Elasticity – A measure of ResponsivenessArc Price Elasticity of Demand(Own) Price Elasticity of DemandFor a linear (“straight line”) demand curveSlide 5Slide 6Slide 7Marginal Revenue and Price Elasticity of DemandInverse Demand and Marginal RevenueInverse Demand, Marginal Revenue and Price ElasticityMarginal and Total RevenueDemand for Good XCross Price Elasticity of DemandIncome Elasticity of DemandAdvertising Elasticity of DemandElasticity – A measure of ResponsivenessThe “X Elasticity of Y” is defined as:If the X elasticity of Y equals 1.5, for example, we may conclude that a one percent increase (decrease) in X causes a one and one-half percent increase (decrease) in Y.,%%Y XY Y XEX X YD �= = �D �Arc Price Elasticity of DemandQPQ1Q0P1P0DOver the range of prices from P0 to P1:(Own) Price Elasticity of DemandLAW OF DEMAND:,X XX XQ PX XQ PEP Q�= ��For a linear (“straight line”) demand curveHere we hold all other variables which affect demand for this good (Income, Advertising, Prices of other Goods, etc.) constant.,X XX XQ PX XQ PEP QD= �D(Own) Price Elasticity of DemandPQ80120Q = 120 – 15PAs the price level rises, ceteris paribus, demand becomes more price elastic because:QPAs the length of the market period increases, demand becomes more elastic. Suppose the price of gasoline rises:Gallons/WeekPrice�0 �1 h���� �0Marginal Revenue and Price Elasticity of Demand( )X X X XX X XX X X XP Q P QTRMR Q PQ Q Q Q� � � ��= = = � + �� � � �X X XTR P Q= �Inverse Demand and Marginal RevenueGiven the Demand Curve Q = a – bP, the INVERSE DEMAND CURVE is:The inverse demand curve tells us, for any amount Q a firm takes to market, the maximum price the firm can charge and sell all of it. Maximum total revenue a firm can expect from this output Q will be:Thus Marginal Revenue, for any level of output Q, will be:The marginal revenue curve has the same intercept as the inverse demand curve, and its slope is twice as steep.Inverse Demand, Marginal Revenue and Price ElasticityQPDQ = a - bPMarginal and Total Revenueaa00QQa/bQ = a - bPPTRDemand for Good X( , , , ; )X X X YQ Q P P I A= W Price of Good XXP = Price of Good YYP = Average Household IncomeI = Advertising BudgetA = All other variables that affect QXW =Cross Price Elasticity of Demand,%%X YX Y XQ PY X YQ P QEP Q P� D= � =� D,0 Goods X and Y are ComplementsX YQ PE < �,0 Goods X and Y are SubstitutesX YQ PE > �Income Elasticity of Demand,%%XX XQ IXQ QIEI Q I� D= � =� D,0 Good X is an Inferior GoodXQ IE < �,0 Good X is a Normal GoodXQ IE > �Advertising Elasticity of DemandIf Advertising is successful in either (1) informing more households about the availability of Good X, or (2) persuading more households that Good X is a superior good, better than other alternatives, this elasticity will be positive.,%%XX XQ AXQ QAEA Q A� D= � =