Changes

Let’s take another example.  Suppose that airlines increase the price on their flights from New York to Florida from an average of $300 per seat to $500 per seat.  That is a 67% increase.  What would that do to the tourist traffic to Florida from New York?  It only takes a day and a half to drive to Florida, which incurs gas charges of less than $100 and a hotel charge of perhaps $80.  Tourists would likely drive rather than pay the higher fares.  The demand for these higher-priced tickets could fall by 75%, assuming that business travel is only a small percentage of that traffic.

Let’s take another example.  Suppose that airlines increase the price on their flights from New York to Florida from an average of $300 per seat to $500 per seat.  That is a 67% increase.  What would that do to the tourist traffic to Florida from New York?  It only takes a day and a half to drive to Florida, which incurs gas charges of less than $100 and a hotel charge of perhaps $80.  Tourists would likely drive rather than pay the higher fares.  The demand for these higher-priced tickets could fall by 75%, assuming that business travel is only a small percentage of that traffic.

What is the price elasticity of this demand?  The percent change in quantity demanded is -75% (3/4) and the percent change in price is 67% (2/3), so the elasticity is -3/4 divided by 2/3 = -9/8.  The sign is dropped so the elasticity is expressed as 9/8.  It is greater than 1, and thus is described as having an “elastic demand” rather than an “inelastic demand,” which is less than 1.  (If it equalled 1, then it would be called “unit elasticity of demand.”)

What is the price elasticity of this demand?  The percent change in quantity demanded is -75% (3/4) and the percent change in price is 67% (2/3), so the elasticity is -3/4 divided by 2/3 = -9/8.  The sign is dropped so the elasticity is expressed as 9/8.  It is greater than 1, and thus is described as having an “elastic demand” rather than an “inelastic demand,” which is less than 1.  (If it equaled 1, then it would be called “unit elasticity of demand.”)

What does it mean to a company if its goods have “elastic demand”?  It means the company should be cautious in raising prices.  Look at what happens to the revenue to the airlines due to the elastic demand for seats on their planes.  The initial revenue was price times quantity, which is PxQ, or PQ.  The revenue after the pricing change is (5/3)(P)(1/4)(Q) = (5/12)PQ.  Its revenue fell to 5/12 of its initial revenue due to the price increase.  The airlines lost over half of its revenue by increasing its price!  Uh oh, that requires laying off many employees, reporting losses to the investors, and firing the persons responsible for that price increase.

What does it mean to a company if its goods have “elastic demand”?  It means the company should be cautious in raising prices.  Look at what happens to the revenue to the airlines due to the elastic demand for seats on their planes.  The initial revenue was price times quantity, which is PxQ, or PQ.  The revenue after the pricing change is (5/3)(P)(1/4)(Q) = (5/12)PQ.  Its revenue fell to 5/12 of its initial revenue due to the price increase.  The airlines lost over half of its revenue by increasing its price!  Uh oh, that requires laying off many employees, reporting losses to the investors, and firing the persons responsible for that price increase.