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The Use of Price Elasticity of Demand

The Use of Price Elasticity of Demand

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The Use of Price Elasticity of Demand

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  1. The Use of Price Elasticity of Demand Why Elasticity matters?

  2. Elasticity, Total Revenue, and Demand • The elasticity of demand tells suppliers how their total revenue will change if their price changes. • Total revenue equals total quantity sold multiplied by price of good.

  3. Elasticity, Total Revenue, and Demand • If ED is elastic (ED > 1), a rise in price lowers total revenue. • Price and total revenue move in opposite directions.

  4. Elasticity, Total Revenue, and Demand • If ED is unit elastic (ED = 1), a rise in price leaves total revenue unchanged.

  5. Elasticity, Total Revenue, and Demand • If ED is inelastic (ED< 1), a rise in price increases total revenue. • Price and total revenue move in the same direction.

  6. $10 8 F Gained revenue 6 Price Lost revenue 4 2 0 1 2 3 4 5 6 7 8 9 Quantity Elasticity and Total Revenue Unit Elastic Demand E = 1 TRE= $4x6=$24 TRF= $6x4=$24 TR constant C E A B

  7. Gained revenue Lost revenue Elasticity and Total Revenue Inelastic Demand E < 1 $10 TR rises if price increases 8 TRG = $1 x 9 = $9 TRH = $2 x 8 = $16 6 Price 4 H 2 G C A B 0 8 1 2 3 4 5 6 7 9 Quantity

  8. Gained revenue J K Lost revenue B Elasticity and Total Revenue Elastic Demand E > 1 $10 C TR falls if price increases. 8 TRJ = $8 x 2 = $16 TRK = $9 x 1 = $9 6 A Price 4 2 0 1 2 3 4 5 6 7 8 9 Quantity

  9. Total Revenue Along a Demand Curve • With elastic demand – a rise in price lowers total revenue. • With inelastic demand – a rise in price increases total revenue.

  10. Q0 Price 0 Quantity Q0 Total Revenue Along a Demand Curve Elastic ED > 1 ED = 1 Inelastic ED< 1 Total revenue 0 Quantity

  11. Relationship Between Elasticity and Total Revenue 7-11

  12. Elasticity of Individual and Market Demand • Price discrimination occurs when a firm separates the people with less elastic demand from those with more elastic demand.

  13. Elasticity of Individual and Market Demand • Firms that price discriminate charge more to the individuals with inelastic demand and less to individuals with elastic demands.

  14. Elasticity of Individual and Market Demand • Examples of price discrimination include: • Airlines’ Saturday stay-over specials. • The phenomenon of selling new cars. • The almost-continual-sale phenomenon.