The complete course on

Elasticity &its business aspect

by Evrim Kanbur
 CONTENT
CHAPTER 1: Price Elasticity of Demand (PED) :
The assumption and de nition
How to calculate PED?
Analysis of Elasticity zones and curves
The factors of Price Elasticity of Demand
Other Demand Elasticities (Income and Cross-Price)

CHAPTER 2: Price Elasticity of Supply (PES):

The assumption and de nition
How to calculate PES?
Analysis of Elasticity zones and curves
The factors of Price Elasticity of Supply

CHAPTER 3: The use of Price Elasticity in business

Why do companies want to know Price Elasticity?
How do companies use Price Elasticity?
What are the common mistakes managers make with Price Elasticity?
Total Revenue & Price Elasticity
Cost & Price Elasticity
Tax Incidence & Price Elasticity
The business aspect of other Price Elasticities Online courses by Evrim Kanbur
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CHAPTER 1: Price Elasticity of Demand (PED)
The assumption and de nition
How to calculate PED?
Analysis of Elasticity zones and curves
The factors of Price Elasticity of Demand
Other Demand Elasticities (Income and Cross-Price)

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 The Assumption & De nition

The Assumption:
Most customers are accepted as price sensitive related with the speci c
product or service. We assume that:
. when price increases, less people will buy the product or service.
. when price decreases, more people will buy the product or service.
BUT
There is more to that. The concept has a quantitative as well as qualitative
aspect. We’ll start our course with exploring the quantitative aspect and
then move towards the qualitative aspect.

De nition: Price elasticity of demand shows how responsive customer

demand is for a product or service based on its price.

“Business owners, marketers need to have a deeper understanding how sensitive,

elastic or inelastic their target audience is to uctuations in price when a decision has
to be made on how to set or change a price.”

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 How to calculate PED?

Percentage change in quantity demanded

Price elasticity
=
of demand
Percentage change in price

There are two ways to calculate price elasticity of demand:

Method A: The Point Elasticity Method (The Basic Elasticity Formula)

Let’s break this formula into smaller steps to show you how we nd percentage changes.

Qd1: The rst quantity demanded

Qd2: The second quantity demanded
(Qd1 -Qd2)

Price elasticity Qd1

=
of demand
(P1 -P2) P1: The rst price
P2: The second price
P1

*Price Elasticity of demand ignores the negative numbers. We use

absolute value in elasticity calculations as what matters is it’s
magnitude of distance from 1.
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 How to calculate PED?

Percentage change in quantity demanded

Price elasticity
=
of demand
Percentage change in price

Method B is the most accurate one:

Method B: Midpoint Method (Arc Elasticity), a better way to calculate PED

Let’s break this formula into smaller steps to show you how we nd percentage changes.

(Qd1 -Qd2) Qd1: The rst quantity demanded

Qd2: The second quantity demanded
(Qd1+Qd2)
Price elasticity 2
=
of demand
(P1 -P2) P1: The rst price
P2: The second price
(P1+P2)
2

*Price Elasticity of demand ignores the negative numbers. We use

absolute value in elasticity calculations as what matters is it’s
magnitude of distance from 1.
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The drawback of Point Elasticity Method
When calculating Point Elasticity method based on two speci c points on the demand curve,
you’ll see an important drawback of Point Elasticity method.
Point A: Price: 100, Quantity demanded: 50
Point B: Price: 80 , Quantity Demanded: 95
Price

. Point A
Price

. Point A

.
100

.
100

Point B 80 Point B
80

50 95 50 95 Quantity
Quantity

If we move along the demand curve If we move along the demand curve
from Point A to Point B: from Point B to Point A:
(50 -95) (95 -50)
50 95
= |-4,5| = 4,5 =|-1,89| = 1,89
(100 - 80) (80 -100)
100 80

As you can see we have the same two points on the same demand curve in the
examples above, but we get two different values for elasticity which is confusing
and not a desired outcome. That’s why we use the Midpoint Method to have an
accurate result.

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 The reason why we choose Midpoint Method
When calculating Midpoint method based on two speci c points on the demand curve, both
results are the same
Point A: Price: 100, Quantity demanded: 50
Point B: Price: 80 , Quantity Demanded: 95
Price

. Point A
Price

. Point A

.
100

.
100

Point B 80 Point B
80

50 95 50 95 Quantity
Quantity

If we move along the demand curve If we move along the demand curve
from Point A to Point B: from Point B to Point A:

(50 -95)
(95 -50)
(50 + 95)
(95 + 50)
2
= |-2,8| = 2,8 2
(100 - 80) = |-2,8| = 2,8
(80 - 100)
(100 + 80)
(80 + 100)
2
2

As you can see, Midpoint method xed the problem of inconsistency caused by
Point Elasticity method.

