{"id":110,"date":"2016-11-01T12:02:15","date_gmt":"2016-11-01T16:02:15","guid":{"rendered":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/?post_type=chapter&#038;p=110"},"modified":"2017-05-22T20:49:15","modified_gmt":"2017-05-23T00:49:15","slug":"4-4-elasticity-and-revenue","status":"publish","type":"chapter","link":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/chapter\/4-4-elasticity-and-revenue\/","title":{"raw":"4.2 Elasticity and Revenue","rendered":"4.2 Elasticity and Revenue"},"content":{"raw":"<div class=\"bcc-box bcc-highlight\">\r\n<h3 itemprop=\"educationalUse\">Learning Objectives<\/h3>\r\nBy the end of this section, you will be able to:\r\n<ul>\r\n \t<li>Analyze graphs in order to classify elasticity as constant unitary, infinite, or zero<\/li>\r\n \t<li>Describe the price effect and the quantity effect<\/li>\r\n \t<li>Analyze how price elasticities impact revenue and expenditure<\/li>\r\n<\/ul>\r\n<\/div>\r\nIn Topic 4.1, we\u00a0introduced the concept of elasticity and how to calculate it, but we didn\u2019t explain why it is useful.\u00a0Recall that\u00a0<strong>elasticity<\/strong>\u00a0measures responsiveness of one variable to changes in another variable. If you owned a coffee shop and wanted to increase your prices, this \u2018responsiveness\u2019\u00a0is something you need to consider. When you increase prices, you know quantity will fall, but by how much?\r\n\r\nElasticities can be divided into three broad categories: elastic, inelastic, and unitary. An\u00a0<strong>elastic demand<\/strong>\u00a0is one in which the elasticity is greater than one, indicating a high responsiveness to changes in price. Elasticities that are less than one indicate low responsiveness to price changes and correspond to\u00a0<strong>inelastic demand.<\/strong>\u00a0<strong>Unitary elasticities<\/strong>\u00a0indicate proportional responsiveness of either demand or supply, as summarized in\u00a0the following table:\r\n<table id=\"Table_05_01\" summary=\"If percentage change in quantity is greater than percentage change in price then percentage change in quantity divided by percentage change in price is greater than 1, and it is called \u201cElastic.\u201d If percentage change in quantity is equal to percentage change in price then percentage change in quantity divided by percentage change in price is equal to 1, and it is called \u201cUnitary.\u201d If percentage change in quantity is less than percentage change in price then percentage change in quantity divided by percentage change in price is less than 1, and it is called \u201cInelastic.\u201d\">\r\n<thead>\r\n<tr>\r\n<th>If . . .<\/th>\r\n<th>Then . . .<\/th>\r\n<th>And It Is Called . . .<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>$latex \\%\\;change\\;in\\;quantity &gt; \\%\\;change\\;in\\;price$<\/td>\r\n<td>$latex \\frac{\\%\\;change\\;in\\;quantity}{\\%\\;change\\;in\\;price)} &gt; 1$<\/td>\r\n<td>Elastic<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>$latex \\%\\;change\\;in\\;quantity = \\%\\;change\\;in\\;price$<\/td>\r\n<td>$latex \\frac{\\%\\;change\\;in\\;quantity}{\\%\\;change\\;in\\;price)} = 1$<\/td>\r\n<td>Unit Elastic<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>$latex \\%\\;change\\;in\\;quantity &lt; \\%\\;change\\;in\\;price$<\/td>\r\n<td>$latex \\frac{\\%\\;change\\;in\\;quantity}{\\%\\;change\\;in\\;price)} &lt; 1$<\/td>\r\n<td>Inelastic<\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"3\">Elastic, Inelastic, and Unitary: Three Cases of Elasticity<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<span>If we were to calculate elasticity at every point on a demand curve, we could divide it into these elastic, unit elastic, and inelastic areas, as shown in Figure 4.2a. \u00a0This means the impact of a price change will depend on where we are producing. Feel free to calculate the elasticity in any of the regions, you will\u00a0find that it\u00a0indeed fits the description.