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Math 1525
Elasticity Of Demand

Excel

Lab 11

Spring 2002

If you change the price of an Item you sell, you should expect the number of sells to change. In general, a higher price means less demand for your product. We are going to investigate how much a price change really affects the sales of a given item. The change in demand as related to change in price varies with different products. For example, a change in the price of a candy bar by one dollar will affect the demand for that candy bar in a substantial way, but if the price of a computer system is changed by one dollar, the demand is not affected at all. Instead of considering the absolute change in price, it is easier to consider and compare the percent change in price. We investigate how a 1% change in price affect the demand. We look at the percent change in demand rather than the absolute change. The percent change in demand is given by q/q, and the percent change in price is given by p/p. The ratio of percent change in demand to the percent change in price is (q/q)/( p/p). If the absolute value of the ratio is large then a change in price caused a larger change in demand. We can also rewrite the ratio as follows: ( q/q)/( p/p) = ( q/q) *(p/ p) =( p/q) *( q/ p) = (p/q)/( p/ q) = ( p/q)/(dp/dq) for very small changes in the independent variable. Therefore the Elasticity of Demand for a product is defined to be the ratio of percent change in demand to percent change in price which is given by the equation, E = (p/q)/(dp/dq). If the Absolute value of E > 1 the elasticity is called elastic , which means that 1% change in price causes a relatively larger change in demand . If the absolute value of E = 1 (this is called unit elastic) then a 1% change in price produces approximately a 1% change in demand. If the absolute value of E < 1 (this is called inelastic) then a 1% change in price little or no change in demand. Elasticity and revenue are related as follows: Maximum revenue occurs when demand is unit elastic. If demand is inelastic, then revenue is increased by raising the price. If demand is elastic then revenue is increased by lowering the price. Elastic Demands : silver, furniture, cars, musical instruments, T.Vs, sporting goods, etc. Inelastic Demands: electricity, beverages, food, clothing, Medicines, insurance, water, etc Example I : A white water rafting company wishes to raise their rates from $75 to $80 per person. He is afraid that in doing this, the number of customers will decrease from 100 to 90 per week. a) What is the elasticity of demand? b) Should the company raise the price? First find the percent change in price, the percent change in demand and then the elasticity. Ans: E = -1.5 Show your work and give your conclusion in complete sentences. Example 2: If the demand for a product is given by q = 1000 - 2p2 , find the elasticity at p = 10.

Solution: Since E = (p/q)*(dq/dp), fill in this formula as follows: E = ( p/q)*(-4p) = (10/800)*(-40) = -0.5 therefore at a price of $10, a 1% increase in price will result in approximately .5% decrease in demand. The demand is inelastic. Now try the same problem again for the price p = $15. Show your work and give your answers in complete sentences. Example 3: If the demand for a product is given by p = 60 - 0.5q , Find the elasticity at q = 80.

Solution: Since E =( p/q)/(dp/dq), fill in this formula as follows: E = (p/q)/ (-0.5) = (-20/40)/(-0.5) = ?? Find the answer and determine if this demand is elastic, unit elastic or inelastic. Interpret the results as in example 2. Example 4: Find the elasticity for the demand function q = 343(.837)p for p 0 on the interval [4, 5]. Use the form

of the equation E = (q/q)/( p/p) and the values for p = 4 , q = 168 and for p = 5, q = 141 to get that E = -.643. Therefore the demand is elastic.

2 Problems to turn for Lab #5;

1) Find the elasticity of the demand equation p = 100 - 5q (where p is price and q is quantity) for q = 12, q = 10, q = 8 2) A commuter bus line determines it's demand equation to be q = 81 - p2. Where q is the number of tickets sold and p is the price charged. Use Excel to determine the Elasticity of demand. In the first column put in values for p starting with 0. You may have to expand your original values entered as needed. In the second column type in the elasticity formula for the given demand equation. Run your values to determine where unit elasticity occurs. Verify this answer by algebra. (Set your Elasticity equation = -1 and solve.) Verify that revenue is maximum at that value by showing where MR = 0. Determine the values of p for which the demand is inelastic. 3) The demand of a coffee blend from South America is given by q = 63 - 2p2 where q is the number of pounds of coffee and p is the price per pound. a) If the current price of the coffee is $4 /lb, how many pound will be sold? b) Is the demand elastic or inelastic at $4? What would be correct to say? 1) "People must have their coffee" or 2) " Coffee is a luxury item." c) At a price of $4/lb what is the total revenue for the coffee farmer? d) Use the equation for revenue and find maximum revenue. Find the price for Maximum revenue. e) What quantity is sold at the price found in d). f) show that E = -1 for the price you found in d). 4) According the elasticity value given would the following be a luxury item or a necessity? Item Beanie Babies computer at Tech VCR TV at Tech lightbulbs elasticity -0.27 -0. 30 -1.06 -3.04 -0.33 Luxury or Necessity ________________ ________________ ________________ ________________ ________________

5) A Va Tech student organization trying to raise money by selling T-shirts. The table below gives the data they have accumulated up to this point. P is the price charged and q is the number of T-shirts sold. P Q 10 40 12 34 14 30 16 26 20 13 25 5

Use Excel or a calculator to estimate the elasticity at each of the prices shown.( Since you do not have a given equation for demand, you will use the equation E = (q/q)/( p/p) or find a best fit equation and use the formula for E as before. ) What do you notice? Where does unit elasticity occur? Find the total revenue at each price and confirm that revenue is maximum when E = -1 (approximately)