ECN 104 Lecture Notes - Lecture 6: Midpoint Method, Demand Curve, Inferior Good

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1 Nov 2017

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Defining elasticity of demand: price elasticity of demand is the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve. Equations: % change in quantity demanded = (change in quantity demanded / initial quantity demanded) x 100, % change in price = (change in price / initial price) x 100. Price elasticity of demand = (% change in quantity demanded / % change in price) Price elasticity of demand = (1% / 5%) = 0. 2. Midpoint method is a technique for calculating the percent change. Elastic demand: housing, restaurant meals, airline travel. Two extreme cases of price elasticity of demand: demand is perfectly inelastic when the quantity demanded does not respond at all to changes in the price. When demand is perfectly inelastic, the demand curve is a vertical line: demand is perfectly elastic when any price increase will cause the quantity demanded to drop to zero.

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Calculating the price elasticity of demand - A step-by-step guide

Suppose that during the past year, the price of a laptop computer fell from $2,950 to $2,450. During the same time period, consumer sales increased from 430,000 to 619,000 laptops.

1. Calculate the elasticity of demand between these two price quantity combinations by using the following steps. After each step, complete the relevant part of the table with the appropriate answers. (Note: For decreases in price or quantity, enter values in the Change column with a minus sign.)

a. 36.03%

b. 18.02%

c. 277.51%

Price

a. -18.52%

b.-540%

c. -9.26%

Step 1: Fill in the appropriate values for original quantity, new quantity, original price, and new price.

Step 2: Calculate the average quantity by adding the original quantity and the new quantity, and then dividing by two. Do the same for the average price.

Step 3: Calculate the change in quantity by subtracting the original quantity from the new quantity. Do the same for the price change.

Step 4: Calculate the percentage change in quantity demanded by dividing the change in quantity by the average quantity. Do the same to calculate the percentage change in price.

Step 5: Calculate the price elasticity of demand by dividing the percentage change in quantity demanded by the percentage change in price, ignoring the negative sign.

2. Using the midpoint method, the elasticity of demand for laptops is about

a. 0.051

b. 0.97

c. 1.95

d. 3.89

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1. Grand TV Manufacturer wants to increase the quantity of TVs it sells by 8%. If the price elasticity of demand is 4, the manufacturer must:

a. decrease price by 1.5%.

b. increase price by 1.5%.

c. increase price by 2.0%.

d. decrease price by 2.0%.

2. Suppose that an Italian ice cream firm is facing a linear demand curve and that the current price for the Italian ice cream is set at a point where the price elasticity is 0.7. If the firm decreases the product price,

Select one:

a. the demand becomes less inelastic, and total revenue increases.

b. the demand becomes more inelastic, and total revenue decreases.

c. the demand becomes more inelastic, and total revenue increases.

d. the demand becomes less inelastic, and total revenue decreases.

3. Suppose that in a month, the price of movie rentals decreases from $3.25 to $3. At the same time, the quantity of movie rentals demanded increases from 100 to 120. The price elasticity of demand for movie rentals (calculated using the midpoint formula) is:

a. elastic.

b. zero.

c. inelastic.

d. unitary elastic.

4. The price elasticity of demand for color printers is 1.6, and you would like to see the quantity demanded of color printers increase by 32%. Then the percentage change in price should be:

Select one:

a. 15%.

b. 25%.

c. 10%.

d. 20%.

5. The price of apple increases from $1 to $1.10. At the same time, the quantity of apples demanded decreases from 100 to 90. The price elasticity of demand for apples (calculated using the initial value formula) is:

a. 0.9.

b. 0.02.

c. 1.1.

d. 1.

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As we have learned, many economic topics have been obsolete for decades. Yet, some topics and concepts continue to stand the test of time and are therefore useful today. Price point elasticity is a hallmark subtopic of microeconomics that is also considered a serious sub-topical contender for the modern body of knowledge surrounding our study of a sustainable economy. The reason for the legitimacy is that it based upon the mathematical ratio of price and quantity demanded along the demand curve. This basic calculation is in actuality a simple ratio that is based upon the linear slope relationship of price and quantity demanded for a specific product or service. Results render quantitative decision support for price adjustments and their consequence. For every one percent increase in price, the price point elasticity tells you how much less quantity will be demanded as a percent. Conversely, for every one percentage decrease in price, price point elasticity tells you how much more quantity will be demanded, as a percent.

Results are percentage so further calculation is needed to determine if the price adjustment is justified by a loss or gain relative to leaving the price the same. For example, the price demand schedule below says that for every one percent change we will see a two percent negative change in quantity demanded. So if we change the price five percent, we will see a negative impact of ten percent less product sold. If our product sells for $40 and we increase it to $42 we will see a drop of 200 sold. If the scale of our schedule is in millions sold, we will see a decrease of 200 million sold. Do you think it is worth the trouble of changing the price? Why?
We may gain $4000 by increasing price but we will also may lose 200 sales and at the new price of 42 dollars so our estimated loss of $8400 will be far greater than the gain. Of course, these are estimates and real world pricing may be in pennies instead of dollars, especially in this price range and other factors must be considered such as substitutes, complements, changing trends, taste, obsolesce, incomes, and a series of demographic fluctuations that are representative of the population of customers. Nonetheless, isolating price and quantity is the first exercise when considering the demand for a product or service.

Price	Demand
50	1000
45	1500
40	2000
35	2500
30	3000
25	3500

Table 3 Price/demand schedule for some product or service

ECN 104 Lecture Notes - Lecture 6: Midpoint Method, Demand Curve, Inferior Good

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