<\/span>\r\n\r\n[caption id=\"attachment_738\" align=\"alignnone\" width=\"491\"]<img src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3a.jpg\" alt=\"figure-4-3a\" width=\"491\" height=\"345\" class=\"wp-image-738\" \/> Figure 4.2a[\/caption]\r\n\r\nTo demonstrate, we have calculated the elasticities at a point in each of the zones:\r\n\r\n<strong>Point A =\u00a0<\/strong>$latex \\frac{\\Delta Q}{\\Delta P}\\cdot \\frac{P}{Q}=\\frac{9}{6.75}\\cdot \\frac{4.5}{3}=2$ =\u00a0<strong>Elastic<\/strong>\r\n\r\n<strong>Point B = <\/strong>$latex \\frac{\\Delta Q}{\\Delta P}\\cdot \\frac{P}{Q}=\\frac{9}{6.75}\\cdot \\frac{3}{5}=0.8$ =\u00a0<strong>Inelastic<\/strong>\r\n\r\n<strong>Point C =\u00a0<\/strong>$latex \\frac{\\Delta Q}{\\Delta P}\\cdot \\frac{P}{Q}=\\frac{9}{6.75}\\cdot \\frac{3.375}{4.5}=1$ =\u00a0<strong>Unit Elastic<\/strong>\r\n\r\nIn reality, the only point we need to find to determine which areas are elastic and inelastic is our point where elasticity is 1, or Point C. This isn\u2019t as hard as it may seem. Since our formula is equal to the inverse of our slope multiplied by a point on the graph, it will only equal 1 when our point is equal to the slope of our graph.\u00a0For a linear graph, this only occurs at the middle point, which is (4.5, 3.325) in this case.\r\n<h2>Why is This Useful?<\/h2>\r\n[caption id=\"attachment_782\" align=\"alignleft\" width=\"592\"]<img src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Starbucks-B1G1-FREE-Holiday-Drink.jpg\" width=\"592\" height=\"333\" class=\"wp-image-782\" alt=\"\" \/> When Starbucks runs a buy one get one free promotion, they effectively lower the price of a drink by 50%. The company sells more drinks, but at a lower price. Elasticity determines whether or not this promotion will be profitable. Of course, promotions are not always intended to be profitable in the short term. Oftentimes, firms will cut prices to increase awareness of their new products, as Starbucks does with its holiday drinks. (Credit: Starbucks)[\/caption]\r\n\r\nSo far, we have determined how to calculate elasticity at and between different points, but why is this knowledge useful?\r\n\r\nConsider a coffee shop owner considering a price hike. The\u00a0owner\u00a0has two things to account for\u00a0when deciding whether to raise the price, one that increases revenue and one that decreases it. Elasticity helps us determine which effect is greater. Referring back to our table:\r\n<ol>\r\n \t<li>When you increase price, you increase revenue on units sold\u00a0<strong>(The Price Effect).<\/strong><\/li>\r\n \t<li>When you increase price, you sell fewer units\u00a0<strong>(The Quantity Effect).<\/strong><\/li>\r\n<\/ol>\r\nThese two effects work against each-other. To determine which outweighs the other we can look at elasticity:\r\n\r\nWhen our point is\u00a0<strong>elastic\u00a0<\/strong>our\u00a0<span>$latex \\%\\;change\\;in\\;quantity &gt; \\%\\;change\\;in\\;price$ meaning if we increase price, our quantity effect\u00a0outweighs\u00a0the price effect, causing a decrease in revenue.\u00a0<\/span>\r\n\r\n<span>When our point is\u00a0<strong>inelastic<\/strong><\/span><strong>\u00a0<\/strong><span>our\u00a0$latex \\%\\;change\\;in\\;quantity &lt; \\%\\;change\\;in\\;price$<\/span><span>\u00a0meaning if we increase price, our price\u00a0effect\u00a0outweighs\u00a0the quantity\u00a0effect, causing a increase\u00a0in revenue.\u00a0<\/span>\r\n\r\nThis information is summarized in Figure 4.2b:\r\n\r\n[caption id=\"attachment_742\" align=\"alignleft\" width=\"365\"]<img src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3b.jpg\" alt=\"Figure 4.3b \" width=\"365\" height=\"501\" class=\"wp-image-742\" \/> Figure 4.2b[\/caption]\r\n\r\n&nbsp;\r\n\r\nThe first thing to note is that revenue is maximized at the point where elasticity is unit elastic. Why? If you are the coffee shop owner, you will notice that there are untapped opportunities when demand is elastic or inelastic.\r\n\r\n<strong>If elastic:\u00a0<\/strong>The quantity effect outweighs the price effect, meaning if we decrease prices, the revenue gained\u00a0from the more\u00a0units sold will outweigh the revenue lost from the decrease in price.