## Introduction to Elasticity

Read this chapter to learn about the concept of elasticity. Be sure to read all the sections in this chapter (Sections 5.1-5.4) following the introduction.

### 5.3 Elasticity and Pricing

#### Does Raising Price Bring in More Revenue?

Imagine that a band on tour is playing in an indoor arena with 15,000 seats. To keep this example simple, assume that the band keeps all the money from ticket sales. Assume further that the band pays the costs for its appearance, but that these costs, like travel, setting up the stage, and so on, are the same regardless of how many people are in the audience. Finally, assume that all the tickets have the same price. (The same insights apply if ticket prices are more expensive for some seats than for others, but the calculations become more complicated.) The band knows that it faces a downward-sloping demand curve; that is, if the band raises the price of tickets, it will sell fewer tickets. How should the band set the price for tickets to bring in the most total revenue, which in this example, because costs are fixed, will also mean the highest profits for the band? Should the band sell more tickets at a lower price or fewer tickets at a higher price?

The key concept in thinking about collecting the most revenue is the price elasticity of demand. Total revenue is price times the quantity of tickets sold. Imagine that the band starts off thinking about a certain price, which will result in the sale of a certain quantity of tickets. The three possibilities are laid out in Table 5.3. If demand is elastic at that price level, then the band should cut the price, because the percentage drop in price will result in an even larger percentage increase in the quantity sold – thus raising total revenue. However, if demand is inelastic at that original quantity level, then the band should raise the price of tickets, because a certain percentage increase in price will result in a smaller percentage decrease in the quantity sold ­– and total revenue will rise. If demand has a unitary elasticity at that quantity, then a moderate percentage change in the price will be offset by an equal percentage change in quantity ­– so the band will earn the same revenue whether it (moderately) increases or decreases the price of tickets.

If Demand Is . . . Then . . . Therefore . . .
Elastic
$\% \text { change in } \mathrm{Qd}>\% \text { change in } \mathrm{P}$

A given % rise in P will be more than offset by a larger % fall in Q so that total revenue (P × Q) falls.
Unitary

$\% \text { change in } \mathrm{Qd}=\% \text { change in } \mathrm{P}$

A given % rise in P will be exactly offset by an equal % fall in Q so that total revenue (P × Q) is unchanged.
Inelastic

$\% \text { change in } \mathrm{Qd} < \% \text { change in } \mathrm{P}$

A given % rise in P will cause a smaller % fall in Q so that total revenue (P × Q) rises.

Table5.3 Will the Band Earn More Revenue by Changing Ticket Prices?

What if the band keeps cutting price, because demand is elastic, until it reaches a level where all 15,000 seats in the available arena are sold? If demand remains elastic at that quantity, the band might try to move to a bigger arena, so that it could cut ticket prices further and see a larger percentage increase in the quantity of tickets sold. Of course, if the 15,000-seat arena is all that is available or if a larger arena would add substantially to costs, then this option may not work.

Conversely, a few bands are so famous, or have such fanatical followings, that demand for tickets may be inelastic right up to the point where the arena is full. These bands can, if they wish, keep raising the price of tickets. Ironically, some of the most popular bands could make more revenue by setting prices so high that the arena is not filled – but those who buy the tickets would have to pay very high prices. However, bands sometimes choose to sell tickets for less than the absolute maximum they might be able to charge, often in the hope that fans will feel happier and spend more on recordings, T-shirts, and other paraphernalia.