Markets:  Elasticity Continued

Other Demand Elasticities -

Elasticity is a sensitivity measure that may be of interest with respect to any independent variable.  Some other important elasticities can be readily calculated from a demand function.  All of these elasticities are used extensively by firms when setting price and for other decisions as well.

For example:  Cross price elasticity

The purpose of a cross price elasticity estimate is to capture some sense of the responsiveness of sales for one good to a change in the price of some related good.

            The cross price elasticity of good x with respect to a change in the price of a related good y is:

E_XY   = % Q_x^D   
           % P_Y      

Using our percentage change formula (assuming we have the % changes), this could be calculated as:

Example:  Assume that when the price of Coke increased by 3%, the demand for Pepsi increased by 4%.

Cross Price Elasticity =  4/3 = 1.33

Notice that cross price elasticity information can be used to distinguish substitutes from complements.  In this case, the coefficient is positive, indicating  that the products are substitutes.

How might a manger use this information? 

            To assess responses of competitor's actions.

            To assess how changes in one of the company's product price might change the demand for another one of its products.

            Example:

Another example:  Income elasticity:

            The percentage change in demand brought about by a 1% change in income on "aggregate" demand.

E_I   = % Q_x^D   
        % Income    

Calculations parallel to the price elasticity of demand. 

How might a manger use this information?

            To assess effects of changes in underlying economic conditions

- If  < 1, the good is noncyclical. Ex: Foods, shoes, gasoline.

- If  > 1 We will say the good is cyclical. Ex: Autos, housing, luxury goods.

To assess the relationship between income and the demand for the good (for marketing reasons):

- If the sign is negative the good is inferior

- If the sign is positive the good is normal.

Some Applications:

            Assessing susceptibility to economic conditions.  Goods with a big income elasticity of demand are more susceptible to economic swings in personal income.

              Example, Income elasticity of demand for autos is 3.  So when the economy takes a downturn in general, the auto industry is hit hard.  Income really matters!      

            Forecasting:  Remember that the elasticity tells us how a 1% change in income will change demand.  So:

Suppose income elasticity for cigarettes is .6.   A 5% increase in personal income could be expected to increase demand by :

                        .6%         x          5       =           3 or 3%

Another Example:  Advertising Elasticity

The percentage change in Quantity induced by a one percent change in advertising expenditures. 

E_AD   = % Q_x^D   
           % Ad Expenditures     

Example: 

High Country Rides increased its advertising expenditures by 20% and saw an increase in demand for their jeep rides by 30%.

Advertising Elasticity = 30/20 = 1.5

Was the advertising effective?  Yes -- this is elastic, consumers are responsive to their advertising campaign.  For every 1% increase in ad expenditures, demand increased by 1.5%.

How might a manger use this information?

It is one of the variables the firm can control, and can use to respond to changes in the things it cannot control (such as the price of related goods, income etc.) 

Notice that advertising elasticity should be positive.  If not, it is an advertising campaign that is detracting from sales -- like bad publicity!

More Examples.

            -Suppose that the income elasticity of demand is .5, and the advertising elasticity of demand is .2.  If income falls by 2%, how much would a firm have to increase advertising to make up for the difference?

            Remember that for every decrease in income by 1%, demand falls by .5%.  So since income has decreased by 2%, demand has gone down by 1% (.5 x 2)

            So how much advertising does the firm need to do to increase demand back up by 1%? 

            For every 1% change in advertising, the firm gets a .2% increase in demand.  So to bring that to 1%, the firm would have to increase their advertising by 5% (5 x .2 = 1%).

Can you think of any other possible type of elasticity a manger might use?

    How about a Production Elasticity -- how responsive is output to a percentage change in a given variable input?  Does that make sense?

What would the equation be?

Supply Elasticity

Concept:

E_s   = % Q_x^s   
           % _Px   

Determinants:

Time -

Substitutability of resources -

When the supply curve is more elastic, the effect of a change in demand will be greater on quantity than on price of the product.  On the other hand, with a supply curve of low elasticity, a change in demand will have a greater effect on price than quantity.