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Factors Affecting Price Elasticity

Factors Affecting Price Elasticity. Is the good a necessity? Necessities tend to be relatively inelastic. Are there substitutes? When there are few substitutes, demand for good tends to be relatively inelastic. What % of income is spent on good?

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Factors Affecting Price Elasticity

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  1. Factors Affecting Price Elasticity • Is the good a necessity? • Necessities tend to be relatively inelastic. • Are there substitutes? • When there are few substitutes, demand for good tends to be relatively inelastic. • What % of income is spent on good? • Lower % of income spent on good, demand tends to be relatively inelastic • How much time to adjust to price change? • Less time to adjust, good tends to be relatively inelastic. Becomes more elastic as time passes and adjustments made.

  2. Price elasticity • Responsiveness of quantity demanded to changes in price. • Income elasticity • Responsiveness of quantity demanded to changes in income. % change in Q EP = % change in P • Cross price elasticity • Responsiveness of quantity demanded to changes in prices of related goods. % change in Q EP = % change in QX % change in Y EP = % change in PY Elasticity of Demand (3 types)

  3. Demand, Revenue, and MR EP = (dQ/dP)(P/Q) = slope x P/Q P 300 200 100 0 1,600 Q 400 1,200 800 MR

  4. Demand, Revenue, and MR Q = 1,600 – 4P (dQ/dP) = - 4 P Price elastic Unit elastic (-1) 300 200 Price inelastic 100 0 1,600 Q 400 1,200 800 MR

  5. Demand, Revenue, and MR -4 (300/400) = -3.0 P Price elastic 300 200 100 0 1,600 Q 400 1,200 800 MR

  6. Demand, Revenue, and MR P 300 -4 (100/1200) = -.33 200 Price inelastic 100 0 1,600 Q 400 1,200 800 MR

  7. MR = zero = profit max Demand, Revenue, and MR P -4 (200/800) = -1 300 Unit elastic (-1) 200 100 0 1,600 Q 400 1,200 800 MR

  8. Optimal Pricing • Maximizing Revenue • Sometimes a conflict between maximizing profit and maximizing revenue • Pure selling problem = little or no variable costs are incurred in production or supply of a good or service. • With no variable costs, profit max IS where revenue is maximized. • Examples, airline industry, event ticket sales, software copies

  9. Optimal Pricing • Maximizing Revenue • Profit max is where MR = MC • Revenue max is where MR = 0. • In pure selling problem, marginal costs are zero, so profit max and revenue max are where MR = 0.

  10. P 300 200 100 0 1,600 Q 400 1,200 800 MR R = 400Q - .25Q2 Q = 800 at MR =0

  11. EP P = MC 1 + EP Optimal Pricing • Optimal Markup Pricing • Markup Rule: The size of a firm’s markup (above MC and expressed as a percentage of price) depends inversely on the price elasticity of demand. Markup Equation:

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