Elasticity, part 2

Price Elasticity of Demand

• Definition: Measures how sensitive the quantity demanded is to changes in price.

• Formula:

  • Price elasticity of demand = (Percentage change in quantity demanded) / (Percentage change in price)

Calculation of Elasticity Coefficients

• Traditional calculation raises concerns due to directional dependence on A or B points of the demand curve.

• To resolve this, we use the Midpoint Formula.

  • Midpoint formula averages the starting points to avoid directionality issues:

    • Denominator = (Data Point A + Data Point B) / 2

• Examples of calculated elasticity coefficients:

  • Coefficients of -2.1 and -0.29 calculated; absolute values considered for ease of interpretation.

Insights from the Calculation

• As one moves down a downward sloping demand curve:

  • The elasticity coefficient decreases; starting from higher values (6.33, 3.4) to lower values (0.16).

• Interpretation of Coefficients:

  • Elastic: Coefficient > 1

  • Inelastic: Coefficient < 1

  • Unit Elastic: Coefficient = 1

Total Revenue Test

• Total Revenue (TR): TR = Price x Quantity

• Observes the impact of price changes on total revenue:

  • TR is maximized at the unit elastic portion of the demand curve.

  • Moving away from unit elasticity leads to decreased total revenue, whether increasing or decreasing price.

• Example scenarios demonstrate that:

  • In elastic segments, increasing prices leads to decreased total revenue.

  • In inelastic segments, decreasing prices results in decreased total revenue.

Demand Curve Description

• Elastic vs. Inelastic Curves: Relative to sensitivity to price changes:

  • Steeper curves indicate inelastic demand.

  • Flatter curves denote more elastic demand.

• Examples illustrate how demand sensitivity varies based on context (grocery store vs. event venue), affecting personal price sensitivity.

Determinants of Elasticity of Demand

1. Availability of Substitutes:

   • More substitutes lead to increased price sensitivity.

   • Closer substitutes increase elasticity, meaning consumers are more likely to switch to alternatives when prices rise.

2. Income Consideration:

   • Higher product prices relative to consumer budgets prompt increased price sensitivity.

   • Goods that take up a larger portion of a consumer's income tend to have more elastic demand.

3. Necessities vs. Luxuries:

   • Necessities show less price sensitivity (inelastic demand).

   • Luxuries show more price sensitivity (elastic demand), as consumers can forego them when prices rise.

4. Time Factor:

   • The longer consumers have to make a decision, the more price sensitivity increases.

   • In the short term, consumers may stick to their initial choices; in the long term, they may adjust their purchasing behavior based on price changes.

Conclusion

• Understanding price elasticity helps businesses predict consumer behavior and manage pricing to optimize revenue.

• Price elasticity of demand is assessed both analytically (mathematical calculations) and descriptively (contextual behavior of consumers).

• Factors influencing elasticity lead to variations in consumer response, highlighting the necessity for businesses to adapt to market conditions.