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Points to consider about both methods

Percentage change in quantity demanded

Price elasticity
=
of demand
Percentage change in price

The Point Elasticity Method Midpoint Method (Arc Elasticity)

(Qd1 -Qd2)
(Qd1 -Qd2) (Qd1+Qd2)
Qd1 2
PED = PED =
(P1 -P2) (P1 -P2)
P1 (P1+P2)
2

• Note that the directional discrepancy caused by point elasticity gets larger when the two speci c points get
further apart, so the case for using the Midpoint formula gets stronger when the points being used are not
that close to one another.

• If the two speci c points are close to each other, it is insigni cant which you formula use and, as the
distance between the points gets smaller, two formulas give almost the same value.

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 Analysis of PED zones and curves
Ex: Let’s assume that Gucci decreases the price of one of its bags from $1,200 to $400. Based
on this change, the demand increased from 50 bags to 350 bags.

(50 -350)
(50+350)
Qd1: 50 P1: $1,200 150
2
Qd2: 350 P2: $400 PED = = = |-1,5| = 1,5
(1,200 -400) 100
(1,200+400) We always put
2 the outcome in
absolute value

How are we going to analyse this outcome, “1,5”?

What we look at is its magnitude of distance from 1. The higher the absolute value of the
elasticity, the more responsive and sensitive customers are to the change in price

PED=1, Unit elastic 1,5 is bigger than 1, based on the elasticity zones on the left,
PED >1, Elastic this Gucci bag is elastic. This means that when Gucci bag’s
price changes, people respond more than the change in
PED <1, Inelastic price.

PED = 0, Perfectly Inelastic

TIP: When we say elasticity is higher, buyers will respond
PED = ,Perfectly Elastic more than the change in price.
When we say elasticity is lower, buyers will respond less than
the change in price.

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Analysis of PED zones and curves

There are 5 zones of elasticity and each one of them is represented with a unique curve.

1) PED=1, Unit elastic

Price

2) PED > 1, Elastic 3) PED < 1, Inelastic

Price
Price

Q Q

4) PED, Perfectly Elastic 5) PED, Perfectly Inelastic

Price Price

Q Q
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 Analysis of PED zones and curves
1) PED=1, Unit elastic When PED=1, the product or the service is Unit
Price Elastic. It means that the percentage change in
quantity demanded (Q d ) is the same as the
percentage change in price. Goods with unit elasticity
are not common in the real world.
Q

For example:
Let’s assume H&M decreases the price of one of its coats from $100 to $50. Based on this
change, the demand increased from 400 bags to 800 coats.
P (400 - 800)
(400+800)
2 -67%
$100 PED = = = |-1| = 1
67%
(100 -50) 67%
$50
(100+50)
400 800 Q
2
67%

ANALYSIS: When a product is unit elastic, the change in quantity demanded will be the
same with the change in price, so the revenue of this product won’t change. It is important
for companies to understand the elasticity of their products before they make a change in
the price, even while setting a price for their product in the rst place.

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Analysis of PED zones and curves
2) PED > 1, Elastic When PED<1, the product or the service is known as
Price
Elastic. It means that the percentage change in
quantity demanded (Qd) is bigger than the
percentage change in price.

Q TIP: When you see a atter demand curve, it shows

an elastic product or service.
For example:
Let’s assume Mc Donalds increases the price of Big Mac from $10 to $20. Based on this
change, the demand decreased from 400 to 100.
P (500 - 100)
(500+100)
2
PED = = |-2| = 2
$20
(10 -20)
$10 (10+20)
100 500 Q 2

ANALYSIS: Here, you see PED of Big Mac is 2, which is bigger than 1. Based on this
value, we can say that Big Mac is an elastic product. This means that whenever there is
a price increase, more people will switch their demand to other products as Big Mac has
a lot of substitutes, therefore the revenue will decrease.

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Analysis of PED zones and curves
3) PED < 1, Inelastic When PED>1, the product or the service is known as
Price Inelastic. It means that the percentage change in
quantity demanded (Qd) is smaller than the
percentage change in price.

TIP: When you see a steeper demand curve, it shows

Q an inelastic product or service.
For example:
Let’s assume the price of insulin increased from $50 to $150. Based on this change, the
demand decreased from 100 to 300.

