Other Demand Elasticities AP Micro 9/18

Warm Up Imagine two different companies – a toilet paper company and a strawberry farm – are thinking about raising their prices in order to make more revenue. Which company would be more successful in raising their prices, and why?

Total Revenue Test For firms, elasticity is important as it determines how price changes impact total revenue and profits Total revenue: the total value of sales of a good or service – money coming in TR = Price X Quantity TR does not mean profit!!!! Profit = TR – Total Costs (TC)

Total Revenue Test When a seller raises the price of a good, there are two countervailing effects in action (except in the rare case of a good with perfectly elastic or perfectly inelastic demand): A price effect: After a price increase, each unit sold sells at a higher price, which tends to raise revenue. A quantity effect: After a price increase, fewer units are sold, which tends to lower revenue.

Total Revenue Test If total revenue changes in the opposite direction from price, demand is elastic In this case, the quantity effect is stronger than the price effect. If total revenue changes in the same direction as price, demand is inelastic In this case, the price effect is stronger than the quantity effect. If total revenue does not change when price changes, demand is unit elastic In this case, the sales effect and the price effect exactly offset each other.

Total Revenue Graphically Price $10 Elastic Demand Schedule and Total Revenue for a Linear Demand Curve 9 Unit- elastic 8 7 6 Inelastic Quantity demanded Total Revenue Price 5 4 3 $0 10 $0 2 1 1 9 9 D 2 8 16 1 2 3 4 5 6 7 8 9 10 Quantity 3 7 21 Total revenue 4 6 24 5 5 25 $25 6 4 24 24 7 3 21 21 8 2 16 16 9 1 9 10 9 The price elasticity of demand changes along the demand curve 1 2 3 4 5 6 7 8 9 10 Quantity Demand is elastic: a higher price reduces total revenue Demand is inelastic: a higher price increases total revenue

Practice Problem This business is losing revenue, and has decided to increase their prices in order to make more money. Business #1 increased the price of its product from $10 to $20. After that price increase, the business went from selling 100 units to 80 units. Determine the relative price elasticities of demand for the business’s product by calculating the coefficient AND doing the total revenue test. Did the business make the correct call in increasing prices in order to make more revenue?

Midpoint Elasticity: =% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑= −20 ( 100+80)/2 𝑥 100= −20 90 𝑥 100=−22% =% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒= 10 ( 10+20)/2 𝑥 100= 10 15 𝑥 100=67% 𝐸𝑑 = −22 67 =0.33 ****This is demand inelastic because it is < 1. Total Revenue: Total revenue: 10x100= 1000 New Total revenue: 20x 80= 1600 *****This also shows demand inelastic because as price increases, revenue also increased.

Cross-Price Elasticity The cross-price elasticity of demand between two goods measures the effect of the change in one good’s price on the quantity demanded of the other good ***Can either be pos or neg. Denoted as EAB The Cross-Price Elasticity of Demand between Goods A and B

Cross-Price Elasticity Goods are substitutes when the cross-price elasticity of demand is positive. Larger # = better substitutes Goods are complements when the cross-price elasticity of demand is negative. Very negative # = stronger complements Goods are independent when the cross-price elasticity is zero.

Practice Problem As the price of Coke rises by 20%, consumers increase their Pepsi consumption by 5%. Calculate the cross-price elasticity of demand between Coke and Pepsi. = 5 20 = 1 4 = .25 As the price of broccoli decreases by 10%, consumers decrease their cauliflower consumption by 50%. Calculate the cross-price elasticity of demand between broccoli and cauliflower. = −50 −10 =5 Which are closer substitutes? Coke and Pepsi, or broccoli and cauliflower? Broccoli and cauliflower are closer substitutes

As the price of peanut butter decreases by 10%, consumers increase their jelly consumption by 5%. Calculate the cross-price elasticity of demand between peanut butter and jelly. As the price of hot dogs increase by 30%, consumers decrease their hot dog bun consumption by 90%. Calculate the cross-price elasticity of demand between hot dogs and buns. Which are stronger complements? Peanut butter and jelly, or hot dogs and buns?

As the price of peanut butter decreases by 10%, consumers increase their jelly consumption by 5%. Calculate the cross-price elasticity of demand between peanut butter and jelly. = 5 −10 =− 1 2 =−.05 As the price of hot dogs increase by 30%, consumers decrease their hot dog bun consumption by 90%. Calculate the cross-price elasticity of demand between hot dogs and buns. =− 90 30 =−3 Which are stronger complements? Peanut butter and jelly, or hot dogs and buns? Hotdogs and buns