Raise your latte price a dime and some customers shrug while others cross the street. Elasticity is the number that tells you which kind you have, and your Daily Report prints it every day.
Learning objectives. After this week you can (1) compute price elasticity of demand; (2) classify demand as elastic, inelastic or unit elastic; and (3) use the total-revenue test.
Remember this: elastic means price and revenue move in opposite directions. Inelastic means they move together.
1) Measuring elasticity
Price Elasticity of Demand = % change in Quantity ÷ % change in Price
We drop the minus sign. If cups fall 20% when price rises 10%, elasticity is 20 ÷ 10 = 2.0.
| % change in quantity | % change in price | Elasticity | Type |
|---|---|---|---|
| −20% | +10% | 2.0 | Elastic |
| −5% | +10% | 0.5 | Inelastic |
| −10% | +10% | 1.0 | Unit elastic |
2) Elastic or inelastic?
Elastic (above 1): buyers react a lot. Inelastic (below 1): they barely react. Unit elastic (exactly 1): sales change by the same percent as price. Demand is more elastic when there are close substitutes (a rival across the street), when the good is a luxury rather than a necessity, when it takes a big share of the budget, and over a longer time, as buyers find alternatives.
3) The total-revenue test
Total Revenue = Price × Quantity
You sell 300 lattes at $4.00: revenue $1,200. Raise the price 10% to $4.40. If elasticity is 2.0, cups fall 20% to 240, and 240 × $4.40 = $1,056: revenue fell. If elasticity is 0.5, cups fall 5% to 285, and 285 × $4.40 = $1,254: revenue rose.
So with elastic demand a price rise lowers revenue and a cut raises it. With inelastic demand a rise raises revenue. With unit elastic demand revenue stays the same.
4) Your report's ε
Your Unit economics line ends with ε, your shop's elasticity that day. It prints with a minus sign (say, ε −2.10) because price and quantity move in opposite directions. Drop the sign to classify it: 2.10 is elastic. It changes from day to day as your prices, your street and the rival change.
Quick self-check
(a) Quantity falls 6% when price rises 12%. Elasticity, and which type? (b) Your report shows ε −0.80. Would a small price rise raise or lower revenue? (Answers: 6 ÷ 12 = 0.5, inelastic; raise it, because 0.80 is inelastic.)
Common mistakes
- Assuming a price rise always raises revenue. With elastic demand it lowers it.
- Dividing the wrong way. The quantity change goes on top.
- Reading the minus sign as a type. Drop the sign, then compare with 1.
This week in the arena
Write down the ε from each Daily Report this week next to your latte price. Is your demand elastic or inelastic, and does it stay on the same side of 1 all week? Before you change a price, use the total-revenue test to predict what the change will do to revenue, then check the next report.