P (300 - 250)
(300+250)
$150
2
PED = = |-0.2| = 0.2
(50 -150)
$50
(50+150)
250 300 Q 2

ANALYSIS: Here, you see PED of insulin is 0.2, which is smaller than 1. Based on this
value, we can say that insulin is an inelastic product. This means that whenever there is
a price increase, less people respond as insulin is necessity for people who have
diabetes. The revenue of inelastic goods will increase when there is an increase in price.
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Elastic and Inelastic demand on a linear curve

P
$18

$16
.. Elasticity is bigger than 1

$12

$10
.. Elasticity is smaller than 1

50 120 160 200 Q

The elasticity along a linear demand curve is not constant.

• At points with a low price but high quantity, the demand curve inelastic.
Along the inelastic demand curve, an increae in price, increases total
revenues.
• At points with a high price but low quantity, the demand curve is elastic.
Any price in this part of demand curve will lead to a loss in total revenue.

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Analysis of PED zones and curves
4) PED= , Perfectly Elastic When PED= , the product or the service is known
Price as Perfectly Elastic. It means that even if the price
doesn’t change or if there is a small change in price,
quantity demanded changes massively. This is an
extreme case and rare to see in real life.

Q TIP: When you see a horizontal demand curve, it

shows a perfectly elastic product or service.

5) PED = 0, Perfectly Inelastic When PED=0 , the product or the service is known as
Price Perfectly Inelastic. It means that no matter what price
is, quantity demanded doesn’t change. This is an
extreme case and rare to see in real life.

TIP: When you see a vertical demand curve, it shows

Q
a perfectly inelastic product or service.

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The factors of PED

1-) How widely or narrowly a market is de ned

Example: Clothing & Blue Jeans

One is widely de ned and the other one is narrowly. When we are talking about
elasticity of clothing, is there a substitue for clothing? No. When we’re talking about the
elasticity of blue jeans, is there a substitute for it? Yes, many, like skirts, dresses,
shorts, trousers etc.

A widely de ned market’s (clothing) elasticity will be low as there aren’t any options for
us to use instead of clothing. A narrowly de ned market’s (blue jeans) elasticity will be
higher as there are more options if we want to switch from.

2-) Whether it has enough close substitutes or not

Example: Insulin and breakfast cereal

We don’t have close substitues for insulin so its elasticity will be lower but we have a
lot of close substitutes for breakfast cereal so its elasticity will be higher.

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 The factors of PED

3-) Whether it is a necessity or luxury

Example: Medication vs a cruise holiday
This is a huge factor in elasticity. If the goods and services are seen as necessity like
medication, then the elasticity of these goods and services will be low. If the goods
and services are seen as luxury, their elasticity will be high.
Keep in mind that necessities and luxuries are also related with individual’s
preferences and culture factor as well. Like in some countries, people see legal
services as necessity so when they start a business, they immediately work with a
lawyer from the beginning not to have any problems in the future. On the other hand,
in some countries, people will nd a lawyer when a problem occurs. Another case is,
in some cultures people visit doctors regulary not to get sick, but in other cultures
people only visit doctors when they are sick.

4-) Time horizon

Example: An increase in gasoline prices
In the short term the elasticity of gasoline is lower as people won’t be able respond
faster by taking major actions, but in the long run they might switch to hybrid or
electric cars, take metro or bus, or they might even move somewhere closer to their
of ce.

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 The factors of PED
The other factors that in uence PED are:

5-) Income Level

Elasticity of demand for any good is generally less for higher income level groups in
to people with low incomes. It happens because high level income groups are not
in uenced as much as low income level groups do by changes in the price of
goods. As low level income groups are highly affected by increase or decrease in
the price of goods, elasticity of goods that lower income groups demand is highly
elastic.

6-) The proportion of consumer income spent on the good

The PED for a newspaper is likely to be much lower than that for a new car!

7-) Brand loyalty & habits

Brand loyalty as well as having a habit to consume a speci c good reduces
sensitivity to price changes and reduces PED.

8-) The impact of advertising

Due to a successful ad campaign where a rm uses persuasive advertising to get
new customers and retain the existing ones by establishing customers’ loyalty, the
products of this company might have a lower PED.

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The factors of PED
The other factors that in uence PED are:
9-) Life cycle of a product
PED of a product will be different depending
on where the product is in its life cycle. When
new products are launched and if there are
few competitors (there are always exceptions
though), then PED will be relatively inelastic.
As other rms launch similar products, the
wider choice (substitutes) increases PED.

When a product begins to decline in its lifecycle, consumers might be highly

responsive to a change in price, therefore imlplemeting a promotion strategy that
involves discounts in prices is widely used by companies.