\r\n\r\n<strong>If inelastic:\u00a0<\/strong>The price\u00a0effect outweighs the quantity\u00a0effect, meaning if we increase\u00a0prices, the revenue gained\u00a0from the higher price will outweigh the revenue lost from less units sold.\r\n\r\nThe effects of price increase and decrease at different points are summarized in Figure 4.2c.\r\n\r\n&nbsp;\r\n\r\n[caption id=\"attachment_744\" align=\"aligncenter\" width=\"569\"]<img src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2016-11-13-at-2.32.59-PM.png\" width=\"569\" height=\"247\" class=\"wp-image-744 size-full\" \/> Figure 4.2c[\/caption]\r\n\r\n&nbsp;\r\n<h2>What about Expenditure<\/h2>\r\nYou will notice that expenditure is mentioned whenever revenue is. This is because a dollar earned by the coffee shop corresponds to a dollar spent by the consumer. Therefore, if the firm\u2019s revenue is rising, then the consumer\u2019s expenditure is rising as well.\u00a0You must understand how to answer questions from both sides.\r\n<h2>Summary<\/h2>\r\nElasticity is used to measure the responsiveness of one variable to another.\u00a0This responsiveness\u00a0can be labelled as elastic (e &gt; 1), unit elastic (e = 1), and inelastic (e &lt; 1). We can apply this to the demand curve, with unit elastic corresponding to the middle of the demand curve (x-intercept\/2 , y-intercept\/2). Everything to the left is\u00a0elastic and everything to the right is\u00a0inelastic. This information can be used to maximize revenue or expenditure,\u00a0with the understanding that when elastic, the quantity effect outweighs the price effect, and when inelastic, the price effect outweighs the quantity effect.\r\n<div class=\"textbox\">\r\n<h2>Glossary<\/h2>\r\n<dl id=\"fs-idm51600048\" class=\"definition\">\r\n \t<dt><strong>Elastic<\/strong><\/dt>\r\n \t<dd id=\"fs-idp17805888\"><em>when the elasticity \u00a0is greater than one, indicating\u00a0that a 1 percent increase in price will result in a more\u00a0than 1 percent increase in quantity; this indicates a high\u00a0responsiveness to price.<\/em><\/dd>\r\n<\/dl>\r\n<dl id=\"fs-idm51600048\" class=\"definition\">\r\n \t<dt><strong>Inelastic<\/strong><\/dt>\r\n \t<dd id=\"fs-idp17805888\"><em>when the elasticity is less than one, indicating that a 1 percent increase in price paid to the firm will result in a less than 1 percent\u00a0increase in quantity; this indicates a low responsiveness to price.<\/em><\/dd>\r\n<\/dl>\r\n<dl id=\"fs-idm51600048\" class=\"definition\">\r\n \t<dt><strong>Unitary elastic<\/strong><\/dt>\r\n \t<dd id=\"fs-idp17805888\"><em>when the calculated elasticity is equal to one indicating that a change in the price of the good or service results in a proportional change in the quantity demanded or supplied<\/em><\/dd>\r\n<\/dl>\r\n<\/div>\r\n<div class=\"bcc-box bcc-info\">\r\n<h3 itemprop=\"educationalUse\">Exercises 4.2<\/h3>\r\nUse the demand curve diagram below to answer the following TWO questions.\r\n\r\n<img src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.34-PM.png\" alt=\"\" width=\"305\" height=\"239\" class=\"alignnone size-full wp-image-1110\" \/>\r\n\r\n<strong>1.<\/strong> What is the own-price elasticity of demand as price decreases from $8 per unit to $6 per unit? Use the mid-point formula in your calculation.\r\n\r\na) Infinity.\r\nb) 7.0\r\nc) 2.0.\r\nd) 1.75\r\n\r\n&nbsp;\r\n\r\n<strong>2.<\/strong> At what point is demand unit-elastic?\r\n\r\na) P = $6, Q = 12.\r\nb) P = $4, Q = 8.\r\nc) P = $2, Q = 12.\r\nd) None of the above.\r\n\r\n&nbsp;\r\n\r\n<strong>3.<\/strong> Which of the following statements about the relationship between the price elasticity of demand and revenue is TRUE?\r\n\r\na) If demand is price inelastic, then increasing price will decrease revenue.\r\nb) If demand is price elastic, then decreasing price will increase revenue.\r\nc) If demand is perfectly inelastic, then revenue is the same at any price.\r\nd) Elasticity is constant along a linear demand curve and so too is revenue.