Price Elasticity of Demand

1
Price Elasticityof Demand

• ECO 105
• Lecture 2.3
• 19 September 2008

2
Generalities and Specifics

• Weve discussed demand, supply, and price
  determination.
• We can solve qualitative problems.
• Today well investigate a quantitative problem.
• This requires us to measure the demand curve.

3
Total Revenue Maximization

• By trial and error you found that TR is maximized
  at
• Why that price? Is this just happenstance?
• Or does it have something to do with the
  characteristics of the demand curve?

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Price Elasticity of Demand

• Measures how much quantity demanded responds
• ed - DQd/DP
• (We typically ignore the minus sign and just
  think of ed as a positive number.)

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Midpoint formula for elasticity over a range
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Formula for point elasticity
DQd
P
x
ed
Q
DP
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What weve learned so far

• TR is maximized at the point at which price
  elasticity of demand
• When demand is inelastic (ed lt 1), TR can be
  increased by
• When demand is elastic (ed gt 1), TR can be
  increased by

8
Changing Elasticity

• Elasticity changes along nearly all demand curves.

P
P1
P0
D
Quantity
Q0
Q1
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Example
Slope of D ?
P
Whats the elasticity at P 8?
Whats the elasticity at P 2?
Q
0, 0
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Differing Elasticities of Demand

• Different demand curves have different
  elasticities, ranging from perfectly inelastic to
  perfectly elastic.
• Perfectly _________ vertical
• Perfectly _________ horizontal

P
Q
P
Q
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What determines elasticity of demand?

• A number of factors.

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Necessities vs. Luxuries

• Demand for goods that are really needed tends to
  be
• E.g., electricity, natural gas
• Demand for goods that are purely luxuries tends
  to be
• E.g., Caribbean cruises, big-screen TVs

13
Availability of Close Substitutes

• Close substitutes cause the demand for a good to
  be
• E.g., Pepsi and Coke
• Absence of close substitutes causes the demand to
  be
• E.g., salt or shaving cartridges (razor blades)

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Definition of the Market

• The more broadly the market is defined, the more
• E.g., the demand for pasta is _____ elastic than
  the demand for tortellini.
• The demand for automobiles is _____ elastic than
  the demand for Honda Accords.

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Time Horizon

• The shorter the time horizon, the more __________
  demand is likely to be.
• E.g., the demand for gasoline is highly _________
  over the period of a month, but quite ________
  over a period of three or four years.

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Size of Purchase

• Inexpensive goods tend to have more _________
  demand curves than expensive goods.
• E.g., if the price of shaving cream rises by 10,

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The Bottom Line

• If good alternatives exist at the present time,
  demand tends to be relatively
• If no good alternatives exist at the present
  time, demand tends to be more