10-) The cost of switching between products

When customers switch their demand to other substitutes, the process might
include extra costs, in that case demand will be less elastic. For example, mobile
phone service providers in some countries require you to have a commitment of a
year that you’ll use their services and in case of breaking the contract, there will be
extra costs involved.

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Elasticity of different goods
Examples from real life

Goods and services Elasticity of price

Housing 0.12
Economy class air travel 0.12 The table on the left shows a selection
of demand elasticities for different
Rail transit, rush hour 0.15
goods and services drawn from a
Electricity 0.20 variety of different studies by
Taxi 0.22 economists.

Gasoline 0.35 Keep in mind that the statistical

First class air travel 0.40 techniques used to obtain these datas
Wine 0.55 require some assumptions. about the
world, and these assumptions might
Beef 0.59 not be true in practice.
Business class 0.62
Chicken 0.64
Soft drinks 0.70
Beer 0.80
Computer 1.44
Restaurant meals 2.27

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 Other Demand Elasticities
Income Elasticity of Demand
The Income Price Elasticity of demand measures how the quantity demanded of the a good
responds to a change in the consumers’ income level.

Income Percentage change in quantity demanded

Elasticity of =
Demand
Percentage change in income

Let’s break this formula into smaller steps to show you how we nd percentage changes.

(Qd1 -Qd2) Qs1: The rst quantity demanded

Qs2: The second quantity demanded
(Qd1+Qd2)
Income
2
Elasticity of =
Demand (I1 -I2) I1: The rst income level
I2: The second income level
(I1+I2)
2

When the income elasticity of demand is positive ,then the good is a normal good.
When the income elasticity of demand is negative, then the good is an inferior good.

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Other Demand Elasticities - Income Price Elasticity
Income Elasticity of Demand
Example 1 Example 2
Let’s take Gucci, the luxury brand as an Let’s take cheap bags as an example. Let’s
example. Let’s assume that Economy is booming assume that Economy is doing great and
and the income level in the country increases by the income level in the country increases by
200%. Because now people have more money to 20%. Because now people have more
spend on consumption, the quantity of Gucci money to spend, the quantity of cheap bags
bags demanded increases by 20%. demanded decreases by 15%.
20% 15%
Income Price Income Price
= 0,1 = -0,75
Elasticity = Elasticity =
200% 20%

Analysis of Income Elasticity of Demand

Here Gucci bags, a luxury branded bag, is a normal good, a kind of good whose quantity
demanded increases when income level increases because people now can enjoy a higher quality
of bags.
Here cheap bags are inferior goods, a kind of good whose quantity demanded decreases when
income level increases because people don’t need to limit themseves with cheaper options of the
goods.

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 Other Demand Elasticities
Cross-Price Elasticity of Demand
The Cross-Price Elasticity of demand measures how the quantity demanded of the rst good
responds to a change in the price of the second good.

Percentage change in quantity supplied

Cross-Price
=
Elasticity
Percentage change in price

Let’s break this formula into smaller steps to show you how we nd percentage changes.

(Qd1 -Qd2) Qs1: The rst quantity demanded of

The rst good the rst good
(Qd1+Qd2) Qs2: The second quantity demanded
of the rst good
Cross-Price 2
=
Elasticity
(P1 -P2)
The second good
(P1+P2) P1: The rst price of the second good
P2: The second price of the second
2 good

When the cross-price elasticity is positive then the two goods are be substitutes.
When the cross-price elasticity is negative the two goods are complements.

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 Other Demand Elasticities - Cross-Price Elasticity
Cross-Price Elasticity of Demand
Example 1 Example 2
Let’s take Gucci, the luxury brand as an Let’s take gasoline as an example. Let’s
example. Let’s assume that the price of Burberry assume that price of gasoline increases by
bags, one of Gucci’s competitors, decreases by 20%. In order for people to be able to use
35%. Assuming Gucci bags’ price is held xed, their cars they need to buy gasoline. In the
the quantity of Gucci bags demanded decreases short-run, it is seen that the quantity of cars
by 45%. demanded decreases by 12%.

45% 15%
Income Price Income Price
= 1,3 = -0,6
Elasticity
= Elasticity =
35% 20%

Analysis of Cross-Price Elasticity

Here Gucci bags and Burberry bags, luxury bags, are substitutes. Substitute goods are type of
goods that give the same or similar bene ts. In this way one one goods price increase, the other
goods quantity demanded will be increased.
Here gasoline and cars are complements. Complements are two goods that complete each other.
When one of the good’s price increases, the other’s quantity demanded will be decreased.

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CHAPTER 2: Price Elasticity of Supply (PES)
The assumption and de nition
How to calculate PES?
Analysis of Elasticity zones and curves
The factors of Price Elasticity of Supply

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 How to calculate PES?