\r\n\r\n&nbsp;\r\n\r\n<strong>4.<\/strong> Suppose BC Ferries is considering an increase in ferry fares. If doing so results in an increase in revenues raised, which of the following could be the value of the own-price elasticity of demand for ferry rides?\r\n\r\na) 0.5.\r\nb) 1.0.\r\nc) 1.5.\r\nd) All of the above.\r\n\r\n&nbsp;\r\n\r\n<strong>5.<\/strong> Use the demand diagram below to answer this question. Note that P \u00d7 Q equals $900 at every point on this demand curve.\r\n\r\n<img src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.50-PM.png\" alt=\"\" width=\"437\" height=\"397\" class=\"alignnone size-full wp-image-1111\" \/>\r\n\r\nWhich of the following statements correctly describes own-price elasticity of demand, for this particular demand curve?\r\n\r\nI. Demand is unit elastic at a price of $30, and elastic at all prices greater than $30.\r\nII. Demand is unit elastic at a price of $30, and inelastic at all prices less than $30.\r\nIII. Demand is unit elastic for all prices.\r\n\r\na) I and II only.\r\nb) I only.\r\nc) I, II and III.\r\nd) III only.\r\n\r\n&nbsp;\r\n\r\n<strong>6.<\/strong> Suppose that, if the price of a good falls from $10 to $8, total expenditure on the good decreases. Which of the following could be the (absolute) value for the own-price elasticity of demand, in the price range considered?\r\n\r\na) 1.6.\r\nb) 2.3.\r\nc) Both a) and b).\r\nd) Neither a) or b).\r\n\r\n&nbsp;\r\n\r\n<strong>7.<\/strong> Consider the demand curve drawn below.\r\n\r\n<img src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.58-PM.png\" alt=\"\" width=\"312\" height=\"231\" class=\"alignnone size-full wp-image-1112\" \/>\r\n\r\nAt which of the following prices and quantities is revenue maximized?\r\n\r\na) P = 40; Q = 0.\r\nb) P = 30; Q = 5.\r\nc) P = 20; Q = 10.\r\nd) P = 0; Q = 20.\r\n\r\n<\/div>\r\n&nbsp;","rendered":"<div class=\"bcc-box bcc-highlight\">\n<h3 itemprop=\"educationalUse\">Learning Objectives<\/h3>\n<p>By the end of this section, you will be able to:<\/p>\n<ul>\n<li>Analyze graphs in order to classify elasticity as constant unitary, infinite, or zero<\/li>\n<li>Describe the price effect and the quantity effect<\/li>\n<li>Analyze how price elasticities impact revenue and expenditure<\/li>\n<\/ul>\n<\/div>\n<p>In Topic 4.1, we\u00a0introduced the concept of elasticity and how to calculate it, but we didn\u2019t explain why it is useful.\u00a0Recall that\u00a0<strong>elasticity<\/strong>\u00a0measures responsiveness of one variable to changes in another variable. If you owned a coffee shop and wanted to increase your prices, this \u2018responsiveness\u2019\u00a0is something you need to consider. When you increase prices, you know quantity will fall, but by how much?<\/p>\n<p>Elasticities can be divided into three broad categories: elastic, inelastic, and unitary. An\u00a0<strong>elastic demand<\/strong>\u00a0is one in which the elasticity is greater than one, indicating a high responsiveness to changes in price. Elasticities that are less than one indicate low responsiveness to price changes and correspond to\u00a0<strong>inelastic demand.<\/strong>\u00a0<strong>Unitary elasticities<\/strong>\u00a0indicate proportional responsiveness of either demand or supply, as summarized in\u00a0the following table:<\/p>\n<table id=\"Table_05_01\" summary=\"If percentage change in quantity is greater than percentage change in price then percentage change in quantity divided by percentage change in price is greater than 1, and it is called \u201cElastic.\u201d If percentage change in quantity is equal to percentage change in price then percentage change in quantity divided by percentage change in price is equal to 1, and it is called \u201cUnitary.\u201d If percentage change in quantity is less than percentage change in price then percentage change in quantity divided by percentage change in price is less than 1, and it is called \u201cInelastic.\u201d\">\n<thead>\n<tr>\n<th>If . . .<\/th>\n<th>Then . . .<\/th>\n<th>And It Is Called . . .