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Unformatted text preview: ortant Relationship
Between Elasticity and Total
Demand is elastic for one good and
inelastic for another good. Does it matter?
As you just read, it can matter to you as an
individual, and it definitely matters to the
sellers of goods. In particular, it matters to a
seller’s total revenue (money sellers receive
for selling their goods). To see how elasticity
of demand relates to a business’s total revenue, let’s consider four cases in detail. The
cases look at both elastic and inelastic goods
and what happens to each when the price
rises, and when the price falls.
• Case 1: Elastic Demand and a Price
Javier currently sells 100 basketballs a
week at a price of $20 each. His total
revenue (price × quanity) per week is
$2,000. Suppose Javier raises the price of
his basketballs to $22 each, a 10 percent
increase in price. As a result, the quantity
demanded falls from 100 to 75, a 25
percent reduction. The demand is
elastic because the change in quantity
demanded (25%) is greater than the
change in price (10%). What happened
to Javier’s total revenue at the new price
and quantity demanded? It is $1,650:
the new price ($22) multiplied by the
number of basketballs sold (75).
Notice that if demand is elastic, a
price increase will lead to a decline in
total revenue. Even though he raised the
price, Javier’s total revenue went down,
from $2,000 to $1,650. An important
lesson here is that an increase in price
does not always bring about an increase
in total revenue.
Elastic demand Price increase
Total revenue decrease • Case 2: Elastic Demand and a Price
In case 2, as in case 1, demand is elastic.
This time, however, Javier lowers the
price of his basketballs from $20 to $18, a he Bureau of Labor Statistics
(BLS) is an agency within the
U.S. Department of Labor.
The agency collects data on prices
in the economy. To see whether consumer prices are rising,
falling, or remaining constant, go to the BLS Web site at
www.emcp.net/prices. Once there, click on “Inflation &
Consumer Spending.” Next, scroll down the page until you
see “Consumer Price Index (CPI).” The CPI is a measure of
the prices of the goods and services purchased by consumers.
Have prices risen, fallen, or remained constant in the last
month reported? If prices have risen or fallen, by what percentage have they risen or fallen? T 10 percent reduction in price. We know
that if price falls, quantity demanded will
rise. Also, if demand is elastic, the percentage change in quantity demanded is
greater than the percentage change in
price. Suppose quantity demanded rises
from 100 to 130, a 30 percent increase.
Total revenue at the new, lower price
($18) and higher quantity demanded
(130) is $2,340. Thus, if demand is elastic
and price is decreased, total revenue will
Elastic demand Price decrease
Total revenue increase • Case 3: Inelastic Demand and a Price
Now let’s assume that the demand for
basketballs is inelastic, rather than elastic, as it was in cases 1 and 2. Suppose
Javier raises the price of his basketballs
to $22 each, a 10 percent increase in
price. If demand is inelastic, the percentage change in quantity demanded
must fall by less than the percentage
rise in price. Suppose the quantity
demanded falls from 100 to 95, a 5 percent reduction.
Javier’s total revenue at the new price
and quantity demanded is $2,090, which Section 3 Elasticity of Demand 105 04 (086-109) EMC Chap 04 11/17/05 ? 4:37 PM Who’s
of Demand”? R ock stars need to know more
than how to write and play
music. They also need to know
about elasticity of demand. In fact,
a large part of their earnings will
depend on whether they know
about elasticity of demand.
Suppose you are a rock star.
You write songs, record them, and
spend 150 days each year on the
road performing. Let’s say that
tonight you will be performing in
Chicago. The auditorium there seats Page 106 30,000 people. Do you earn more
income if all 30,000 seats are sold
or if only 20,000 seats are sold?
This question seems a little silly.
It seems obvious that you would be
better off if you sold more tickets
than fewer tickets. Certainly 30,000
would be better than 20,000,
wouldn’t it? “You can’t always get
what you want
But if you try sometimes
You just might find
You’ll get what you need”
—The Rolling Stones
The obvious answer here is not
necessarily correct. The answer
really depends on an understanding
of elasticity of demand. Let’s say
that to sell all 30,000 seats, the
price per ticket has to be
$30. At this ticket price,
total revenue, which is the
number of tickets sold
times the price per ticket,
If the demand for
your Chicago performance
is inelastic, a higher ticket
price will actually raise
total revenue. (Remember: Inelastic demand +
Price increase = Increase
in total revenue.) Suppose
you raise the ticket price is the new price ($22) multiplied by the
number of basketballs sold (95). Notice
that if demand is inelastic, a price
increase will lead to an incre...
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