Percentage change in quantity supplied

Price elasticity
=
of supply (PES)
Percentage change in price

There are two ways to calculate price elasticity of supply:

Method A: The Point Elasticity Method (The Basic Elasticity Formula)

Let’s break this formula into smaller steps to show you how we nd percentage changes.

Qd1: The rst quantity supplied

Qd2: The second quantity supplied
(Qs1 -Qs2)
Qs1
Price elasticity =
of supply (PES) (P1 -P2) P1: The rst price
P2: The second price
P1

*Price elasticity of supply ignores the negative numbers. We use

absolute value in elasticity calculations as what matters is it’s
magnitude of distance from 1.
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 How to calculate PES?

Percentage change in quantity supplied

Price elasticity
=
of supply (PES)
Percentage change in price

Method B is the most accurate one:

Method B: Midpoint Method (Arc Elasticity), a better way to calculate PED

Let’s break this formula into smaller steps to show you how we nd percentage changes.

(Qs1 -Qs2) Qs1: The rst quantity supplied

Qs2: The second quantity supplied
(Qs1+Qs2)
Price elasticity = 2
of supply (PES) (P1 -P2) P1: The rst price
P2: The second price
(P1+P2)
2

*Price elasticity of supply ignores the negative numbers. We use

absolute value in elasticity calculations as what matters is it’s
magnitude of distance from 1.
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Analysis of PES zones and curves
Ex: Let’s suppose the price of milk increases from $4.99 to $5.99. Based on this change, dairy
farmers production increase from 12,000 to 18,000 gallons.

Qs1: 12,000 P1: $4.99 (12,000 -18,000)

Qs2: 18,000 P2: $5.99
(12,000+18,000)
Price elasticity 2
= = |-2,1| = 2,1
of supply
(4.99 -5.99)
We always put
(4.99+5.99) the outcome in
absolute value
2
How are we going to analyse this number?

What we look at is its magnitude of distance from 1.The higher the absolute value of the
elasticity, the more responsive and sensitive suppliers are to the change in price

PES=1, Unit elastic 2,1 is bigger than 1, based on the elasticity zones
PES >1, Elastic on the left, milk is elastic. This means that when
price changes, suppliers respond more than the
PES <1, Inelastic change in price.
PES = 0, Perfectly Inelastic
TIP: When we say elasticity is higher, suppliers will respond
PES = ,Perfectly Elastic more than the change in price.
When we say elasticity is lower, suppliers will respond less
than the change in price.
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Analysis of PES zones and curves

There are 5 zones of elasticity and each one of them is represented with a unique curve.

1) PES=1, Unit elastic

P

2) PES > 1, Elastic 3) PES < 1, Inelastic

P P

Q Q

4) PES= , Perfectly Elastic 5) PES = 0, Perfectly Inelastic

P P

Q Q

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Analysis of PES zones and curves
1) PES =1, Unit elastic
Price
When PES=1, the product or the service is Unit
Elastic. It means that the percentage change in
quantity supplied (Qs) is the same as the percentage
change in price.

Q
For example:
Let’s assume that the price of rice increases to $5 to $15. Based on this change, the supply
increased from 50 bags to 150 bags.
P (5 - 15)
(5+15)
2
PES = = |1| = 1
(50 -150)
$15
(50+150)
$5 2
50 150 Q

ANALYSIS: When a product is unit elastic, the change in quantity supplied will be the
same with the change in price.

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Analysis of PES zones and curves
2) PES >1, Elastic When PES <1, the product or the service is known as Elastic. It
Price means that the percentage change in quantity supplied (Qs) is
bigger than the percentage change in price.

TIP: When you see a atter supply curve, it shows an

elastic product or service.
Q
For example:
Let’s assume that prices of orange juices increased from $10 to $18. Based on this change, the
supply of orange juices increased from 50 to 120.
P (50 - 120)
(50+120)
2
PES = =|1,4| =1,4
(10 -18)
$18
(10+18)
$10 2

50 120 Q

ANALYSIS: When a product is elastic, the change in quantity supplied will be higher than
the change in price.

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Analysis of PES zones and curves
3) PES < 1, Inelastic When PES >1, the product or the service is known as
P Inelastic. It means that the percentage change in
quantity supplied (Qs) is smaller than the percentage
change in price.