<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>[latex]\\%\\;change\\;in\\;quantity > \\%\\;change\\;in\\;price[\/latex]<\/td>\n<td>[latex]\\frac{\\%\\;change\\;in\\;quantity}{\\%\\;change\\;in\\;price)} > 1[\/latex]<\/td>\n<td>Elastic<\/td>\n<\/tr>\n<tr>\n<td>[latex]\\%\\;change\\;in\\;quantity = \\%\\;change\\;in\\;price[\/latex]<\/td>\n<td>[latex]\\frac{\\%\\;change\\;in\\;quantity}{\\%\\;change\\;in\\;price)} = 1[\/latex]<\/td>\n<td>Unit Elastic<\/td>\n<\/tr>\n<tr>\n<td>[latex]\\%\\;change\\;in\\;quantity < \\%\\;change\\;in\\;price[\/latex]<\/td>\n<td>[latex]\\frac{\\%\\;change\\;in\\;quantity}{\\%\\;change\\;in\\;price)} < 1[\/latex]<\/td>\n<td>Inelastic<\/td>\n<\/tr>\n<tr>\n<td colspan=\"3\">Elastic, Inelastic, and Unitary: Three Cases of Elasticity<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p><span>If we were to calculate elasticity at every point on a demand curve, we could divide it into these elastic, unit elastic, and inelastic areas, as shown in Figure 4.2a. \u00a0This means the impact of a price change will depend on where we are producing. Feel free to calculate the elasticity in any of the regions, you will\u00a0find that it\u00a0indeed fits the description.<\/span><\/p>\n<figure id=\"attachment_738\" aria-describedby=\"caption-attachment-738\" style=\"width: 491px\" class=\"wp-caption alignnone\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3a.jpg\" alt=\"figure-4-3a\" width=\"491\" height=\"345\" class=\"wp-image-738\" srcset=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3a.jpg 441w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3a-300x211.jpg 300w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3a-65x46.jpg 65w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3a-225x158.jpg 225w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3a-350x246.jpg 350w\" sizes=\"auto, (max-width: 491px) 100vw, 491px\" \/><figcaption id=\"caption-attachment-738\" class=\"wp-caption-text\">Figure 4.2a<\/figcaption><\/figure>\n<p>To demonstrate, we have calculated the elasticities at a point in each of the zones:<\/p>\n<p><strong>Point A =\u00a0<\/strong>[latex]\\frac{\\Delta Q}{\\Delta P}\\cdot \\frac{P}{Q}=\\frac{9}{6.75}\\cdot \\frac{4.5}{3}=2[\/latex] =\u00a0<strong>Elastic<\/strong><\/p>\n<p><strong>Point B = <\/strong>[latex]\\frac{\\Delta Q}{\\Delta P}\\cdot \\frac{P}{Q}=\\frac{9}{6.75}\\cdot \\frac{3}{5}=0.8[\/latex] =\u00a0<strong>Inelastic<\/strong><\/p>\n<p><strong>Point C =\u00a0<\/strong>[latex]\\frac{\\Delta Q}{\\Delta P}\\cdot \\frac{P}{Q}=\\frac{9}{6.75}\\cdot \\frac{3.375}{4.5}=1[\/latex] =\u00a0<strong>Unit Elastic<\/strong><\/p>\n<p>In reality, the only point we need to find to determine which areas are elastic and inelastic is our point where elasticity is 1, or Point C. This isn\u2019t as hard as it may seem. Since our formula is equal to the inverse of our slope multiplied by a point on the graph, it will only equal 1 when our point is equal to the slope of our graph.\u00a0For a linear graph, this only occurs at the middle point, which is (4.5, 3.325) in this case.<\/p>\n<h2>Why is This Useful?<\/h2>\n<figure id=\"attachment_782\" aria-describedby=\"caption-attachment-782\" style=\"width: 592px\" class=\"wp-caption alignleft\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Starbucks-B1G1-FREE-Holiday-Drink.jpg\" width=\"592\" height=\"333\" class=\"wp-image-782\" alt=\"\" srcset=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Starbucks-B1G1-FREE-Holiday-Drink.jpg 500w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Starbucks-B1G1-FREE-Holiday-Drink-300x169.jpg 300w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Starbucks-B1G1-FREE-Holiday-Drink-65x37.jpg 65w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Starbucks-B1G1-FREE-Holiday-Drink-225x126.jpg 225w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Starbucks-B1G1-FREE-Holiday-Drink-350x197.jpg 350w\" sizes=\"auto, (max-width: 592px) 100vw, 592px\" \/><figcaption id=\"caption-attachment-782\" class=\"wp-caption-text\">When Starbucks runs a buy one get one free promotion, they effectively lower the price of a drink by 50%. The company sells more drinks, but at a lower price. Elasticity determines whether or not this promotion will be profitable. Of course, promotions are not always intended to be profitable in the short term. Oftentimes, firms will cut prices to increase awareness of their new products, as Starbucks does with its holiday drinks. (Credit: Starbucks)<\/figcaption><\/figure>\n<p>So far, we have determined how to calculate elasticity at and between different points, but why is this knowledge useful?