ch. 5: elasticity and its application - jacob hochard 5: elasticity and its application elasticity:...

Chapter 5: Elasticity and Its Application

Ch. 5: Elasticity and Its Application

Why are breakfast

foods cheaper than

tobacco products?


Elasticity: is a numerical measure of the responsiveness ofquantity demanded or quantity supplied to one of its determinants.

• How much more ice cream will a firm sell if it decreases itsprice by $0.50 per scoop?

• The Law of Demand says... a firm will sell more ice cream...but how much more?

• This relationship is called the price elasticity of demand.


Price elasticity of demand:

The price elasticity of demand, loosely speaking, measures theprice-sensitivity of buyers’ demand.

Price Elasticityof Demand =

Percentage change in quantity demanded (∆ Q)

Percentage change in Price (∆ P)

How do we calculate it, in practice?


Price elasticity of demand: calculating it

The price elasticity of demand, loosely speaking, measures theprice-sensitivity of buyers’ demand.

Price Elasticityof Demand =

Percentage change in quantity demanded (∆ Q)

Percentage change in Price (∆ P)



Elasticity ranges from 0 to infinity.

A product with a low elasticity (0 to 1) is said to be inelastic;consumers will continue to purchase large amounts of that producteven when the price becomes extremely high.

Insulin

Oil Water

Cigarettes

Heroin

Medical treatmentElectricity



Elasticity ranges from 0 to infinity.

A product with a high elasticity (greater than 1) is said to beelastic; consumers will reduce their purchase of that product whenthe price becomes extremely high.

Vacations

Newspapers


Real world elasticities:

Real world elasticities

0.1

0.2

Eggs

Healthcare

Rice

0.5

Housing

0.7

Beef

Restaurants

1.62.34.4


What causes a product to be more or less elastic?

• Availability of close substitutes.

• Necessities versus luxuries.

• Definition of the market (how narrow, how broad).Does food have many substitutes? how about bananas?

• Time horizon.If gas prices increase, can yousubstitute to a prius tomorrow?


Terminology

Elasticity terminology

Elasticity number Term

0 Perfectly inelastic

Greater than 0, less than 1

Inelastic

1 Unit elastic

Greater than 1, less than infinity

Elastic

Infinity Perfectly elastic

No matter what the price, the product will still be purchased.

If the price increases by 1 cent, no one will purchase the product.

?


Price-inelastic demand: oil

Quantity demanded (Millions of barrels of oil per day)

00 5

$40

$80

$120

Price of a barrel of oil

U.S. Daily Demand for Oil

$160

10 15 20 25

A steep demand curve represents inelastic

demand – quantity demanded is highly less

responsive to changes in price.

Notice if the price of oil increases 100% (from $80 to

$160) demand only drops 33% (from 15 to 10)

Perfectly price-inelastic demand

would be given by a perfectly

vertical demand curve.


Price-elastic demand: mountain dew

Quantity demanded (cans of mountain dew per day – millions)

00 5

$0.50

$0.75

$1.00

Price of a can of mountain

dew

U.S. Daily Demand for Mountain Dew

$1.25

10 15 20 25

A flat demand curve represents elastic

demand – quantity demanded is highly

responsive to changes in price.

Notice if the price of mountain dew increases by 10%

(from $0.75 to $0.825) demand drops 50% (from 20

to 10)

Perfectly price-elastic demand

would be given by a perfectly

horizontal demand curve.

$0.825


Price-elastic demand: perfectly inelastic demand

Quantity of insulin demanded

00

Perfectly inelastic demand:

demand for insulin

50 100 150 200

$10

$30

Price of a insulin

PointA

PointB

𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 =% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸

% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷=

𝟎%

𝟔𝟔.𝟔%= 𝟎

Demand for insulin

𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒑𝒆𝒓𝒇𝒆𝒄𝒕𝒍𝒚 𝒗𝒆𝒓𝒕𝒊𝒄𝒂𝒍


Price-elastic demand: inelastic demand

Gallons of gasoline demanded

00

Inelastic demand:

demand for gasoline

50

$3

$5

Price of a gallon of gasoline

PointA

PointB



𝟑𝟎%

𝟒𝟎%= 𝟎. 𝟕𝟓

Demand for gasoline

𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒓𝒆𝒍𝒂𝒕𝒊𝒗𝒆𝒍𝒚 𝒔𝒕𝒆𝒆𝒑

65

Consumers’ price sensitivity is relatively low


Price-elastic demand: unit elastic demand

00

Unit elastic demand:

demand for ice cream

50

$2

Price of a scoop of

ice cream

PointA

PointB



𝟓𝟎%

𝟓𝟎%= 𝟏

Demand for ice cream

𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒎𝒐𝒅𝒆𝒓𝒂𝒕𝒆𝒍𝒚 𝒔𝒕𝒆𝒆𝒑

75

Consumers’ price sensitivity is

moderate

100

$4

Scoops of ice cream demanded


Price-elastic demand: elastic demand

40%3.75


Price-elastic demand: perfectly elastic demand

00

Perfectly elastic demand:

???

50

Price of a can of

perfectly elastic good

PointA

PointB



𝟐𝟎𝟎%

𝟎%= 𝒊𝒏𝒇𝒊𝒏𝒊𝒕𝒚 (∞)

Demand curve for a perfectly elastic

good

𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒑𝒆𝒓𝒇𝒆𝒄𝒕𝒍𝒚 𝒇𝒍𝒂𝒕

150

Consumers’ demand is completely

sensitive to price

$8

Quantity of perfectly elastic good demanded


How does price elasticity relate to total revenue generation?

In any given market, the demand revenue created at a given priceis the product of the price and the quantity demanded.

Quantity of sandwiches

00

Total revenue in the Jimmy John’s sandwich market

50 100 150 200

$3

$6

$9

$12Price of a sandwich

50 sandwiches X $9 per sandwich = 450 dollars of revenue


How does price elasticity relate to total revenue generation?

There is a tradeoff between increasing price and decreasingquantity in total revenue generation.

• Increasing the price makes each unit more valuable butreduces the number of units being sold.

• Decreasing the price makes each unit less valuable butincreases the number of units being sold.

The effect on revenue will depend on the price elasticity ofdemand! .

Price increase, inelastic demand

If price elasticity of demand is < 1, a rising price will increase at afaster rate than the falling quantity.

Increasing the price will increase revenue.

Price increase, unit elastic demand

If price elasticity of demand is = 1, a rising price will increase atthe same rate as the falling quantity. These forces are perfectlyoffsetting!

Increasing the price will leave the revenue unchanged.

Price

Quantity demanded

Unit elastic demand – perfectly offsetting quantity and price effects.

q’ q

p’

p

Revenue’

Revenue

Price increase, unit elastic demand

If price elasticity of demand is > 1, a rising price will increase at aslower rate than the falling quantity.

Increasing the price will decrease the revenue.

Other forms of elasticity:

Income elasticity of demand: a measure of how much thequantity demanded of a good responds to a change in consumers’income.

Cross-price elasticity of demand: a measure of how much thequantity demanded of a good responds to a change in the price ofanother good.

Price elasticity of supply: a measure of how much the quantitysupplied of a good responds to a change in consumers’ income.

ch. 5: elasticity and its application - jacob hochard 5: elasticity and its application elasticity:...

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