TIP: When you see a steeper supply curve, it shows

Q an inelastic product or service.
For example:
Let’s assume price of eggs decreased from $12 to $6. Based on this change, the supply
decreased from 200 to 150.
(200 - 150)
P
(200+150)
$12
2
PES = =|0,4| = 0,4
(12 -6)
$6 (12+6)
2
150 300 Q

ANALYSIS: Here, you see PES of eggs as 0,4, which is smaller than 1. Based on this
value, we can say that egg is an inelastic product. This means that whenever the
eggs‘ price decreases, less suppliers will decrease their supplies.

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 Elastic and Inelastic supply on the same curve

P
$28

$22
.. Elasticity is smaller than 1

Elasticity is bigger than 1

$18

$10 . .
50 120 50 150 Q

Companies often have a maximum capacity for production, the

elasticity of supply maybe very high at low levels of quantity supplied
and very low at high levels of quantity supplied.
As you can see from here, even on the same supply curve:
*the at part of the curve has an elastic supply,
*the steeper part of the same curve has an inelastic supply.

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Analysis of PED zones and curves

4) PES= , Perfectly Elastic When PES= , the product or the service is known
Price as Perfectly Elastic. It means that even if the price
doesn’t change or if there is a small change in price,
quantity supplied changes massively. This is an
extreme case and rare to see in real life.

Q TIP: When you see a horizontal supply curve, it shows

a perfectly elastic product or service.

5) PES = 0, Perfectly Inelastic When PES=0 , the product or the service is known as
Price Perfectly Inelastic. It means that no matter what price
is, quantity supplied doesn’t change. This is an
extreme case and rare to see in real life.

TIP: When you see a vertical supplied curve, it shows

Q
a perfectly inelastic product or service.

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 The factors of PES
1-) Flexibility in terms of production
Example: a 5 star resort & books
Elasticity depends on the exibility of sellers to change the amount of goods they
produce. A 5 star resort has a lower elasticity than
2-) Time horizon
Example: Insulin and breakfast cereal.
Supply is more elastic in the long term than in the short term. In a short amount of
time, rms cannot easily respond to the changes like changing size of the factories
whether to produce more or produce less but in the long run rms can build new
factories or close the existing ones. In the long run rms are able to respond to
changes more than they can in the short run..
3-) Availability of resources
Example: rubber trees
If there are some limitations to the raw material, then the price elasticity of supply will
get affected by it. Rubber trees, for example, take 15 years to grow. So it is not
possible to increase the supply of rubber overnight.
4-) Factor mobility
Example: farmers switch producing from wheat to carrot
If the factors of production can be easily moved from one use to another, it will affect
elasticity of supply. The higher the mobility of factors, the greater is the elasticity of
supply of the good.
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CHAPTER 3: The use of Price Elasticity in business
Why do companies want to know Price Elasticity?
How do companies use Price Elasticity?
What are the common mistakes managers make with Price Elasticity?
Total Revenue & Price Elasticity
Cost & Price Elasticity
Tax Incidence & Price Elasticity
The business aspect of other Price Elasticities

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 Why do companies want to know Price Elasticity?
From now on we use “Price Elasticity” for Price Elasticity of Demand. There are several
reasons why rms gather information about PED of their products.

A rm knows much more about its internal operations and product costs than about its
external environment. Therefore, gathering data on how consumers respond to changes
in price can help decrease risks as well as uncertainly. More speci cally, businesses
want to have the knowledge of PED to set its price and forecast its sales.

Sales forecasting Pricing & Non-pricing policies

The rm can forecast the impact of a Knowing PED helps the rm set its initial
change in price on its sales volume, and price and decide whether to raise or
total revenue by using PED. For example, lower price, or whether to apply different
PED of a product = 2 price levels to different segments (price
discrimination). If demand is elastic,
A 10% reduction in price (say, from $10 revenue is gained by reducing price, but
to $9) will lead to a 20% increase in sales if demand is inelastic, revenue is gained
(say from 1000 to1200). In this case, by raising price.
revenue will rise from $10,000 to $10,800.
When PED is highly elastic, the rm can
use advertising and other promotional
techniques to reduce elasticity.

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 How do companies use this?
It is the most important thing for Marketing managers’ responsibility is to create such
companies to set the right price for their products or services that are differentiated, unique
product or service as it has such a big and deliver sustainable value to the target audience
impact on the total revenue of the compared to other available options. As a marketer, I
company. Business owners, marketers should be able to know that it my product’s elasticity is
need to understand one of the key high, then it is perceived as a commodity. My goal
metrics of pricing, what economists call should be moving my product from a relatively elastic
price elasticity. zone to relatively inelastic zone.

