Getting less from more: The law of diminishing marginal utility

Chapter 4 Using the Elasticity Shortcut

In This Chapter

▶ Grasping the basics of elasticity ▶ Understanding and calculating quantity demanded changes ▶ Identifying the effect of price changes on revenue ▶ Examining how income, other goods’ prices, and advertising influence demand

This chapter brings you up to speed on the concept of elasticity and how it works. It explains how elasticity determines a business’s revenue side and tells you what price to charge, how much advertising to do, and how changes in other prices or income affect your sales. If you remember only one concept in managerial economics, elasticity is it. The fact that a single concept provides all this information makes it magical. Calculating an elasticity value is like pulling a rabbit out of a hat; one number tells nearly everything to the amazement of those watching (your coworkers). And when you combine elasticity and revenue information with production costs, you can determine how the firm will maximize its profit.

Using Elasticity Is The Key to Flexibility

The law of demand states that increasing a good’s price reduces the good’s quantity demanded (the amount of the good that customers purchase given its price). This relationship is important, but somewhat obvious. Similarly, demand reacts to changes in incomes, the price of related goods, and advertising efforts. Elasticity measures the responsiveness of one economic variable to another and is the concept you use to determine these relationships. For example, when the price of movie tickets goes up, you and other customers will buy fewer tickets. So, for the theater manager, the critical question is how much will the number of tickets sold decrease — will it be a little or a lot? Similarly, the theater manager needs to know how movie ticket demand reacts to changes in incomes, the price of popcorn at the concession stand, and advertising for the blockbuster movie.