optimal price formula substitutes complements cross-price elasticity income elasticity normal goods inferior goods. counter-cyclical noncyclical normal goods cyclical normal goods
Graphing the Market Demand Curve
Market demand is total demand.
Evaluating Market Demand Demand differs among market segments. Add segment demand to get market demand.
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Price Elasticity of Demand
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Any elasticity is simply the percentage change in one thing divided by the percentage change in something else
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Price Elasticity of Demand
Arc Price Elasticity
Any elasticity is simply the percentage change in one thing divided by the percentage change in something else
China, China,glassware, glassware,etc. etc. Restaurant Restaurantmeals meals
1.54 1.54 2.27 2.27
Clothing Clothing
.49 .49
Lamb Lamband andmutton mutton
2.65 2.65
• The relationship between price elasticity of demand and revenue is of particular interest. • Why?
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Price Elasticity and Revenue
Price Elasticity and Revenue
TR = P * Q
• The relationship between price elasticity of demand and revenue is of particular interest.
and
Q = 400 - 4P
MR = dTR/dQ
• Why? Because many situations we observe in the real world can be explained if you have knowledge of how total revenue changes with the price elasticity of demand.
Elasticity and Revenue TR = 100Q - .25Q*Q MR = dTR/dQ = 100 - .5Q Graphing these results gives:
Figure Figure5.5 5.5 Elasticity and Revenue Relationship 24
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At price = $90 e = -9.0
At price = $70 e = -2.33
Figure Figure5.5 5.5
Figure Figure5.5 5.5
Elasticity and Revenue Relationship
Elasticity and Revenue Relationship
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At price = $50 e = -1.00
At price = $30 e = -0.43
Figure Figure5.5 5.5
Figure Figure5.5 5.5
Elasticity and Revenue Relationship
Elasticity and Revenue Relationship
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At price = $10 e = -0.11
Elastic Inelastic Figure Figure5.5 5.5
Figure Figure5.5 5.5
Elasticity and Revenue Relationship
Elasticity and Revenue Relationship
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5
Thus:
Thus:
• If demand is price elastic:
• If demand is price elastic: decrease price --> increase tot. rev. increase price --> decrease tot. rev.
• If demand is price inelastic:
• If demand is price inelastic:
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Thus:
Thus:
• If demand is price elastic: decrease price --> increase tot. rev. increase price --> decrease tot. rev.
• If demand is price elastic: decrease price --> increase tot. rev. increase price --> decrease tot. rev.
• If demand is price inelastic: decrease price --> decrease tot. rev. increase price --> increase tot. rev.
• If demand is price inelastic: decrease price --> decrease tot. rev. increase price --> increase tot. rev.
Note: Price and Revenue do NOT always move in the same direction 34
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Question?
Question?
• Should a firm always produce at the point of unitary elasticity? After all, this is the point of highest revenue.
• Should a firm always produce at the point of unitary elasticity? After all, this is the point of highest revenue.
• Real world examples ...
• Real world examples ... – The Mineral Spring
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Question?
What Affects Price Elasticity?
• Should a firm always produce at the point of unitary elasticity? After all, this is the point of highest revenue.
• Number of Substitutes
• Real world examples ... – The Mineral Spring – The Football Stadium
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What Affects Price Elasticity?
What Affects Price Elasticity?
• Number of Substitutes
• Number of Substitutes
• Price as Fraction of Income
• Price as Fraction of Income • Time Period
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Price Elasticity An Example of Its Use
Price Elasticity
price elasticity of smokers by age: 12-17 years 20-25 years 26-35 years 36-74 years
Bus ridership is a service with a price elasticity (in Connecticut) ranging from -1.82 to -3.45.
-1.40 -0.89 -0.47 -0.45
Could revenues be increased by raising fares?
Would a tax on tobacco affect young or old smokers the most? Source: The Margin (Dec. 1987) 42
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Price Elasticity Yet Another Example
Price Elasticity Yet Another Example
price elasticities for air tickets: First Class -0.45 Regular Economy -1.30 Excursion -1.83
Gasoline
1929 - 41
1948 - 73
-0.06
-0.26
Will all passengers react in the same manner to a fare change?
Knowing this, will raising the tax on gasoline help to conserve energy? Who will bear the burden of this tax, the rich or the poor?
Source: Business Economics (Sept. 1980)
Source: Review of Business and Economic Research (Winter 75-76)
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Coupons An Example of Elasticity
Coupons An Example of Elasticity
• Why would firms offer coupons rather than simply lowering the price of their product?
• Why would firms offer coupons rather than simply lowering the price of their product? • The answer lies in the difference between individuals who use coupons and those who do not use coupons.
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Coupons An Example of Elasticity
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Why would firms offer coupons rather than simply lowering the price of their product?
The answer lies in the difference between individuals who use coupons and those who do not use coupons.
Coupon users and nonusers have different price elasticities.
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Coupons An Example of Elasticity • Issuing coupons is a form of third-degree price discrimination.
See Seepage page145 145 52
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Coupons An Example of Elasticity
Coupons An Example of Elasticity
• Issuing coupons is a form of third-degree price discrimination.
Issuing coupons is a form of thirdthird-degree price discrimination.