drill: oct. 3, 2013 why do people complain about gasoline prices going up but continue to fill up...
TRANSCRIPT
Drill: Oct. 3, 2013
Why do people complain about gasoline prices going up but continue to fill up their tank?
Do you think there is a price increase at which consumers will stop buying gas? What price do you think that will be?
CHAPTER 5 ELASTICITY AND ITS APPLICATIONS
© 2007 Thomson South-Western
Elasticity . . .
… allows us to analyze supply and demand with greater precision.
… is a measure of how much buyers and sellers respond to changes in market conditions
Why is Elasticity important?
Knowledge of elasticity will help us determine how market variables will respond to changes in market conditions, which sometimes can be unexpected
Example: Good Weather and the Wheat Market
Quantity ofWheat
0
Price ofWheat
3. . . . and a very small increase in quantity sold. As a result,revenue falls from $300 to $220.
D
S1 S2
2. . . . leadsto a large fallin price . . .
1. an increase in supply . . .
2
110
$3
100
Can the good weather be
detrimental to farmers???
Knowledge of elasticity can explain this
phenomenon
THE ELASTICITY OF DEMAND
A fall in price increases the quantity demanded. BY HOW MUCH??
The price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.
THE ELASTICITY OF DEMAND
Elasticity is a responsiveness that is measured in percentage terms.
Specifically, the price elasticity of demand is the percentage change in quantity demanded due to a percentage change in the price.
The Price Elasticity of Demand and Its Determinants
Availability of Close SubstitutesNecessities versus LuxuriesDefinition of the MarketTime Horizon
Computing the Price Elasticity of Demand
The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.
P rice e las tic ity o f d em an d =P ercen tag e ch an g e in q u an tity d em an d ed
P ercen tag e ch an g e in p rice
Computing the Price Elasticity of Demand
P rice e las tic ity o f d em an d =P ercen tag e ch an g e in q u an tity d em an d ed
P ercen tag e ch an g e in p rice
Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:
( )
( . . ).
1 0 81 0
1 0 0
2 2 0 2 0 02 0 0
1 0 0
2 0 %
1 0 %2
The Midpoint Method: A Better Way to Calculate Percentage Changes and
Elasticities
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the price change.
Price elasticity of demand =Q avgP
P avgQ
2 1 2 1
2 1 2 1
( ) /[( ) / 2]Price elasticity of demand =
( ) /[( ) / 2]
Q Q Q Q
P P P P
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:
(10 8)22%(10 8) / 2
2.32(2.20 2.00) 9.5%
(2.00 2.20) / 2
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
What does a price elasticity of demand equal to 2.32 mean? It means that a 1% increase in price results in a 2.32%
decrease in quantity demanded.
%2.32
%
change in quantity demanded
change in price
The Variety of Demand Curves
Inelastic Demand Quantity demanded does not respond strongly to price
changes. Price elasticity of demand is less than one.
Elastic Demand Quantity demanded responds strongly to changes in
price. Price elasticity of demand is greater than one.
Computing the Price Elasticity of Demand
Demand is price elastic.
$5
4Demand
Quantity1000 50
3percent 22
percent 67
5.00)/2(4.005.00)(4.00
50)/2(10050)(100
ED
Price
Calculating Elasticity
DE .Let denote the absolute value of price elasticity
DE 1 .demand is price elastic
DE 1 .demand is price inelastic
DE 1 .demand is unit elastic
Figure 1 The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
$5
4
Quantity
Demand
1000
1. Anincreasein price . . .
2. . . . leaves the quantity demanded unchanged.
Price
Quantity demanded does not respond to price changes
Figure 1 The Price Elasticity of Demand
(b) Inelastic Demand: Elasticity Is Less Than 1
Quantity0
$5
90
Demand1. A 22%increasein price . . .
Price
2. . . . leads to an 11% decrease in quantity demanded.
4
100
Figure 1 The Price Elasticity of Demand
2. . . . leads to a 22% decrease in quantity demanded.
(c) Unit Elastic Demand: Elasticity Equals 1
Quantity
4
1000
Price
$5
80
1. A 22%increasein price . . .
Demand
Figure 1 The Price Elasticity of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Demand
Quantity
4
1000
Price
$5
50
1. A 22%increasein price . . .
2. . . . leads to a 67% decrease in quantity demanded.
