1. Elasticity of Demand
How does a firm go about determining the price at which they should sell their product in order to maximize total revenue?
Total Revenue = Price ´ Quantity

2. You are a marketing manager for Intel
A new computer chip has been developed
Decision to Be Made
Do you sell the new chip at a high price ($400)?
Do you sell the new chip at a low price ($200)?

3. Demand and Total Revenue
400
Price (dollars per chip)
300
200 Da
100
Quantity (millions of chips per year)

4. Demand and Total Revenue
400
Price (dollars per chip)
300
200 Da
100
Quantity (millions of chips per year)

5. Demand and Total Revenue
loss
400
Price (dollars per chip)
300
200 Da
Total
revenue
gain
100
Quantity (millions of chips per year)

6. Demand and Total Revenue
400
Price (dollars per chip)
300
200
100 Db
Quantity (millions of chips per year)

7. Demand and Total Revenue
400
Price (dollars per chip)
300
200
100 Db
Quantity (millions of chips per year)

8. Demand and Total Revenue
loss
400
Price (dollars per chip)
300
200
Total
revenue
gain
100 Db
Quantity (millions of chips per year)

9. Demand and Total Revenue
Price (dollars per chip)
Price (dollars per chip) Da Db
Quantity (millions of chips per year)
Quantity (millions of chips per year)

10. Slope Depends on Units of Measurement
In these two examples, we can compare the slopes of the demand curves
We cannot do so if we are dealing with different goods and services.
Elasticity is independent of the units of measurement.

11. Price elasticity of demand
A measure of the responsiveness of the quantity demanded of a good to a change in its price (ceteris paribus).

12. Elasticity: A Units-Free Measure
Percentage change
in quantity demanded
Price elasticity of
demand =
Percentage change in price

13. Calculating Elasticity
The changes in price and quantity are expressed as percentages of the average price and average quantity.
Avoids having two values for the price elasticity of demand

14. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
400
390 Da
Quantity (millions of chips per year)

15. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
400
New
point
390 Da
Quantity (millions of chips per year)

16. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
= -$20
400
New
point
390 Da
= 8
Quantity (millions of chips per year)

17. Price (dollars per chip)
Original
point
410
Price (dollars per chip)
= -$20
400
Pave = $400
New
point
390 Da
= 8
Quantity (millions of chips per year)

18. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
= -$20
400
Pave =$400
New
point
Qave = 40
390 Da
= 8
Quantity (millions of chips per year)

19. Calculating Elasticity
Price elasticity of demand =
Percentage change in quantity demanded
Percentage change in price

20. Calculating Elasticity
Price elasticity of demand =
Percentage change in quantity demanded
Percentage change in price
= - 4

21. Inelastic and Elastic Demand
Three demand curves that cover the entire range of possible elasticities of demand:
Perfectly inelastic
Unit elastic
Perfectly elastic

22. Inelastic and Elastic Demand
Perfectly inelastic demand
Implies that quantity demanded remains constant when price changes occur.
Price elasticity of demand = 0

23. D1
Price
Elasticity = 0 12
Perfectly Inelastic 6
Quantity

24. Inelastic and Elastic Demand
Unit elastic demand
Implies that the percentage change in quantity demanded equals the percentage change in price.
Price elasticity of demand = -1

25. Inelastic and Elastic Demand
Price
Elasticity = -1 12
Unit Elasticity 6 D2
Quantity

26. Inelastic and Elastic Demand
Perfectly elastic demand
Implies that if price increases by any percentage, quantity demanded will fall to 0 and if price decreases by any percentage, quatity will rise to infinity.
Price elasticity of demand =

27. Inelastic and Elastic Demand
Price
Elasticity = 12 D3 6
Perfectly Elastic
Quantity

28. Inelastic and Elastic Demand
Inelastic demand
Implies the percentage change in quantity demanded is less than the percentage change in price.
In absolute sense, price elasticity of demand > 0 and < 1
Elastic demand
Implies the percentage change in quantity demanded is greater than the percentage change in price.
In absolute sense, price elasticity of demand > 1

