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Page 1: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Elasticity

6

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand

• Measures buyers’ responsiveness to price changes

LO1

• Formula for price elasticity of demand

Ed =

Percentage Change in QuantityDemanded of Product X

Percentage Change in Priceof Product X

Page 3: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand Formula

• Eliminate the minus sign

• Easier to compare elasticities

LO1

Page 4: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand

• Elastic demand, Ed > 1

• Sensitive to price changes

• Large change in quantity for small price change

• Inelastic demand, Ed < 1

• Insensitive to price changes

• Small change in quantity for large price change

• Unit elastic demand, Ed = 1–Equal changes in quantity and price

LO1

Page 5: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Extreme Cases

LO1

D1P

Perfectly inelastic demand

Perfectly inelastic demand(Ed = 0)

0

Page 6: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Extreme Cases

LO1

Perfectly elastic demand

P

D2

Perfectly elasticdemand(Ed = ∞)

0

Page 7: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand

• Can not use slope to determine elasticity

• Can use slope to determine relative elasticity.

LO2

Page 8: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Total Revenue Test

• Total Revenue = Price X Quantity

• Inelastic demand• P and TR move in the same direction

• Elastic demand• P and TR move in opposite directions

• Unit elastic demand• TR doesn’t change when P changes

LO2

Page 9: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Total Revenue Test

LO2

Table 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test

(1)Total Quantity of

Tickets Demanded per Week, Thousands

(2)Price per Ticket

(3)Elasticity

Coefficient (Ed)

(4)Total

Revenue(1) X (2)

(5)Total

Revenue Test

1 $8 $8,000

2 7 5.00 14,000 Elastic

3 6 2.60 18,000 Elastic

4 5 1.57 20,000 Elastic

5 4 1.00 20,000 Unit Elastic

6 3 0.64 18,000 Inelastic

7 2 0.38 14,000 Inelastic

8 1 0.20 8,000 Inelastic

Page 10: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Summary of Price Elasticity of Demand

LO2

Table 6.2 Price Elasticity of Demand: A Summary

Absolute Value of Elasticity Coefficient Demand Is: Description

Impact on Total Revenue of a:

Price Increase Price Decrease

Greater than 1(Ed > 1)

Elastic or relatively elastic

Qd changes by a larger percentage than does price

Total Revenue decreases

Total Revenue increases

Equal to 1(Ed = 1)

Unit or unitary elastic

Qd changes by the same percentage as does price

Total revenue is unchanged

Total revenue is unchanged

Less than 1(Ed < 1)

Inelastic or relatively inelastic

Qd changes by a smaller percentage than does price

Total revenue increases

Total revenue decreases

Page 11: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Determinants of Elasticity of Demand

• Substitutability• More substitutes, demand is more elastic

• Proportion of Income• Higher proportion of income, demand is more

elastic

• Luxuries vs. Necessities• Luxury goods, demand is more elastic

• Time• More time available, demand is more elastic

LO1

Page 12: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand

LO1

Table 6.3 Selected Price Elasticities of Demand

Product or ServicePrice Elasticity of Demand (Ed) Product or Service

Price Elasticity of Demand (Ed)

Newspapers .10 Milk .63

Electricity (household) .13 Household appliances .63

Bread .15 Liquor .70

MLB Tickets .23 Movies .87

Telephone Service .26 Beer .90

Cigarettes .25 Shoes .91

Sugar .30 Motor vehicles 1.14

Medical Care .31 Beef 1.27

Eggs .32 China, glassware 1.54

Legal Services .37 Residential land 1.60

Automobile repair .40 Restaurant meals 2.27

Clothing .49 Lamb and mutton 2.65

Gasoline .60 Fresh peas 2.83

Page 13: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Applications of Ed

• Large Crop Yields• Inelastic demand, lower total revenue

• Excise Taxes• Inelastic demand, more total revenue

• Decriminalization of Illegal Drugs• Inelastic demand, more total revenue

• Decrease street crime

LO1

Page 14: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Supply

• Measures sellers’ responsiveness to price changes

• Elastic supply (Es > 1 ), producers are responsive to price changes

• Inelastic supply (Es < 1), producers are not responsive to price changes

LO3

Percentage Change in QuantitySupplied of Product X

Percentage Change in Priceof Product X

Es =

Page 15: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Supply

• Time is primary determinant of elasticity of supply

• Time periods considered

• Immediate Market period•Can’t adjust any resources

• Short Run•Able to adjust some resources

• Long Run•Able to adjust all resources

LO3

Page 16: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Applications of Elasticity of Supply

• Antiques

• Inelastic supply

• Reproductions

• More elastic supply

• Volatile gold prices

• Inelastic supply

LO3

Page 17: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Cross Elasticity of Demand

• Measures responsiveness of sales to change in the price of another good

• Substitutes – positive sign

• Complements – negative sign

• Independent goods - zero

LO4

Percentage change in quantity demanded of product X

Ex,y = Percentage change in price of product Y

Page 18: Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Income Elasticity of Demand

• Measures responsiveness of buyers to changes in income

• Normal goods – positive sign

• Inferior goods – negative sign

LO4

Percentage change in quantity demanded

Ei =

Percentage change in income


Chapter 15 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

Chapter Interest Rates McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 9

Chapter © 2008The McGraw-Hill Companies, Inc. All rights reserved. Creating Effective Organizations 17 McGraw-Hill/IrwinCopyright © 2008 by The McGraw-Hill

12 Cost Analysis McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 4 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

Consumer Behavior 9 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 12 Government Imperfections McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved

Computer Software Chapter 4 McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 5 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

Chapter 7 Trade McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved

Chapter One Managers and Managing McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 12. LABOUR McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 12

McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved. Confidence Intervals Chapter 8

Chapter © 2008The McGraw-Hill Companies, Inc. All rights reserved. Leadership 16 McGraw-Hill/IrwinCopyright © 2008 by The McGraw-Hill Companies, Inc. All

McGraw-Hill/IrwinCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. SURVEYS Chapter 10

Chapter 17 Auditors’ Reports McGraw-Hill/IrwinCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 3 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

Chapter © 2008The McGraw-Hill Companies, Inc. All rights reserved. Foundations of Motivation 8 McGraw-Hill/IrwinCopyright © 2008 by The McGraw-Hill Companies,

Data Resource Management Chapter 5 McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 02 Professional Standards McGraw-Hill/IrwinCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 7. PRODUCTION McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7

Chapter Mutual Funds McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 4

Chapter © 2008The McGraw-Hill Companies, Inc. All rights reserved. Influence, Empowerment, and Politics 15 McGraw-Hill/IrwinCopyright © 2008 by The McGraw-Hill

Chapter 7 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

Computer Hardware Chapter 3 McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 8 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

Competing in Foreign Markets McGraw-Hill/IrwinCopyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved

Copyright © 2006. The McGraw-Hill Companies, Inc.McGraw-Hill/IrwinCopyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Flexible Budgets and

Chapter 8 Costs McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved

11 Salesperson Compensation and Incentives McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 10 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

Computer Hardware Chapter 3 McGraw-Hill/IrwinCopyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 16 McGraw-Hill/IrwinCopyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Fundamentals of Variance Analysis Chapter 16