Demand Elasticity

•Work on the ½ sheet of problems at door.•Have out HW & Test Corrections to be

collected.

Warm Up Problems

1. P1 $100 P2 $1252. Q1 10 Q2 83. P1 $64 P2 $324. P1 $80 P2 $1205. Q1 50 Q2 1506. Q1 16 Q2 20

Answer: +25%

Answer: -20%

Answer: -50%

Answer: +50%

Answer: +200%

Answer: +25%

Warm Up Problems

Point Price Q.D.

1 $12 6

2 $8 9

Point Price Q.D.

1 $60 100

2 $80 90

Answer: Price decreases 33%

Quantity increases 50%

%ΔQD > %ΔP = Elastic

Ed = 1.5

Answer: Price increases 33%

Quantity decreases 10%

%ΔP > %ΔQD = Inelastic

Ed = 0.30

Elasticity and Total Revenue

• We have seen that OPEC increased its revenues in the 1970s by restricting supply and pushing up the market price of crude oil. We also argued that a similar strategy by OBEC would probably fail. Why?

Total Revenue• We can now use the more formal definition of

elasticity to make more precise our argument of why OPEC would succeed and OBEC would fail. In any market, P × Q is total revenue (TR) received by producers:

• TOTAL REVENUE = PRICE × QUANTITY• TR = P × Q• Because total revenue is the product of P and Q,

whether TR rises or falls in response to a price increase depends on which is bigger (the percentage increase in price or the percentage decrease in quantity demanded).

Testing Total Revenue

P Q TR1 $5 102 $2.50 40

%∆ ↓50% ↑300%

$50

$100

%ΔQD > %ΔP = Elastic;

Decreasing Price will = Increase TR

× =

Testing Total Revenue

P Q TR1 $200 1502 $450 75

%∆ ↑125% ↓50%

$30,000

$33,750

%ΔP > %ΔQD = Inelastic;

Increasing Price will = Increase TR

Testing Total Revenue

P Q TR1 $12 362 $15 24

%∆ ↑25% ↓33%

$432

$360

%ΔQD > %ΔP = Elastic;

Increasing Price will = Decrease TR

Testing Total Revenue

P Q TR1 $36 402 $24 50

%∆ ↓33% ↑25%

$1440

$1200

%ΔP > %ΔQD = Inelastic;

Decreasing Price will = Decrease TR

Total Revenue RulesEffect of Price on

QuantityType of

ElasticityChange in

Total Revenue

P × QP × QP × QP × Q

Inelastic TR ↑

Inelastic TR ↓

Elastic TR ↑

Elastic TR ↓