8.

Elasticity

 Point and Arc Elasticities

 So far - point elasticities

 If considering responsiveness over a range of prices / quantities

then arc elasticity is more appropriate
8. Elasticity

 Define:

 Thus:
 Figure 34: Arc Elasticity of Demand

a b

p0

p1

0 q0 q1 a q
8. Elasticity

 Arc elasticity between, e.g., p0 and p1 (q0 and q1) is equivalent to

point elasticity at:

 Or:
8. Elasticity

 Determinants of Elasticity

 Ultimately a matter of tastes - how essential is the good; how much

do individuals want it.

 Also time; more elastic in long run as consumers can substitute away.

 Most important consideration is the ease with which consumers can

substitute another good that fulfils approximately the same function
8. Elasticity

 Applications of Elasticity

 Determining price and quantity the maximises revenue.

 Seller can choose either how many goods to sell or the price
at which to sell them, but not both. i.e:

 R = p*q
8. Elasticity

 Consider effect of cut in price on Revenue (R)

(i) R falls because sell fewer goods at lower p;

(ii) R rises because sell more goods at higher p.

 Thus trade off!

 Question: Where is trade off optimised?

8. Elasticity

 Recall: If E > 1 then a 1% cut in p will lead to a more than

1% increase in qd

 Thus R will rise since increase in qd dominates fall in p

 Conversely if E < 1.
8. Elasticity

 Strategy

 If E > 1 then cut price to increase revenue.

 If E < 1 then raise price to increase revenue.