L4 - Elasticity

L4 - Elasticity - You design websites for local businesses....

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Unformatted text preview: You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you’re thinking of raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase? You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you’re thinking of raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase? A scenario… Elasticity • Elasticity measures how much one variable responds to changes in another variable. – Example: how much demand for your websites will fall if you raise your price. • Elasticity is a numerical measure of the responsiveness of Q d or Q s to one of its determinants. Price Elasticity of Demand • Price elasticity of demand measures how much Q d responds to a change in P . Price elasticity of demand = Percentage change in Q d Percentage change in P • Loosely speaking, it measures the price- sensitivity of buyers’ demand. Price Elasticity of Demand Price elasticity of demand equals P Q D Q 2 P 2 P 1 Q 1 P rises by 10% Q falls by 15% 15% 10% = 1.5 Price elasticity of demand = Percentage change in Q d Percentage change in P Example: Price Elasticity of Demand Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as positive numbers . Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as positive numbers . P Q D Q 2 P 2 P 1 Q 1 Price elasticity of demand = Percentage change in Q d Percentage change in P Calculating Percentage Changes P Q D $250 8 B $200 12 A Demand for your websites Standard method of computing the percentage (%) change: end value – start value start value x 100% Going from A to B, the % change in P equals ($250–$200)/$200 = 25% Calculating Percentage Changes P Q D $250 8 B $200 12 A Demand for your websites Problem : The standard method gives different answers depending on where you start. From A to B, P rises 25%, Q falls 33%, elasticity = 33/25 = 1.33 From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50 Calculating Percentage Changes • So, we instead use the midpoint method : end value – start value midpoint x 100% • The midpoint is the number halfway between the start & end values, also the average of those values....
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This note was uploaded on 12/02/2011 for the course ECON 200 taught by Professor Vincent during the Fall '08 term at Maryland.

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L4 - Elasticity - You design websites for local businesses....

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