4.3 Elasticity and Pricing
Learning Objectives
By the end of this section, you will be able to:
- Analyze how price elasticities impact revenue
- Evaluate how elasticity can cause shifts in demand and supply
- Predict how the long-run and short-run impacts of elasticity affect equilibrium
- Explain how the elasticity of demand and supply determine the incidence of a tax on buyers and sellers
Studying elasticities is useful for a number of reasons, pricing being most important. Let’s explore how elasticity relates to revenue and pricing, both in the long and short run. First, let’s look at the elasticities of some common goods and services.
Table 4.2 shows a selection of demand elasticities for different goods and services drawn from a variety of different studies by economists, listed in order of increasing elasticity.
|
Goods and Services |
Elasticity of Price |
|
Housing |
0.12 |
|
Transatlantic air travel (economy class) |
0.12 |
|
Rail transit (rush hour) |
0.15 |
|
Electricity |
0.20 |
|
Taxi cabs |
0.22 |
|
Gasoline |
0.35 |
|
Transatlantic air travel (first class) |
0.40 |
|
Wine |
0.55 |
|
Beef |
0.59 |
|
Transatlantic air travel (business class) |
0.62 |
|
Kitchen and household appliances |
0.63 |
|
Cable TV (basic rural) |
0.69 |
|
Chicken |
0.64 |
|
Soft drinks |
0.70 |
|
Beer |
0.80 |
|
New vehicle |
0.87 |
|
Rail transit (off-peak) |
1.00 |
|
Computer |
1.44 |
|
Cable TV (basic urban) |
1.51 |
|
Cable TV (premium) |
1.77 |
|
Restaurant meals |
2.27 |
Note that demand for necessities such as housing and electricity is inelastic, while items that are not necessities such as restaurant meals are more price-sensitive. If the price of a restaurant meal increases by 10%, the quantity demanded will decrease by 22.7%. A 10% increase in the price of housing will cause only a slight decrease of 1.2% in the quantity of housing demanded.
LINK IT UP
Read this discussion of movie prices and movie attendance for an example of how price elasticity may have affected you.
Does Raising Price Bring in More Revenue?
Imagine that a band on tour is playing in an indoor arena with 15,000 seats. To keep this example simple, assume that the band keeps all the money from ticket sales. Assume further that the band pays the costs for its appearance, but that these costs, like travel, and setting up the stage, are the same regardless of how many people are in the audience. Finally, assume that all the tickets have the same price. (The same insights apply if ticket prices are more expensive for some seats than for others, but the calculations become more complicated.) The band knows that it faces a downward-sloping demand curve; that is, if the band raises the ticket price and, it will sell fewer seats. How should the band set the ticket price to generate the most total revenue, which in this example, because costs are fixed, will also mean the highest profits for the band? Should the band sell more tickets at a lower price or fewer tickets at a higher price?
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