Elasticity
How price and quantity
interact
Price and Demand



People buy more at lower prices and buy less at
higher prices
Price Elasticity of Demand measures how much
more or less will be purchased with a change in
price
Usually negative: Higher price means less
demand
Price and Supply




People and companies supply more at higher
prices.
Price Elasticity of Supply measures how much
or less will be supplied for a change in price
Usually positive: Higher price means more
supply
Lower price means less supply
Example: Hercules SUV Dealer
Month
Average Price
Units Sold
August
$30,000
1,300
September
$35,000
1,000
Calculate Elasticity: simple method
(Most Commonly Used) Preferred
Old Price = $30,000 = Po
New Price = $35,000 = Pn
Old Quantity = 1,300 = Qo
New Quantity = 1,000 = Qn
% Change in Price = P
= (Pn – Po)/Po
P = $5,000/$30,000
P = 16.67%
% Change in Quantity = Q
= (Qn – Qo)/Qo
Q = -300/1,300
Q = -23.08%
Elasticity = Q/P
Q/P = -23.08%/16.67%
Elasticity = -1.4
Minus 1.4
IMPACT OF ELASTICITY
(Using Simple Method)
Sales were: 1,300 @
$30,000 = $39 million
Example A
INELASTIC (< 1)
Example B
ELASTIC (> 1)
New Price
$35,000
$35,000
P
+ 16.67%
+ 16.67%
Units Sold
1,170
1,000
Q
- 10.00%
- 23.08%
 Q/ P
0.60
-1.38
Interpret Elasticity



Elasticity < 1 is INELASTIC: means that Q is less than
P (Q is insensitive to P). Indicates few substitutes for this
SUV. NOTE: this refers to the number itself, not the sign.
Minus 1.4 is elastic. Minus 0.6 is inelastic.
Elasticity > 1 is ELASTIC: means that Q is more than P
(Q is sensitive to P). Indicates many substitutes for this
SUV.
Elasticity = 1 is UNIT ELASTIC: means that Q is equal
to P (Q is sensitive to P). Indicates some – but not many substitutes for this SUV.
Impact on Sales Revenues
Sales were: 1,300 @
$30,000 = $39 million
INELASTIC
ELASTIC
New Price
$35,000
$35,000
Units Sold
1,170
1,000
New Sales
$ million
$40.95
$35.00
 Sales
$ million
+ $1.95
- $4.00
Business and people like profits





In the previous slide, we saw that the change in
revenue from a change in price depends on the
elasticity
Profits also change.
Profits or Net Income = Revenue minus Cost
Revenue = Number sold x price
Cost = Number sold x cost per unit
Impact on Cost of Sales
Sales were: 1,300 @
$30,000 = $39
million
INELASTIC
ELASTIC
New Unit Sales
1,170
1,000
Cost per Unit
$25,000
$25,000
Cost of Sales
$29.25 million
$25.00 million
Impact on Profit
Sales were: 1,300 @
$30,000 = $39 million
INELASTIC
ELASTIC
Old Sales
$39.00 million
$39.00 million
Old Cost of Sales:
$32.50 million
$32.50 million
Old Profit
$6.50 million
$6.50 million
$40.95 million
$35.00 million
$29.25 million
$25.00 million
$11.70 million
$10.00 million
+ $5.20 million
+ $3.50 million
New Sales
New Cost of Sales
New Profit
Impact on Profit
Profits Rose




In both cases profits increased
However, there comes a point where elasticity of
demand becomes Highly Elastic.
No One would buy the SUV at $500,000 per
vehicle
If the price increase is too high, profit decreases
Practical Implications of Elasticity


It may be profitable to sell at a discount to buyers
with very elastic demand, if they can be
segmented, so that regular buyers don’t get the
discount.
Typical examples are:






Senior discounts
Student discounts
Early bird dinners
Ladies nights
Standby airfares
After-Christmas sales
Supply and Demand

Hercules SUV
2000
1500
1000
500
0
$2
0,
0
$2 00
5,
0
$3 00
0,
00
$3 0
5,
0
$4 00
0,
00
0

Supply curve: slopes
up
Demand curve: slopes
down
Intersect: where
Supply & Demand are
equal, at price of
$30,000
Units

Price
Summary

INELASTIC DEMAND: Few
substitutes, high prices.



Examples – Rolex, Rolls Royce,
Tiffany, Armani, Waterford,
Hermes.
Strategy: high price, high
margin, low volume.
ELASTIC DEMAND: Many
substitutes, low prices.


Examples – McDonalds, Taco
Bell, Amazon, Hyundai, WalMart.
Strategy: low price, low margin,
high volume.