through marketing &

Elastic Inelastic
product development

In order to track this progress Succesful companies use price By having a deeper understanding of
we need to keep an eye on the elasticity by changing prices price elasticity and the factors
price elasticity. It is a tough job multiple times and observing affecting it, the next research should
as price elasticity is affected by the impact of each price point be done on how those factors will
many factors like companies on demand. In practice, these change over time. In order to stay true
marketing mix strategy, the price changes won’t be done on to your customers, keeping a
economy, income level of the a wider scale, rather than that, it sustainable effort to differentiate your
target audience, competitors is impelemented on a smaller product from those in the market and
and many more. You can’t look scale like running focus groups. adjusting your price considering the
at price elasticity in isolation Besides, using price elasticity value promise is also important as
and try to make the strategies help companies spot under or price elasticity is just one metric to in
based on it work. over priced products in their this decision making process.
portfolio.
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 Total Revenue and Price Elasticity
Price elasticity of demand and total revenue are closely interrelated because they deal
with the same two variables, P and Q.

P * Q=Total Revenue The total amount received by sellers of a good, calculated

by multiplying price and quantity sold.
P

$10

P * Q = 3,000
P
(total revenue) D

300 Q
Q

The box below the demand curve is the the area where we use to calculate total revenue.

Here P is $10 and Q is 300 so the total revenue of the company is 10 * 300 = $3,000

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Total Revenue and Price Elasticity
Does “increasing price" always result in more revenue?
The impact of a price change on total revenue depends on the elasticity of demand. It is
important for management to know whether its product has inelastic or elastic demand.
P P
Elastic Demand Inelastic Demand

$30

A<B A
$20
$10
A
$10
A>B
B B
100 500 Q 400 500 Q

10 * 500 = $5,000 10 * 500 = $5,000

P TR P TR
20 * 100 = $2,000 30 * 400 = $12,000

STRATEGY STRATEGY
In order to increase the total revenue, In order to increase the total revenue,
companies should decrease the price of companies should increase the price of
that elastic good. P will decrease, but Q that inelastic good. In that case the item
will increase at a greater rate, thus will be sold slightly less but you will make
increasing total revenue. higher revenue.

As now, we know that increasing price for all the goods is not the sure way to increase revenue. In the
same way decreasing price for all the goods does not always lead the company to a higher revenue.
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Cost and Price Elasticity
Can companies re ect almost all the costs on to customers
to increase their revenue?
Having an ef cient cost structure is a major competitive advantage in today’s business
world, therefore companies have endless struggles to nd a way to decrease their costs
to increase their pro t margin.

Even if they can control internal factors, companies are open to changes in external
factors like an increase in the price of a key ingredient that is out of their control or a
new technology is discovered that decreases the cost of producing goods.

How they should respond to these kind of changes in the market by adjusting their
prices lies in the hand of knowing and using their product’s price elasticity.

For example:

Coffee shops, they have no control over the price of coffee beans in the world market.

Petroleum companies, they too have no control over the price of crude oil.

Cigarette companies, they too have no control when a new tax is being placed on their
product.

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 Cost and Price Elasticity
Can companies re ect almost all the costs on to customers
to increase their revenue?
For example: Airlines companies are a great example for this diagram.

P Elastic Demand There are a lot of companies providing air travel.

Let’s assume that there is a technological
breakthrough that shifts the supply curve to the
S1
S2
right and decreasing the price.

$15
$10
-0.48
D PES = = |1,19| = 1,19
-0.4
400 650 Q

In this case, the technological breakthrough leads to a major increase in quantity demanded
compared to the change in price. In this case, the airline companies can enjoy a rise in their
total revenue and an increased cutomer base.

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Cost and Price Elasticity
Can companies re ect almost all the costs on to customers
to increase their revenue?
For example: Medice companies are a great example for this diagram.

P Inelastic Demand Let’s assume there are various companies

producing the same medicine. Thanks to a
S1 S2 technological breakthrough, the cost of producing
that medicine lowers and supply curve shifts to
the right while decreasing the price.
$30

$10
-0.2
PES = = |0,2| = 0,2
D
100 125
-1
Q

But response from the customers is so little that actually this change decreases the total
revenue of the company. As a result, the companies nd themselves in searching for a new
technology that would bring their costs even lower to keep their pro t margins.
From the customers point of view, for an inelastic product customers bene t more when
price decreases cause the change in price is bigger than the change in quantity demanded,
this way they can enjoy the same product or service with a lower price. But when it comes to
an increase in price of an inelastic good, this advantage turns to a drawback where
customers buy the products or services with much higher prices.

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Tax Incidence and Elasticity

Tax Incidence: The manner in which the burden of a tax is shared among buyers and sellers.

1. When a tax is placed on a good or service, buyers and sellers of the good or the service
share the burden of the tax.

2. “How exactly is the tax burden divided?” is the question here. It is rarely shared equally.

