ECO 120 Lecture Notes - Lecture 20: Price Elasticity Of Demand, Midpoint Method, Root Mean Square
March 1, 2016
Elasticity and Its Applications: Chapter 5
Total Revenue
•total revenue= the total amount paid by buyers and received by sellers of a good
The Effect of a Price Increase on Total Revenue
•effects of price increase on a product with inelastic demand: price and total revenue move in
the same direction
•effects of price increase on a product with elastic demand: price and total revenue move in
opposite direction
•effects of price increase on a product with unitary demand elasticity: TR remains constant
The Effect of a Price Cut on Total Revenue
•effects of price decrease on a product with inelastic demand: price and TR move in same
direction
•effects of price decrease on a product with elastic demand: price and TR move in opposite
direction
•effects of price decrease on a product with unitary demand elasticity: TR remains constant
Examples
•the Umaine football team wants to increase attendance at their home games (and make a
little more money). They discover that by dropping the price just a little, they get more fans
and receive more revenue. This means:
-demand for Umaine football tickets is elastic
Notes
•pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall?
•expenditure= P x Q
•since demand is inelastic, Q will fall less than 10%, so expenditure rises
Income Elasticity of Demand
•income elasticity of demand= percentage change in quantity demanded/ percentage change
in income
•if the income elasticity of demand is positive, but <1, then the good is normal and a necessity,
example food, clothing.
•if the income elasticity of demand is positive, but >1, then the good is normal and a luxury
inferior example caviar,boat.
Cross-Price Elasticity of Demand
•cross-price elasticity of demand= percentage change in quantity demanded of one good/
percentage change in price of another good
•substitutes:
-goods typically used in place of one another
-positive cross-price elasticity
•complements
-goods that are typically used together
-negative cross- price elasticity
The Price Elasticity of Supply and its Measurement
•price elasticity of supply: how much the quantity supplies of a good responds to a change in
the price of that good
•price elasticity of supply= percentage change in quantity supplied/ percentage change in price
•it measures seller’s price sensitivity
•midpoint method:
•price elasticity of supply= (Q2-Q1)/ [(Q2 + Q1)/2] / (P2-P1)/ [(P2 + P1)/2]
Document Summary
Total revenue: total revenue= the total amount paid by buyers and received by sellers of a good. Examples: the umaine football team wants to increase attendance at their home games (and make a little more money). They discover that by dropping the price just a little, they get more fans and receive more revenue. Demand for umaine football tickets is elastic. Notes: pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall: expenditure= p x q, since demand is inelastic, q will fall less than 10%, so expenditure rises. Cross-price elasticity of demand: cross-price elasticity of demand= percentage change in quantity demanded of one good/ percentage change in price of another good, substitutes: Goods typically used in place of one another. Applications: elasticity and changes in equilibrium, the supply of beachfront property is inelastic.
