider the following cases:

Making Sales Targets

A Public Transportation Problem:
Can the daily ridership fluctuations be controlled
through a pricing strategy?

The Airliners Pricing Problem:
How can an airliner fill its plains while
maximizing its profit?



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220

TR
0
= 220 x 120 = 26,400

TR
1
= 180 x 140 = 25,200

TR
2
= 180 x 200 = 36,000

120
180
0
Q
D
2
D
1
140 200
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Note: Slope and Scale
o
o
A
B
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Elasticity
A general definition:
Elasticity is a (standard) measure of the
degree of sensitivity ( or responsiveness) of one
variable to changes in another variable.
The price elasticity of Demand
The (self) price elasticity of demand is a
measure of the degree of sensitivity of demand
to changes in the (self) price, ceteris paribus.
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Determining Price Elasticity
Percentage Change in Quantity
Ep =
Percentage Change in Price

Change in Quantity
Quantity
Ep =
Change in Price
Price
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Ep (a --- b) = (10/8)/(-2/10) = -6.25

Ep (c ---d ) = (10/80)/(-2/4) = -.25
P
Q
D
a
b
c
d
2
4
8
10
8
18
80 90
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What does the elasticity
measure really measure?
The elasticity measure is a ratio between
two percentage measures: the percentage
change in one variable over the percentage
change in another variable
A price elasticity of -6.25 means that for
each one percent change in price the
quantity demanded will change by 6.25
percent.
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Arc (Price) Elasticity
P
Q
D
2
4
Note that if we increased
the price,
(from 8 to 10 or 2 to 4)
the original P and Q would
be 2 and 8 and 18 and
90, respectively.
Ep = (-10/18)/(2/8) = -2.22

Ep = (-10/90)/(2/2) = -.11


8
10
8 18 80 90
a
b
c
d
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Arc Elasticity
To get the average elasticity between two
points on a demand curve we take the
average of the two end points (for both
price and quantity) and use it as the initial
value:
Q2-Q1 10
(Q1+Q2) 8+18
Ea = = -3.49
P2-P1 -2
(P1+P2) 10+8


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Elasticity and the Price Level

Along a linear demand curve as
the price goes up, |elasticity |
increases.


Note that between points "a" and
"b" the (arc) elasticity of the
above demand curve is -3.49,
whereas between "c" and "d" it is
-.17.
P
D
8 18 80 90
a
b
c
d
2
4
8
10
| Ep | > 1 : Elastic
| Ep | < 1 : Inelastic
| Ep | = 1 : Unit-elastic
E =-3.49
E = -.17
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Point Elasticity

Q
---------
Q
1
+Q
2
Q P
1
+P
2
Q P
E = ------------ = ------- . ------- = ------- . ------
P P Q
1
+Q
2
P Q
---------
P
1
+P
2

dQ P
Or, = ------ . -----
dP Q
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P,MR
Q
Q
TR
0
0
| E | = 1
Q = C - b P

C 1
P = ----- - ----- Q
b b

C 2
MR = ------ - ------ Q
b b


C
D
MR
Note:
In the demand equation
dQ/dP = -b

That means

P
E p = -b -----
Q
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A note about marginal revenue:
Recall: TR = P.Q ; P = f (Q )
Marginal Revenue = Change in TR resulting from
producing (selling) one additional unit of output.
TR (P.Q) d P d Q
MR = ------ = -------- = ------ .Q + ------ .P
Q Q d Q d Q

d P Q P 1
= ( -----. ----- + ------ ).P = P. ( ------- + 1 )
d Q P P E
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0
Q
Q = C - b P
Slope= -1/b
Slope=-2/b
D
MR
C
P, MR
dQ
---- = - b
d p
dQ P P
E = ----- . ----- = -b . ------
d p Q Q

1
MR = P. ( 1 + ---- )
E
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Special Cases
P
D
D
Q 0 0 Q
Infinitely (price) elastic Infinitely price inelastic
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Important Observations
When demand is elastic, a decrease in price
will result is an increase in the revenue
(sales).
When demand is inelastic, a decrease in
price will result is a decrease in the revenue
(sales).
When demand is unit-elastic, an increase
(or a decrease) in price will not change the
revenue (sales).
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What Determines Elasticity
Necessities versus luxuries
Eating at restaurants
Groceries
Availability of substitutes
Chicken versus beef
How much of our income a good takes
Salt versus Nike sneakers
The passage of time
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Elasticity and Passage of Time
Do
D1
D2 D3
Qo Qo
Q1 Q2 Q3
Q
P
O
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Other Elasticity Measures
Recall: Elasticity is a (standard) measure of
the degree of sensitivity ( or responsiveness) of
one variable to changes in another variable.
Income Elasticity: a measure of the degree of
sensitivity of demand for a good (or service) to
changes in consumers (buyers) income
Cross Price Elasticity: a measure of the degree
of sensitivity of demand for a good (or service)
to changes in the price of another good or
service

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Income Elasticity of Demand
A measure of the degree of responsiveness
of demand (for a good) to a change in
income, ceteris paribus.
(Shift of the demand curve)

Q
2
-Q
1

Q
2
+Q
1
d Q I
E
I
= = or = ------ . ------
I
2
-I
1
d I Q
I
1
+I
2





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Cross (Price) Elasticity
A measure of the degree of responsiveness
of the demand for one good (X) to a change
in the price of another good (Y):
(Shift of demand curve)
Q
x2
- Q
x1

Q
x2
+Q
x1
d Qx Py
Ec = or = ----------- . -------
P
y2
- P
y1
d Py Qx
P
y1
+P
y2



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