9781118041581

90 Chapter 3 Demand Analysis and Optimal Pricing

Price Elasticity and Prediction

Price elasticity is an essential tool for estimating the sales response to possible

price changes. A simple rearrangement of the elasticity definition (Equation 3.7)

gives the predictive equation:

[3.9]

For instance, in Table 3.1, the short-term (i.e., one-year) price elasticity of

demand for gasoline is approximately .3. This indicates that if the average

price of gasoline were to increase from $2.50 to $3.00 per gallon (a 20 percent

increase), then consumption of gasoline (in gallons) would fall by only 6 per-

cent (.3 20%). The table also shows that the price elasticity of demand for

luxury cars is 2.1. A modest 5 percent increase in their average sticker price

implies a 10.5 percent drop in sales. (Caution: Equation 3.9 is exact for very

small changes but only an approximation for large percentage changes, over

which elasticities may vary.)

¢Q/QEP(¢P/P)

Price Income

Good or Service Elasticity Elasticity

Air travel:

Business .18 1.1

Nonbusiness .38 1.8

Automobiles: 1.9

Subcompact .81

Luxury 2.1

Beef .5 .51

Beer .36 1.0

Wine .57 1.0

Cigarettes:

All smokers .7

Ages 15–18 1.4

Gasoline (1-year) .32 .20

Housing .34

Telephone calls

Long distance .5 1.0

TABLE 3.1

Estimated Price and

Income Elasticities for

Selected Goods and

Services

Source:Elasticities were compiled by the authors from articles in economic journals and other

published sources.

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