<\/p>\n<p>Consider a coffee shop owner considering a price hike. The\u00a0owner\u00a0has two things to account for\u00a0when deciding whether to raise the price, one that increases revenue and one that decreases it. Elasticity helps us determine which effect is greater. Referring back to our table:<\/p>\n<ol>\n<li>When you increase price, you increase revenue on units sold\u00a0<strong>(The Price Effect).<\/strong><\/li>\n<li>When you increase price, you sell fewer units\u00a0<strong>(The Quantity Effect).<\/strong><\/li>\n<\/ol>\n<p>These two effects work against each-other. To determine which outweighs the other we can look at elasticity:<\/p>\n<p>When our point is\u00a0<strong>elastic\u00a0<\/strong>our\u00a0<span>[latex]\\%\\;change\\;in\\;quantity > \\%\\;change\\;in\\;price[\/latex] meaning if we increase price, our quantity effect\u00a0outweighs\u00a0the price effect, causing a decrease in revenue.\u00a0<\/span><\/p>\n<p><span>When our point is\u00a0<strong>inelastic<\/strong><\/span><strong>\u00a0<\/strong><span>our\u00a0[latex]\\%\\;change\\;in\\;quantity < \\%\\;change\\;in\\;price[\/latex]<\/span><span>\u00a0meaning if we increase price, our price\u00a0effect\u00a0outweighs\u00a0the quantity\u00a0effect, causing a increase\u00a0in revenue.\u00a0<\/span><\/p>\n<p>This information is summarized in Figure 4.2b:<\/p>\n<figure id=\"attachment_742\" aria-describedby=\"caption-attachment-742\" style=\"width: 365px\" class=\"wp-caption alignleft\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3b.jpg\" alt=\"Figure 4.3b\" width=\"365\" height=\"501\" class=\"wp-image-742\" srcset=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3b.jpg 448w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3b-219x300.jpg 219w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3b-65x89.jpg 65w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3b-225x309.jpg 225w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Figure-4.3b-350x480.jpg 350w\" sizes=\"auto, (max-width: 365px) 100vw, 365px\" \/><figcaption id=\"caption-attachment-742\" class=\"wp-caption-text\">Figure 4.2b<\/figcaption><\/figure>\n<p>&nbsp;<\/p>\n<p>The first thing to note is that revenue is maximized at the point where elasticity is unit elastic. Why? If you are the coffee shop owner, you will notice that there are untapped opportunities when demand is elastic or inelastic.<\/p>\n<p><strong>If elastic:\u00a0<\/strong>The quantity effect outweighs the price effect, meaning if we decrease prices, the revenue gained\u00a0from the more\u00a0units sold will outweigh the revenue lost from the decrease in price.<\/p>\n<p><strong>If inelastic:\u00a0<\/strong>The price\u00a0effect outweighs the quantity\u00a0effect, meaning if we increase\u00a0prices, the revenue gained\u00a0from the higher price will outweigh the revenue lost from less units sold.<\/p>\n<p>The effects of price increase and decrease at different points are summarized in Figure 4.2c.