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Selling gift cards
Chapter 4: Using the Elasticity Shortcut
switch to the lower priced good. So, an increase in the price of potato chips, good y, means customers will switch and purchase more of good x, pretzels. Thus, a direct relationship exists between the price of good y and the demand for good x, and they are substitutes.
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Complements are goods that are used together, such as coffee and cream. For complements, an inverse relationship exists between good y’s price and good x’s demand; if good y’s price increases, the demand for good x decreases and vice versa. So, if the price of coffee increases, good y, you drink less coffee, and your demand for cream, good x, decreases.
Finally, the larger the value, either positive or negative, for the cross-price elasticity of demand, the stronger the relationship between the two goods.
The advertising elasticity of demand measures the responsiveness of a good’s demand to changes in spending on advertising. The advertising elasticity of demand measures the percentage change in demand that occurs given a 1 percent change in advertising expenditure.
The advertising elasticity of demand is calculated using the following formula:
The symbol ηA represents the advertising elasticity of demand. In the formula, the symbol Q0 represents the initial demand or quantity purchased that exists when spending on advertising equals A0. The symbol Q1 represents the new demand that exists when advertising expenditures change to A1.
The advertising elasticity of demand should be positive. (A negative value would indicate the more you spend on advertising, the lower your sales. That is a really bad ad! You should probably fire whomever is in charge of advertising.)
As with all elasticity values, the larger the number, the more responsive the good’s demand is to a change in advertising.
Your vending machine company starts a new ad campaign, “Vend for Yourself.” (Okay, I’ll stick to economics rather than advertising.) Currently, your company sells soft drinks at $1.50 per bottle, and at that price, customers purchase 2,000 bottles per week. Initially, you spend $400 per week on advertising. After a month, you’re spending $500 per week on advertising and,