3. In real life, the decision of how the tax burden is shared among buyers and sellers is
based on the price elasticity of demand and price elasticity of supply.

4. RULE OF THUMB: The side of the market that is less elastic will end up carrying more of
the burden of the tax. If supply is relatively less elastic than demand, then the burden of the tax
falls more on the supplier. But if the demand is relatively less elastic than supply, then the
burden of the tax falls on the buyers.

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Tax Incidence and Elasticity
How exactly is the tax burden divided here?

For example: Solarpower companies are a great example for this diagram.

Elastic Demand & Inelastic Supply Solar power has been around quite a while but it
P
wasn’t since couple years back that it has started
to be taken seriously as a source of energy. The
S2 solar panels and other related equipments have
S1
elastic demand as they are competing with other
products that can use traditional energy sources.
$15
$10
-0.48
D PES = = |1,19| =1,19
-0.4
400 650 Q

Let’s assume governments placed a tax on solarpower companies. In this case, this tax
creates a burden on the operations of these companies. When companies re ect this tax on
their prices, they face with a dramatic decrease in quantity demanded as the demand is
elastic, where as supply is relatively inelastic. In that case, the companies bear more of the
burden of the tax than the buyers.

From the companies point of view, the problem with elastic products are, when they want to
pass higher costs on to customers, quantity demand will decline dramaticaly where
companies lose revenue and it can also lead to a greater loss in the long-run if it is not xed.
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 Tax Incidence and Elasticity
How exactly is the tax burden divided here?

For example: Let’s have a look at cigarettes in this diagram.

Inelastic Demand & Elastic Supply Smoking has been one of the issues that
P governments, NGOs(Non-Governmental
S2 Organizations) & individuals have been
S1 ghting for years. In this case, let’s assume the
government placed a tax on cigarettes to
$30 decrease consumption.
$10

D -0.2
PES = = |0,2| = 0,2
100 125 Q -1

Cigarette companies immediately re ect this high cost on to customers. As smoking is

addictive, the response from the customers is so little, probably mostly from the young
smokers, that actually this change doesn’t create the result the government wants to see in
the society.
As demand is relatively inelastic than supply, buyers bear more of the burden of the tax.
Any product, especially the ones that create addiction, putting taxes and increasing prices
solely won’t help to achieve the results. it should support this with major incentives like
education, campaigns to be a success in the long run.

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The business aspect of other price elasticities
Why Income Price Elasticity matters?
As an economy expands, people in the society will be able to enjoy a higher level income.
In most cases, the demand for some speci c goods and services is likely to increase as
well.
Income Price Elasticity provides a great insight to businesses to analyse their products’
performance during an expansion or a shrink in the economy as well as any changes in
income levels of customers due to a change in the economy.

Why Cross-Price Elasticity matters?

Companies use cross-price elasticity to compare and set their prices. Goods with no
close substitutes can be sold at higher prices, because there is no cross-price elasticity
to consider. For the goods which have close substitutes, incremental changes are done to
determine the appropritae level of demand desired and the associated price of the good.
For the complements, goods are strategically priced based on cross elasticity of demand.
For examples, printers may be sold at a loss with the understanding that the demand for
future complement goods, such as printer ink might increase.

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The common mistakes that managers make with Elasticity?
• Many managers fall into the trap of assuming that once they run a price test on couple price
points, they get the whole picture of understanding the possible response of demand to any
price point. Adding more assumption to price elasticity will make it less accurate and ending
up wasting a lot of time as the real respond in practice might highly be different. That’s why
companies should be able to test extreme price changes as it might provide a valuable
information in terms of customer response.

• Price elasticity is a dynamic concept. Businesses shouldn’t rely too much on historical datas as
what consumers have historically been willing to pay for goods and services are not necessarily
what they are willing to pay today. In that way surveys doesn’t always re ect the real behaviour
of customers cause what they say they would do might be different than what they actually do.
You’ll get the most accurate information by running a in-market A/B test by putting your priduct
in the shelf with a new price point and observe the change in demand, afterwards comparing
the result with the same product with a different price point.

• Keep in mind that elasticity has two aspects. One is quantitative which refers to responsivenes
and the other one is qualitative which refers to sensitivity. Marketers shouldn’t accept these two
as same although they are closely related. When we talk about sensitivity, marketers should dig
deeper on why customers behave the way they do. Understanding the reasons behind
customers’ behaviours is critical to reverse engineer a pattern that might harm your products
sales performance. So quantitative testing and qualitative research will give a bigger picture to
marketers to help their product or service to succeed.

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