ECO100Y1-Pesando-Notes edited by Eva Wu
Topic 4 t Elasticity of Demand
(Week 3-4 Sep 29th t Oct 4th)
z Opening Example:
You own the only spring in town, which produces sparkling water that you sell for $10 a bottle;
You have no costs, so that your profit equals your total revenue (price X quantity sold);
Q1. If you want to increase your revenue, should you raise your price above $10/bottle?
Q2. Would your answer change if these were other springs to town that also sold sparkling water?
Q1: If you raise your price:
a. consumer who continues to buy your water would pay more; you earns more money per bottle;
Revenue = price X quantity; price goes up while quantity sold goes down. Should you raise your price?
Thus introduced the concept of ^W]o]]Ç}(uv_.
z Price Elasticity of Demand
Elasticity of Demand measures the responsiveness of quantity demanded to a change in price.
Formula: Elasticity of demand = % Change in quantity demanded = %¸QD
% Change in price %¸P
(Due to the law of downward-sloping demand, the elasticity will be negative; just ignore the negative sign.)
1. Mid-Point Convention (calculating %change)
%¸QD = ¸QD (change in quantity demanded over average quantity demanded);
%¸P = ¸P (change in price over average price)
Insight: percentage change is the same with going up from A to B or going down from B to A on the curve.
e.g.1 t calculating percentage change
QD is not very responsive to a change in price;
QD changes at the same pace as the price;
QD is very responsive to a change in price;
QD is unlimited at certain price; and zero if price
%¸QD = 200 20%;
%¸P = 0.2 = 20%