29. Elasticity Along a Straight-Line Demand Curve
500
Price (dollars per chip)
400
300
250
200
100
Quantity (millions of chips per year)

30. Elasticity Along a Straight-Line Demand Curve
500
Lowering the price
from $500 to $300
results in a price
elasticity of demand of -4.
Elastic
Price (dollars per chip)
400
300
250
200
100
Quantity (millions of chips per year)

31. Elasticity Along a Straight-Line Demand Curve
500
Lowering the price
from $200 to $0
results in a price
elasticity of demand of -1/ 4.
Price (dollars per chip)
400
Inelastic
300
250
200
Elasticity = -1/4
100
Quantity (millions of chips per year)

32. Elasticity Along a Straight-Line Demand Curve
500
Lowering the price
from $500 to $0
results in a price
elasticity of demand of -1.
|Elasticity| > 1
Price (dollars per chip)
400
|Elasticity| = 1
300
250
200
|Elasticity| < 1
100
Quantity (millions of chips per year)

33. Elasticity, Total Revenue and Expenditure
Elastic demand — a 1 percent decrease in price will result in a greater than 1 percent increase in quantity demanded.
Total revenue will increase
Unit elastic demand — a 1 percent decrease in price will result in a 1 percent increase in quantity demanded
Total revenue will not change

34. Elasticity, Total Revenue and Expenditure
Inelastic demand — a 1 percent decrease in price will result in a less than 1 percent increase in quantity demanded.
Total revenue will decrease

35. Elasticity, Total Revenue and Expenditure
Total Revenue Test
Price elasticity of demand can be estimated by observing the change in total revenue that results from a price change (ceteris paribus).

36. Elasticity, Total Revenue and Expenditure
Total Revenue Test
Price cut and total revenue increases — demand is elastic.
Price cut and total revenue decreases — demand is inelastic
Price cut and total revenue does not change — demand is unit elastic

37. 500
400
Price (dollars per chip)
300
250
200
100 D

38. 500
400
Price (dollars per chip)
300
250
200
100 D 25 20
Total Revenue (billions of dollars) 15 10 TR 5
Quantity (millions of chips per year)

39. Elastic
demand
500
400
Price (dollars per chip)
Unit
elastic
300
250
200
Inelastic
demand
100 25
Maximum
total revenue 20
Total Revenue (billions of dollars) 15
When demand
is inelastic,
price cut decreases
total revenue
When demand
is elastic,
price cut
increases
total revenue 10 5
Quantity (millions of chips per year)

40. More Elasticities of Demand
Cross elasticity of demand
Measures the responsiveness of the demand for a good to a change in the price of a substitute or complement good.
Percentage change
in quantity demanded
Cross elasticity
of demand =
Percentage change in price of
a substitute or complement

41. Cross Elasticity of Demand
Price of Walkmans D0
Quantity of Walkmans

42. Cross Elasticity of Demand
Price of a CD player,
a substitute, rises.
Positive cross elasticity
Price of Walkmans D1 D0
Quantity of Walkmans

43. Cross Elasticity of Demand
Price of a CD player,
a substitute, rises.
Positive cross elasticity
Price of Walkmans
Price of a tape,
a complement,
rises. Negative
cross elasticity D1 D0 D2
Quantity of Walkmans

44. Income Elasticity of Demand
Measures the responsiveness of the demand to a change in income.
Percentage change
in quantity demanded
Income elasticity
of demand =
Percentage change in income

45. Income Elasticity of Demand
Income elasticity (in absolute sense) can be:
) Greater than 1 (normal good, income elastic)
luxury goods - ocean cruises, jewelry
) Between zero and 1 (normal good, income inelastic)
necessities - food, clothing
) Less than zero (inferior good)
potatoes, rice

46. Income Elasticity of Demand
inelastic
Income
inelastic
Income
elastic
Income
elastic
Quantity demanded
Quantity demanded
Quantity demanded
Quantity demanded
Quantity demanded
Positive
income
elasticity
Negative
income
elasticity m
Income
Income
Income
Income
Income
Income