Figure 1 The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Quantity0
Price
$4 Demand
2. At exactly $4,consumers willbuy any quantity.
1. At any priceabove $4, quantitydemanded is zero.
3. At a price below $4,quantity demanded is infinite.
The Variety of Demand Curves
Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.
But it is not the same thing as the slope!
The Variety of Demand Curves
Remember:
1/slopeFor a straight line demand curve, the
slope is constant but the elasticity will vary from one point to another.
DE =Q avgP
P avgQ
0 2 64 108 12 14
2
1
4
3
5
6
$7
Demand is elastic; demand is responsive to changes in price.
Demand is inelastic; demand is not very responsive to changes in price.
Price elasticity of demand from $4 to $5 is…….
Price elasticity of demand from $2 to $3 is……...
Elasticity is > 1 in this range.
Elasticity is < 1 in this range.
Price
Quantity
Figure 4 Elasticity of a Linear Demand Curve
Elasticity of a Linear Demand Curve
Total Revenue and the Price Elasticity of Demand
Law of demand: A higher price leads to a smaller quantity demanded.
How does the higher price affect total revenue (TR)?
QPTR
?
How Total Revenue Changes When Price Changes: Inelastic Demand
Demand
Quantity0
Price
Revenue = $100
Revenue = $240
$1
100
$3
80
An Increase in price from $1 to $3, leads to an Increase in total revenue from $100 to $240
With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.
QPTR
How Total Revenue Changes When Price Changes: Elastic Demand
Demand
Quantity0
Price
Revenue = $200
$4
50
Revenue = $100 $5
20
An Increase in price from $4 to $5, leads to an decrease in total revenue from $200 to $100
With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.QPTR
0 2 64 108 12 14
2
1
4
3
5
6
$7
When price increases from $4 to $5, TR declines from $24 to $20.
When price increases from $2 to $3, TR increases from $20 to $24.
Elastic
Inelastic
Price
Quantity
Revenue changes along a Linear Demand Curve
Other Demand Elasticities
Income Elasticity of Demand Income elasticity of demand measures how much the
quantity demanded of a good responds to a change in consumers’ income.
It is computed as the percentage change in the quantity demanded divided by the percentage change in income.
Income Elasticity Types of Goods
Normal Goods (positive) Inferior Goods (negative)
Other Demand Elasticities
Computing Income Elasticity
In co m e e la stic ity o f d em an d =
P ercen tag e ch an g e in q u an tity d em an d ed
P ercen tag e ch an g e in in co m e
Remember, all elasticities are measured by dividing one percentage change by another
Other Demand Elasticities
Income Elasticity Goods consumers regard as necessities tend to be
income inelastic Examples include food, fuel, clothing, utilities, and
medical services. Goods consumers regard as luxuries tend to be
income elastic. Examples include sports cars, furs, and expensive foods.
THE ELASTICITY OF SUPPLY
Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good.
Price elasticity of supply is the percentage change in quantity supplied resulting from a percentage change in price.
The Price Elasticity of Supply and Its Determinants
Ability of sellers to change the amount of the good they produce. Beach-front land is inelastic. Books, cars, or manufactured goods are elastic.
Time period Supply is more elastic in the long run.
Computing the Price Elasticity of Supply
The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.
P rice e las tic ity o f su p p ly =
P ercen tag e ch an g e in q u an tity su p p lied
P ercen tag e ch an g e in p rice
APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY
Can good news for farming be bad news for farmers?
What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?
Can Good News for Farming Be Bad News for Farmers?
Quantity ofWheat
0
Price ofWheat
D
S1 S2
2
110
$3
100
The decline in price leads to a decrease in total revenue.
What can you say about
the price elasticity of demand?
Does Drug Interdiction Increase or Decrease Drug-Related Crime?
Drug interdiction impacts sellers rather than buyers. Demand is unchanged. Equilibrium price rises although quantity falls.
Drug education impacts the buyers rather than sellers. Demand is shifted. Equilibrium price and quantity are lowered.
Price of Drugs
Quantity of Drugs
Price of Drugs
Quantity of Drugs
Drug Interdiction Drug Education
D2
D1
D1
S2
S1S1
The demand for illegal drugs is inelastic. Interdiction shifts the supply, while education shifts the
demand.The changes in quantities (and TR) are remarkable.
It is amazing how useful knowledge of elasticities can be!
Figure 9 Policies to Reduce the Use of Illegal Drugs