1. Customer Demand
it doesn't pay to either raise or lower prices.
where demand elasticity equals 1
New−Old/Old
Percentage changes should be calculated as:
How sensitive is demand for your product to changes in prices of other products? This is particularly useful to understand the effects of competitive responses and actions—and which other products really affect your demand.
Cross-price elasticity of demand:
A demand curve for an individual buyer simply summarizes that consumer's willingness to pay for various quantities of a product. The convention for graphing demand curves is to represent price on the y-axis, and quantity demanded on the x-axis. Demand curves are convenient representations because one can easily see how a firm's revenues correspond to different prices. A firm's revenue is given by price*quantity demanded, or the area under a demand curve. An individual's demand curve is typically downward sloping because a consumer will have a higher WTP for the first unit of a product, but a lower WTP for subsequent units. This is due to "diminishing marginal returns." The market demand curve reports, at any given price, the aggregate quantity demanded. Market demand curves are downward sloping because fewer consumers are willing to purchase the product at higher prices.
Demand Curve
The slope of a market demand curve measures how responsive buyers are to changes in price. When the curve is flat or near-flat, a small dip in price sparks a large surge in the quantity demanded. When the curve is steep or vertical, changes in price have little impact on the quantity demanded. Steep curves are often called "inelastic," and flat curves are often called "elastic." Demand is typically more elastic if a product is a luxury rather than a necessity, or if the product has many substitutes. The "price elasticity" of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. An important advantage of the elasticity measure over a slope measure is that elasticity is a unit-less measure: it doesn't change as the units used to measure quantity demanded change. As a result, one can also more easily compare the elasticities of demand for different products; slopes do not enjoy this property. Elasticity is different at each point on a demand curve with constant slope (i.e., a straight-line demand curve). However, that demand curve as a whole could be colloquially called "elastic" or "inelastic" depending on how flat or steep its slope is. One can also measure the "income elasticity of demand", the "advertising elasticity of demand", or any other kind of elasticity. For example, the income elasticity of demand measures how sensitive quantity demanded is to a change in consumers' income.
Elasticity
Rise / Run (ΔP/ΔQ)
Formula for Slope:
it pays to lower prices
If demand is elastic
it pays to raise prices
If demand is inelastic
The more available are substitute goods, the less willing consumers will be to put up with increases in price for a particular product.
Price elasticity of demand for a particular product will tend to increase as more substitute goods become available.
This is true because slope measures absolute changes in quantity and is sensitive to the units of measurement; in contrast, elasticity is not.
Price elasticity of demand is a better measure of price sensitivity than slope.
False. This is only true for linear demand curves.
Price elasticity of demand is necessarily equal to one halfway down a demand curve.
This is generally false. The longer the time horizon, the greater the chance of competition in a market and/or the greater chance consumers have to switch away to a substitute good. All else equal (for example, accounting for brand loyalty, consumer habits and other factors), this would make consumers more sensitive to changes in price over time.
Price elasticity of demand tends to decrease over time.
As a result, one can extend the concept of elasticity in a simple way to examine how sensitive demand is to any of these factors. The only difference is that rather than examining the effects of price on quantity demanded, we'll examine the effects of these other factors on quantity demanded.
Remember that willingness to pay—like demand—can depend on a number of factors. Income, gender, age, and weather are all drivers of willingness to pay.
Changes in consumer willingness to pay result in shifts of the demand curve. For example, an increase in a consumer's WTP for a product will shift her demand curve outward; a decrease in WTP will shift her demand curve inward. Slopes versus shifts: Changes in price correspond to movements along the demand curve. Non-price factors that affect WTP correspond to shifts in the demand curve (inward or outward). Factors that shift individual demand curves up or down also shift the market demand curve.
Shifting the Demand Curve
3/4 {We can determine the total market demand at $3 by adding together the total number of cones at which Alex, Maria, and Raj's WTP is $3 or higher. We can see that Alex will buy 3 cones at $3 or higher, Maria will also buy 3, and Raj will buy 2, which adds up to a total of 8 cones demanded at $3. Repeating the same process for $4 (or higher), we get 2 cones for Alex, 2 cones for Maria, and 2 cones for Raj, which adds up to a total of 6 cones demanded at $4. Once we have these quantities for demand at the new and old prices, we can plug them into the equation for price elasticity of demand = absolute value of [(6-8)/8]/[(4-3)/3] = 3/4.}
Suppose that Alex, Maria, and Raj are the only 3 buyers of chocolate ice cream in the market. Based on the chart below showing each buyer's willingness to pay for each additional cone, what is the price elasticity of demand for a change in price from $3 to $4 dollars? WTP Alex Maria Raj 1st cone $8 $6 $4 2nd cone $5 $4 $4 3rd cone $3 $3 $1 4th cone $2 $1 $0
ε=|ΔQ/Q/ΔP/P| ( the percentage change in quantity demanded divided by the percentage change in price.)
The elasticity of a demand curve is:
Willingness to pay is the maximum amount of money a customer is willing to pay for a product or service. WTP is not the same as price. A product may have a price of $0, but there may still be consumers who are willing to pay a lot for it. If the price of a product is higher than a consumer's WTP, that consumer will not purchase the product. Though prices are easily observable, WTP is not. This is what creates a challenge for managers: figuring out what consumer WTP is. A consumer's willingness to pay can be influenced by a variety of factors. Some of these factors are observable, such as income, gender, age, etc. Other factors that drive a consumer's WTP are not easily observable, such as a consumer's intrinsic preference for the product, substitutes and complements to the product, and so on. Understanding the factors that drive consumer's different willingness to pay can help companies segment the market and develop differentiated marketing strategies to target different segments.
Willingness to Pay (WTP)
the price elasticity of demand increases
as price increases
An individual's demand curve is typically downward sloping because a consumer will have a higher WTP for the first unit of a product, but a lower WTP for subsequent units.
diminishing marginal returns.
ε=ΔQ/Q/ΔX/X
what the elasticity of demand is with respect to variable X:
