Elasticity of Demand 83instance, the airline’s sales along the route are affected not only by changes in
competing airline fares but also by train and bus fares and auto-operating costs.
To a greater or lesser degree, these other modes of transportation are substi-
tutes for air travel.
A pair of goods is complementary if an increase in demand for one causes
an increase in demand for the other. For instance, an increase in the sales of
new automobiles will have a positive effect on the sales of new tires. In par-
ticular, tire manufacturers are very interested in the prices car manufactur-
ers announce for new models. They know that discount auto prices will spur
not only the sales of cars, but also the sales of tires. The price of a comple-
mentary good enters negatively into the demand function; that is, an increase
in the price of a complementary good reduces demand for the good in question.For
example, Florida resort packages and travel between Houston and Florida
are to some extent complementary. Thus, the price of resort packages would
enter with a negative coefficient into the demand function for travel along
the route.^6
Finally, a wide variety of other factors may affect the demand for particu-
lar goods and services. Normal populationgrowth of prime groups that con-
sume the good or service will increase demand. As the populations of Houston
and the Florida city grow, so will air travel between them. The main determi-
nant of soft-drink sales is the number of individuals in the 10-to-25 age group.
Changes in preferences and tastes are another important factor. Various trends
over the past 20 years have supported growth in demand for new foods (diet,
natural, organic), new electronic products (cell phones, digital cameras, MP3
players, CD and DVD players), new recreation services (exercise, travel, tan-
ning salons, and so on). The list is endless.ELASTICITY OF DEMAND
Price Elasticity
Price elasticitymeasures the responsiveness of a good’s sales to changes in
its price. This concept is important for two reasons. First, knowledge of a
good’s price elasticity allows firms to predict the impact of price changes on
unit sales. Second, price elasticity guides the firm’s profit-maximizing pric-
ing decisions.
Let’s begin with a basic definition: The price elasticity of demandis
the ratio of the percentage change in quantity and the percentage change(^6) Although we say that autos and tires are complementary goods, the cross-price effects need
not be of comparable magnitudes. Auto prices have a large impact on tire sales, but tire prices
have a very minor impact on auto sales because they are a small fraction of the full cost of a
new car.
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