Elasticity & Total Revenue
Chapter 5 completion….
Linear Demand curves have both elastic
& inelastic ranges
Points with high price & low quantity demand is elastic
Points with low price & high quantity demand is inelastic
Linear Demand Curve Elasticity
Price
$7
Elastic Range: Elasticity > 1
6
5
Unit Elastic at midpoint of line
4
3
Inelastic Range: Elasticity < 1
2
1
0
2
4
6
8
10
12
14
Quantity
Total Revenue
• Total revenue (TR) is not profit
– It is the total amount of revenue (money) received by a business
• TR = Price & Quantity Sold
Coffee Shop:
Price coffee:
Qty Sold:
Total Revenue =
$2 X 500 = $1,000
Profit = TR – all expenses
$2/cup
500 per day
Total Revenue
Price
When the price is $4, consumers
demand 100 units, and spend $400
on this good.
$4
P × Q = $400
P
( total revenue)
0
Demand
100
Q
Quantity
Price increases leads to:
TR rising in inelastic range
TR falling in elastic ranges
TR reaches maximum value at unit elastic
Total Revenue
Price ↑
TR ↑
Linear Demand Curve Elasticity
Price
Price
from $4 to $5 => TR
from $24 to $20.
$7
Elastic Range: Elasticity > 1
6
5
Price
from $2 to $3 => TR
from $20 to $24
4
3
Inelastic Range: Elasticity < 1
2
1
0
2
4
6
8
10
12
14
Quantity
Summary
• Elastic demand curves are flat
• Inelastic demand curves are steep
• Slope is constant, Elasticity is not
• Linear demand curves have both inelastic & elastic ranges
• Total Revenue:
– Falls when Prices ↑ on elastic goods
– Rises when Prices ↑ on inelastic goods
– Firms maximize total revenue by producing at unit elasticity
Total Revenue & Elasticity
Worksheet
Cross-price elasticity of demand
• Change in quantity demanded of one good in response to a
change in price of another good
Cross-price elasticity of demand =
% ∆ in Qty Dgood-1
% ∆ in Pgood-2
• Substitutes have positive cross-price elasticity Ea,b > 0
– Example: Price soda ↑ => Qty D other drinks ↑
• Complements have negative cross-price elasticity Ea,b < 0
– Example: Price gas ↑ => Qty D large SUV’s ↓
Income Elasticity of Demand
• Income elasticity of demand- how much quantity demanded
responds to a change in consumers’ income
–
EI = % ∆ in Qty Demanded
% ∆ in Income
•
•
•
•
Normal Goods have positive Income elasticity (normal good = Income ↑, Qty D ↑)
Inferior Goods: EI < 0
(negative income elasticity)
Income elastic: EI >1
(considered a luxury)
Income inelastic: 1 > EI > 0 (considered a necessity)
Elasticity of Supply
Es > 1
100
200
S1
• Depends on 2 primary factors:
• Ability to change quantity produced
– Beach front property is inelastic
– Books, cars are elastic
• Time Period
– Supply is more elastic in long run vs. short run
– Time allows companies to produce more
$5
--------
$4
------
--------------------
--------------
$4
-----------------------------------
----------
$5
S1
Es < 1
100 120
Practice Test #2