Lecture 8-131003 Flashcards
What is the definition of elasticity?
Elasticity – Is a measure of sensitivity for responsiveness between 2 variables
More specifically elasticity measures the % change in a dependent variable given % change in independent variable also called predictor variable – ceteris paribus (all other predictor variables held constant)
e=(% ∆ Dependent Variable)/(%∆ Independent Variables)
Ceteris paribus
T or F-Always use the absolute value of own price elasticity.
Answers will be negative, always use the absolute value for this elasticity, It is given because of the Law of Demand. All other demand elasticities, the sign is VERY important
How can the elasticity equation be manipulated?
ePx = (% ∆ QDDx)/(%∆ Px)= (∆QDDx/QDDx)/(∆Px/Px)= ((Q2-Q1)/Q1)/((P2-P1)/P1)
When is the own price elastic?
ePx > 1 price is very elastic => lower your price until MC= MR 2/1
for every 10% ↑change Price then Quantity demand double 20%↓
Elastic = highly responsive, it adjusts a lot
What is unitary elasticity
ePx = 1 unitary elastic If you raise 5% Price then Quantity demand goes down 5%
Unitary =one for one
Total Revenues at the unitary point of elasticity are zero.
If you have pricing power and know what the demand elasticity, what can you do?
You can lower price to increase revenues (elastic) or raise prices to increase revenues (market share)(inelastic) Lower price for 10%, elasticity is 2 (e>1), Quantity goes up 20%
Total Revenues will increase because the percentage change in quantity demanded dominates.
Elasticity tells you how much revenues will change by.
Is it possible to increase the prices when it is less than 1
Yes, Elasticity is 0.5 (1/2) (e<1) Raise Price by 10% (increases TR), BUT demanded Q will decrease by 5%. The price raise dominates the decrease in quantity demanded.
Where should the price be on the demand curve to maximize total revenues
Total revenue is maximized when demand elasticity is CLOSEST to unitary, which means that marginal revenues equal zero.
Where should the price be on the demand curve to maximize Profits?
Price should be set at the point where marginal revenue is greater than the marginal costs. NOT the unitary point of elasiticity. If you keep lowering prices, marginal revenues will start going down because increase in variable costs.
True or False-It is possible to raise revenue or profits below the unitary point?
False-It is never a good idea to set the price BELOW the unitary point of elasticity, regardless of whether the firms wants to maximize profits or total revenues
Where should a firm set the price to maximize revenue
As close to the unitary point of elasticity, but NOT at the unitary point of elasticity.
Why are marginal revenues not going up after the unitary point of elasticity?
Because labor will have to increase, equipment will have to increase,. If output increases, total variable costs will also increase.
What can a firm do to increase revenues when there is elasticity.
in an elastic situation a firm can lower prices to increase revenues or in an inelastic it can raise prices, given that it has pricing power!
What are the two reasons for NOT lowering the price for a product below the unitary point of elasticity
- Total Revenues will go down
- The increase in production of the quantity will lead to an increase in marginal costs because of increase in variable costs.
