Making Sales Targets A Public Transportation Problem: Can the daily rider ship fluctuations be controlled through a pricing strategy? The Airliners Pricing Problem: How can an airliner fill its plains while maximizing its profit?
220
TR 0 = 220 x 120 = 26,400
TR 1 = 180 x 140 = 25,200
TR 2 = 180 x 200 = 36,000
120 180 0 Q D 2 D 1 140 200 Note: Slope and Scale o o A B Elasticity A general definition: Elasticity is a (standard) measure of the degree of sensitivity ( or responsiveness) of one variable to changes in another variable. The price elasticity of Demand The (self) price elasticity of demand is a measure of the degree of sensitivity of demand to changes in the (self) price, ceteris paribus. Determining Price Elasticity Percentage Change in Quantity Ep = Percentage Change in Price
Change in Quantity Quantity Ep = Change in Price Price
Ep (a --- b) = (10/8)/(-2/10) = -6.25
Ep (c ---d ) = (10/80)/(-2/4) = -.25 P Q D a b c d 2 4 8 10 8 18 80 90 What does the elasticity measure really measure? The elasticity measure is a ratio between two percentage measures: the percentage change in one variable over the percentage change in another variable A price elasticity of -6.25 means that for each one percent change in price the quantity demanded will change by 6.25 percent.
Arc (Price) Elasticity P Q D 2 4 Note that if we increased the price, (from 8 to 10 or 2 to 4) the original P and Q would be 2 and 8 and 18 and 90, respectively. Ep = (-10/18)/(2/8) = -2.22
Ep = (-10/90)/(2/2) = -.11
8 10 8 18 80 90 a b c d Arc Elasticity To get the average elasticity between two points on a demand curve we take the average of the two end points (for both price and quantity) and use it as the initial value: Q 2 -Q 1 10 (Q1+Q 2 ) 8+18 Ea = = = -3.49 P 2 -P 1 -2 (P 1 +P 2 ) 10+8
Elasticity and the Price Level
Along a linear demand curve as the price goes up, |elasticity | increases.
Note that between points "a" and "b" the (arc) elasticity of the above demand curve is -3.49, whereas between "c" and "d" it is -.17. P D 8 18 80 90 a b c d 2 4 8 10 | Ep | > 1 : Elastic | Ep | < 1 : Inelastic | Ep | = 1 : Unit-elastic E =-3.49 E = -.17 Point Elasticity
Q --------- Q 1 +Q 2 Q P 1 +P 2 Q P E = ------------ = ------- . ------- = ------- . ------ P P Q 1 +Q 2 P Q --------- P 1 +P 2
dQ P Or, = ------ . ----- dP Q P,MR Q Q TR 0 0 | E | = 1 Q = C - b P
C 1 P = ----- - ----- Q b b
C 2 MR = ------ - ------ Q b b
C D MR Note: In the demand equation dQ/dP = -b
That means
P E p = -b ----- Q A note about marginal revenue: Recall: TR = P.Q ; P = f (Q ) Marginal Revenue = Change in TR resulting from producing (selling) one additional unit of output. TR (P.Q) d P d Q MR = ------ = -------- = ------ .Q + ------ .P Q Q d Q d Q
d P Q P 1 = ( -----. ----- + ------ ).P = P. ( ------- + 1 ) d Q P P E 0 Q Q = C - b P Slope= -1/b Slope=-2/b D MR C P, MR dQ ---- = - b d p dQ P P E = ----- . ----- = -b . ------ d p Q Q
1 MR = P. ( 1 + ---- ) E Special Cases P D D Q 0 0 Q Infinitely (price) elastic Infinitely price inelastic Important Observations When demand is elastic, a decrease in price will result is an increase in the revenue (sales). When demand is inelastic, a decrease in price will result is a decrease in the revenue (sales). When demand is unit-elastic, an increase (or a decrease) in price will not change the revenue (sales). What Determines Elasticity Necessities versus luxuries Eating at restaurants Groceries Availability of substitutes Chicken versus beef How much of our income a good takes Salt versus Nike sneakers The passage of time Elasticity and Passage of Time Do D1 D2 D3 Qo Qo Q1 Q2 Q3 Q P O Other Elasticity Measures Recall: Elasticity is a (standard) measure of the degree of sensitivity ( or responsiveness) of one variable to changes in another variable. Income Elasticity: a measure of the degree of sensitivity of demand for a good (or service) to changes in consumers (buyers) income Cross Price Elasticity: a measure of the degree of sensitivity of demand for a good (or service) to changes in the price of another good or service
Income Elasticity of Demand A measure of the degree of responsiveness of demand (for a good) to a change in income, ceteris paribus. (Shift of the demand curve)
Q 2 -Q 1
Q 2 +Q 1 d Q I E I = = or = ------ . ------ I 2 -I 1 d I Q I 1 +I 2
Cross (Price) Elasticity A measure of the degree of responsiveness of the demand for one good (X) to a change in the price of another good (Y): (Shift of demand curve) Q x2 - Q x1
Q x2 +Q x1 d Qx Py Ec = or = ----------- . ------- P y2 - P y1 d Py Qx P y1 +P y2