Elasticity Lesson 1

Types of elasticity

In the Introduction to Elasticity we saw that Elasticity of Demand maybe elastic, inelastic or unit elastic.  As the owner of a firm if you know what type of elasticity you have at your current prices - you may change the prices to increase your revenue.

There are two extreme cases of elasticity:

  • Perfectly inelastic demand - where the consumer is willing to pay any price to buy the product.  This typically applies to health care (you would be willing to pay anything for heart surgery if it will save your life) or it may also apply to illegal drugs (where addicts are willing to do anything to get their drugs).
  • Perfectly elastic demand - where the consumer is only willing to pay a certain price - if the price changes the consumer will not purchase the item.  This is mainly a theoretical exercise  Below are graphs that represent these extreme cases:

It is important to remember that elasticity provides information to maximize revenues - however in a typical demand curve the value of elasticity changes along the demand curve - relative elastic values at higher prices and relative inelastic at lower prices.  The firm will maximize revenues when the value of elasticity is as close as possible to 1.

Practice Questions

  1. The manager at the place you work wants to increase revenue by using elasticity and she has the data below:
    PRICE of Good AQUANTITY of Good B
    $
    $

        Calculate the value of elasticity and advice the manager as to how to manipulate prices in order to maximize revenue.  Explain how raising/lowering prices increases revenue depending on whether the elasticity is greater than or less than one.

     2. If the value of elasticity for gasoline is 0.80 - is gasoline a relatively elastic or inelastic good?  Explain your answer.  Would it be a good idea to raise taxes for gasoline in order to increase tax revenue?  Why/why not?  Explain your answer.

     3. Palomar College has done some research into parking fees and has determined that students will buy 10,000 parking permits at $40 - however if permits price is raised to $50 only 9,000 permits will be sold.  What is the value of elasticity?  Show your work!  If the goal is to maximize revenue should Palomar charge $50?  Or $40?  Why?  Explain your answer.