<\/p>\n<p>&nbsp;<\/p>\n<figure id=\"attachment_744\" aria-describedby=\"caption-attachment-744\" style=\"width: 569px\" class=\"wp-caption aligncenter\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2016-11-13-at-2.32.59-PM.png\" width=\"569\" height=\"247\" class=\"wp-image-744 size-full\" alt=\"image\" srcset=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2016-11-13-at-2.32.59-PM.png 569w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2016-11-13-at-2.32.59-PM-300x130.png 300w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2016-11-13-at-2.32.59-PM-65x28.png 65w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2016-11-13-at-2.32.59-PM-225x98.png 225w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2016-11-13-at-2.32.59-PM-350x152.png 350w\" sizes=\"auto, (max-width: 569px) 100vw, 569px\" \/><figcaption id=\"caption-attachment-744\" class=\"wp-caption-text\">Figure 4.2c<\/figcaption><\/figure>\n<p>&nbsp;<\/p>\n<h2>What about Expenditure<\/h2>\n<p>You will notice that expenditure is mentioned whenever revenue is. This is because a dollar earned by the coffee shop corresponds to a dollar spent by the consumer. Therefore, if the firm\u2019s revenue is rising, then the consumer\u2019s expenditure is rising as well.\u00a0You must understand how to answer questions from both sides.<\/p>\n<h2>Summary<\/h2>\n<p>Elasticity is used to measure the responsiveness of one variable to another.\u00a0This responsiveness\u00a0can be labelled as elastic (e &gt; 1), unit elastic (e = 1), and inelastic (e &lt; 1). We can apply this to the demand curve, with unit elastic corresponding to the middle of the demand curve (x-intercept\/2 , y-intercept\/2). Everything to the left is\u00a0elastic and everything to the right is\u00a0inelastic. This information can be used to maximize revenue or expenditure,\u00a0with the understanding that when elastic, the quantity effect outweighs the price effect, and when inelastic, the price effect outweighs the quantity effect.<\/p>\n<div class=\"textbox\">\n<h2>Glossary<\/h2>\n<dl id=\"fs-idm51600048\" class=\"definition\">\n<dt><strong>Elastic<\/strong><\/dt>\n<dd id=\"fs-idp17805888\"><em>when the elasticity \u00a0is greater than one, indicating\u00a0that a 1 percent increase in price will result in a more\u00a0than 1 percent increase in quantity; this indicates a high\u00a0responsiveness to price.<\/em><\/dd>\n<\/dl>\n<dl id=\"fs-idm51600048\" class=\"definition\">\n<dt><strong>Inelastic<\/strong><\/dt>\n<dd id=\"fs-idp17805888\"><em>when the elasticity is less than one, indicating that a 1 percent increase in price paid to the firm will result in a less than 1 percent\u00a0increase in quantity; this indicates a low responsiveness to price.<\/em><\/dd>\n<\/dl>\n<dl id=\"fs-idm51600048\" class=\"definition\">\n<dt><strong>Unitary elastic<\/strong><\/dt>\n<dd id=\"fs-idp17805888\"><em>when the calculated elasticity is equal to one indicating that a change in the price of the good or service results in a proportional change in the quantity demanded or supplied<\/em><\/dd>\n<\/dl>\n<\/div>\n<div class=\"bcc-box bcc-info\">\n<h3 itemprop=\"educationalUse\">Exercises 4.2<\/h3>\n<p>Use the demand curve diagram below to answer the following TWO questions.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.34-PM.png\" alt=\"\" width=\"305\" height=\"239\" class=\"alignnone size-full wp-image-1110\" srcset=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.34-PM.png 305w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.34-PM-300x235.png 300w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.34-PM-65x51.png 65w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.34-PM-225x176.png 225w\" sizes=\"auto, (max-width: 305px) 100vw, 305px\" \/><\/p>\n<p><strong>1.<\/strong> What is the own-price elasticity of demand as price decreases from $8 per unit to $6 per unit? Use the mid-point formula in your calculation.<\/p>\n<p>a) Infinity.<br \/>\nb) 7.0<br \/>\nc) 2.0.<br \/>\nd) 1.75<\/p>\n<p>&nbsp;<\/p>\n<p><strong>2.<\/strong> At what point is demand unit-elastic?<\/p>\n<p>a) P = $6, Q = 12.<br \/>\nb) P = $4, Q = 8.<br \/>\nc) P = $2, Q = 12.<br \/>\nd) None of the above.<\/p>\n<p>&nbsp;<\/p>\n<p><strong>3.<\/strong> Which of the following statements about the relationship between the price elasticity of demand and revenue is TRUE?<\/p>\n<p>a) If demand is price inelastic, then increasing price will decrease revenue.<br \/>\nb) If demand is price elastic, then decreasing price will increase revenue.<br \/>\nc) If demand is perfectly inelastic, then revenue is the same at any price.