Question

Week 2 HW: Elasticity

Step 1 - E L A S T I C or INELASTIC?

Price Elasticity of Demand is a measure of how responsive demand is to a change in price. If a price change leads to a considerably bigger change in quantity demanded, we would consider the good to be responsive to a price change—hence elastic. If, however, a similar price change leads to a much smaller change in demand, we would consider it inelastic.

To get a more precise measure of the responsiveness to a price change we can calculate a value for price elasticity of demand. We use the formula:

PRICE ELASTICITY OF DEMAND =	percentage change in Q demand percentage change in price
PERCENTAGE CHANGE=	Original Number-New Number        X 100 Average number ((original+new)/2)

Use the formula above to calculate values of Price Elasticity for all the situations below:

Price		Quantity		% change in quantity demanded	% change in price	Elasticity of Demand
Initial	New	Initial	New
25	30	100	40	60%	20%	1. 30
40	70	120	90	25%	75%	2. 0.333
200	220	80	64	20%	10%	3. 2
50	75	150	135	10%	50%	4. 2

In each case identify whether you would describe it as elastic / unitary elastic / inelastic

1. ________Elastic_________                         2. ______Inelastic_______
3. ____Elastic___________                             4. ________Inelastic________

Step 2 - E L A S T I C MONEY?

Different elasticity values will lead to different effects on the level of total revenue a firm receives. For example, if a good is elastic and a firm increases the price by 10%, they will lose more than 10% of their business, and so although they are getting more money for each one they sell, they are selling far fewer.

TR=Price x Quantity Sold

To see the effect that elasticity has on total revenue, fill in the table below:

Price		Quantity		Revenue		Price Elasticity of Demand
Initial	New	Initial	New	Before price change	After price change
25	30	100	40	2500	1200	1. ___3____
40	70	120	90	4800	6300	2. ____0.33___
200	210	80	64	16000	14080	3. ___2___
50	75	150	135	7500	10125	4. ___0.2__

Has revenue increased or decreased in each case?

1. ______Elastic__________                           2. _______Inelastic_______
3. _____Elastic_________                                4. ____Inelastic_________

Step 3 - What determines E L A S T I C I T Y?

As we have seen above it is important to a company to have an idea of the value of the elasticity of demand of its good or service as it will affect what happens to their total revenue as price changes. What should the company aim to do with their price in each of the circumstances below?

Elasticity	Which change in price would increase total revenue?? (Increase or decrease?)
Elastic
Inelastic

If the company wants to estimate the value of the price elasticity of their product, then they need to judge it against the following criteria:

• Number of ____________________:
  • Strength of ___________________:
• Luxuries vs. ___________________:
• Percentage of ________________ spent on good:
• _____________ to adjust:

Answer 1

Step 1.

Elasticity

1. 3, elastic

2. 0.3 inelastic

3. 2, elastic

4. 0.2, Inelastic

Step 2:

1. Decreased

2. Increased

3. Decreased

4. Increased

Step 3: Elastic- Decrease the price

Inelastic- Increase the price.

Step 4:

Number of close substitutes.

Strength of the brand.

Luxury vs necessity

Percentage of income spent on good

Time to adjust

Reason-

Midpoint formula for price elasticity of demand= ((q2-q1)/(q1+q2)/2))÷((p2-p1)/(p2+p1)/2

When good is elastic, total revenue increases when price decreases and vice versa.

When good is inelastic, total revenue increases when price increases and vice versa.

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