Managerial Economics

ninth edition

Thoma
Mauric

Chapter 6
Elasticity and Demand
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Managerial Economics,
Managerial Economics,

Copyright 2008 by the McGraw-Hill Companies, Inc. All

Managerial Economics

Price Elasticity of Demand (E)

Measures responsiveness or sensitivity
of consumers to changes in the price of
a good

%Q
E
%P

P & Q are inversely related by the law of

demand so E is always negative
The larger the absolute value of E, the more
sensitive buyers are to a change in price

6-2

Managerial Economics

Price Elasticity of Demand (E)

Table 6.1
Elasticity

6-3

Responsiveness

Elastic

%
Q % P

Unitary Elastic

%
Q % P

Inelastic

%
Q % P

Managerial Economics

Price Elasticity of Demand (E)

Percentage change in quantity
demanded can be predicted for a given
percentage change in price as:

%Qd = %P x E
Percentage change in price required for
a given change in quantity demanded
can be predicted as:

%P = %Qd E
6-4

Managerial Economics

Price Elasticity & Total Revenue

Table 6.2
Elastic

6-5

Inelastic

%
Q % P

%
Q % P

%
Q % P

TR falls

No change in TR

TR rises

TR rises

No change in TR

TR falls

Quantity-effect
dominates

Price
rises
Price
falls

Unitary elastic
No dominant
effect

Price-effect
dominates

Managerial Economics

Factors Affecting Price Elasticity

of Demand

Availability of substitutes

The better & more numerous the substitutes

for a good, the more elastic is demand

Percentage of consumers budget

The greater the percentage of the
consumers budget spent on the good, the
more elastic is demand

Time period of adjustment

The longer the time period consumers have
to adjust to price changes, the more elastic
is demand
6-6

Managerial Economics

Calculating Price Elasticity of

Demand

Price elasticity can be calculated

by multiplying the slope of demand
( Q/ P) times the ratio of price to
quantity (P/Q)
Q
100
Q P
%Q
Q

E
P
P Q
%P
100
P
6-7

Managerial Economics

Calculating Price Elasticity of

Demand

Price elasticity can be measured at

an interval (or arc) along demand,
or at a specific point on the
demand curve
If the price change is relatively small, a
point calculation is suitable
If the price change spans a sizable arc
along the demand curve, the interval
calculation provides a better measure
6-8

Managerial Economics

Computation of Elasticity Over an

Interval

When calculating price elasticity of

demand over an interval of
demand, use the interval or arc
elasticity formula
Q Average P
E

P Average Q
6-9

Managerial Economics

Computation of Elasticity at a
Point

When calculating price elasticity at a

point on demand, multiply the slope of
demand ( Q/ P), computed at the point
of measure, times the ratio P/Q, using
the values of P and Q at the point of
measure
Method of measuring point elasticity
depends on whether demand is linear or
curvilinear
6-

Managerial Economics

Point Elasticity When Demand is

Linear

Given Q a bP cM dPR , let income &

price of the related good take specific
and P , respectively
values M
R

Then express demand as Q a' bP , where

dP and the slope parameter
a' a cM
R

is b Q P

6-

Managerial Economics

Point Elasticity When Demand is

Linear

Compute elasticity using either of the two

formulas below which give the same value
for E

P
E b
Q

P
or E
PA

Where P and Q are values of price and quantity demanded

at the point of measure along demand, and A ( a'/ b )
is the price-intercept of demand

6-

Managerial Economics

Point Elasticity When Demand is

Curvilinear

Compute elasticity using either of two

equivalent formulas below

Q P
P
E

P Q P A
Where Q P is the slope of the curved demand at
the point of measure, P and Q are values of price and
quantity demanded at the point of measure, and A is
the price-intercept of the tangent line extended to
cross the price-axis

6-

Managerial Economics

Elasticity (Generally) Varies Along

a Demand Curve

For linear demand, price and E vary

directly

The higher the price, the more elastic is

demand
The lower the price, the less elastic is
demand

For curvilinear demand, no general rule

about the relation between price and
quantity
Special case of Q aP b which has a constant
price elasticity (equal to b) for all prices
6-

Managerial Economics

Constant Elasticity of Demand

(Figure 6.3)

6-

Managerial Economics

Marginal Revenue
Marginal revenue (MR) is the change
in total revenue per unit change in
output
Since MR measures the rate of
change in total revenue as quantity
changes, MR is the slope of the total
revenue (TR) curve

TR
MR
Q
6-

Managerial Economics

Demand & Marginal Revenue

(Table 6.3)

6-

TR = P Q

MR = TR/ Q

Unit sales (Q)

Price

$4.50

4.00

$4.00

$4.00

3.50

$7.00

$3.00

3.10

$9.30

$2.30

2.80

$11.20

$1.90

2.40

$12.00

$0.80

2.00

$12.00

$0

1.50

$10.50

$-1.50

--

Managerial Economics

Demand, MR, & TR

Panel A

6-

(Figure 6.4)

Panel B

Managerial Economics

Demand & Marginal Revenue

When inverse demand is linear,
= A + BQ (A > 0, B < 0)

Marginal revenue is also linear,

intersects the vertical (price) axis at
the same point as demand, & is twice
as steep as demand

MR = A + 2BQ

6-

Managerial Economics

Linear Demand, MR, & Elasticity

(Figure 6.5)

6-

Managerial Economics

MR, TR, & Price Elasticity

Table 6.4
Marginal
revenue

Total revenue

MR > 0

TR increases as
Q increases
(P decreases)

MR = 0
MR < 0
6-

Price elasticity
of demand
Elastic
Elastic
( E( >E1) > 1)

Unitelastic
elastic
Unit
TR is maximized
E = 1)
( E (= 1)
TR decreases as Inelastic
Inelastic
Q increases
(
E
<
1)
(
E
<
1)
(P decreases)

Managerial Economics

Marginal Revenue & Price Elasticity

For all demand & marginal revenue
curves, the relation between marginal
revenue, price, & elasticity can be
expressed as

1
MR P 1
E

6-

Managerial Economics

Income Elasticity
Income elasticity (EM) measures the
responsiveness of quantity demanded
to changes in income, holding the price
of the good & all other demand
determinants constant
Positive for a normal good
Negative for an inferior good

EM
6-

%Qd Qd M

%M
M Qd

Managerial Economics

Cross-Price Elasticity
Cross-price elasticity (EXY) measures the
responsiveness of quantity demanded of
good X to changes in the price of related
good Y, holding the price of good X & all
other demand determinants for good X
constant
Positive when the two goods are substitutes
Negative when the two goods are complements

E XY
6-

%Q X Q X PY

%PY
PY Q X

Managerial Economics

Interval Elasticity Measures

To calculate interval measures of
income & cross-price elasticities, the
following formulas can be employed

6-

EM

Q Average M

M Average Q

E XR

Q Average PR

PR Average Q

Managerial Economics

Point Elasticity Measures

6-

For the linear demand function

Q X a bPX cM dPY , point
measures of income & cross-price
elasticities can be calculated as

EM

M
c
Q

E XR

PR
d
Q