<br \/>\nd) Elasticity is constant along a linear demand curve and so too is revenue.<\/p>\n<p>&nbsp;<\/p>\n<p><strong>4.<\/strong> Suppose BC Ferries is considering an increase in ferry fares. If doing so results in an increase in revenues raised, which of the following could be the value of the own-price elasticity of demand for ferry rides?<\/p>\n<p>a) 0.5.<br \/>\nb) 1.0.<br \/>\nc) 1.5.<br \/>\nd) All of the above.<\/p>\n<p>&nbsp;<\/p>\n<p><strong>5.<\/strong> Use the demand diagram below to answer this question. Note that P \u00d7 Q equals $900 at every point on this demand curve.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.50-PM.png\" alt=\"\" width=\"437\" height=\"397\" class=\"alignnone size-full wp-image-1111\" srcset=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.50-PM.png 437w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.50-PM-300x273.png 300w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.50-PM-65x59.png 65w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.50-PM-225x204.png 225w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.50-PM-350x318.png 350w\" sizes=\"auto, (max-width: 437px) 100vw, 437px\" \/><\/p>\n<p>Which of the following statements correctly describes own-price elasticity of demand, for this particular demand curve?<\/p>\n<p>I. Demand is unit elastic at a price of $30, and elastic at all prices greater than $30.<br \/>\nII. Demand is unit elastic at a price of $30, and inelastic at all prices less than $30.<br \/>\nIII. Demand is unit elastic for all prices.<\/p>\n<p>a) I and II only.<br \/>\nb) I only.<br \/>\nc) I, II and III.<br \/>\nd) III only.<\/p>\n<p>&nbsp;<\/p>\n<p><strong>6.<\/strong> Suppose that, if the price of a good falls from $10 to $8, total expenditure on the good decreases. Which of the following could be the (absolute) value for the own-price elasticity of demand, in the price range considered?<\/p>\n<p>a) 1.6.<br \/>\nb) 2.3.<br \/>\nc) Both a) and b).<br \/>\nd) Neither a) or b).<\/p>\n<p>&nbsp;<\/p>\n<p><strong>7.<\/strong> Consider the demand curve drawn below.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.58-PM.png\" alt=\"\" width=\"312\" height=\"231\" class=\"alignnone size-full wp-image-1112\" srcset=\"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.58-PM.png 312w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.58-PM-300x222.png 300w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.58-PM-65x48.png 65w, https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-content\/uploads\/sites\/58\/2016\/11\/Screen-Shot-2017-01-21-at-5.01.58-PM-225x167.png 225w\" sizes=\"auto, (max-width: 312px) 100vw, 312px\" \/><\/p>\n<p>At which of the following prices and quantities is revenue maximized?<\/p>\n<p>a) P = 40; Q = 0.<br \/>\nb) P = 30; Q = 5.<br \/>\nc) P = 20; Q = 10.<br \/>\nd) P = 0; Q = 20.<\/p>\n<\/div>\n<p>&nbsp;<\/p>\n","protected":false},"author":58,"menu_order":2,"comment_status":"closed","ping_status":"closed","template":"","meta":{"pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-110","chapter","type-chapter","status-publish","hentry"],"part":682,"_links":{"self":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/110","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/users\/58"}],"replies":[{"embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/comments?post=110"}],"version-history":[{"count":25,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/110\/revisions"}],"predecessor-version":[{"id":2231,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/110\/revisions\/2231"}],"part":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/parts\/682"}],"metadata":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/110\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/media?parent=110"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapter-type?post=110"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/contributor?post=110"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/license?post=110"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}