harcourt brace & company chapter 5 elasticity and its applications
TRANSCRIPT
Harcourt Brace & Company
Chapter 5
Elasticity and Its Applications
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QUESTION
You have just been hired by Crayola Crayon. The company would like to increase its revenue. The CEO comes to you for advice. She wants to know if the company should lower product prices or raise product prices to increase total revenue. What do you advise?
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Elasticity . . .
… is a measure of how much buyers and
sellers respond to changes in market
conditions. . .
… means responsiveness.
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Price Elasticity of Demand
The percentage (%) change in
Quantity Demanded . . .
. . . given a percentage change in
Price.
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Three Types of Elasticities. . .
Price Elasticity of Demand
Income Elasticity Price Elasticity of
Supply
Price
Quantity
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Price Elasticity of Demand
The percentage change in the quantity
demanded given. . .
. . . a percentage change in the price.
A
B
DemandP
Q
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Ranges of Elasticity . . . (Figure 5-1)
Perfectly Inelastic Consumers are “totally
unresponsive” to price changes.
Perfectly Elastic Consumers are “totally
responsive” to price changes.
Unit Elastic Response is “equal to” change in
price.
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Determinants of Price Elasticity of Demand
Demand tends to be more elastic:– if the good is a luxury;
– the longer the time period;
– the greater the number of close substitutes; and
– the more narrowly defined the market.
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Determinants of Price Elasticity of Demand
Demand tends to be more inelastic:– if the good is a necessity;
– the shorter the adjustment time;
– if there are few good substitutes; and
– the more broadly defined the market.
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Computing Elasticity Coefficient
Computed as the percentage change in the quantity demanded divided by the percentage change in price.
Price Elasticityof Demand
=
Percentage Change in Quantity Demanded
Percentage Change in Price
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Computing Elasticity CoefficientMidpoint Formula
Demand forIce Cream
2.20
2.00
108
ED
Change in P / avg P
Change in QD / avg Q
=
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Computing Elasticity Coefficient
Demand forIce Cream
2.20
2.00
108
ED
(2.20-2.00) / (2.20+2.00)/2
(8-10) / (8+10) / 2
=
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Computing Elasticity Coefficient
Demand forIce Cream
2.20
2.00
108
ED= 2.33
Demand is Elastic
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Elasticity and Linear Demand Curves
Elasticity varies over Price ranges on the same linear demand curve.
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Elasticity and Total Revenue
Over the Elastic Range of
prices and quantity
the relationship between price and total revenue is
INDIRECT or OPPOSITE
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Elasticity and Total Revenue
ED > 1 then
P Q TRand
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Elasticity and Total Revenue
Over the Inelastic Range of prices and quantity
the relationship between price and total revenue is
DIRECT or THE SAME
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Elasticity and Total Revenue
ED < 1 then
P Q TRand
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Income Elasticity of Demand
The percentage change in the quantity demanded
given a percentage change in income.
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Computing Income Elasticity
Computed as the percentage change in the quantity demanded divided by the percentage change in Income.
Income Elasticityof Demand
=
Percentage Change in Quantity Demanded
Percentage Change in Income
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Income Elasticity... Types
YD > 0 Normal Goods
YD < 0 Inferior Goods
YD = 0 Income-neutral Goods
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Income Elasticity... Types
Goods consumers regard as “necessities” tend to be income inelastic...– Examples include: food, fuel, clothing,
utilities, & medical services.
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Income Elasticity... Types
Goods consumers regard as “luxuries” tend to be income elastic...– Examples include: Sports cars, furs, and
expensive foods.
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Price Elasticity of Supply
The percentage change in
quantity supplied
resulting from a percentage
change in price.
Price
Quantity
A
B
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Ranges of Elasticity
Perfectly Elastic infinite Relatively Elastic >1 Unitary or Unit =1 Relatively Inelastic <1 Perfectly Inelastic = 0
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Determinants of Elasticity of Supply
Flexibility or ability of sellers to change the amount of the good they produce.– Beachfront land verses books, cars,
manufactured goods, etc.
– More elastic in the long run.
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Computing Elasticity Coefficient
Computed as the percentage change in the quantity supplied divided by the percentage change in price.
Elasticityof Supply
=
Percentage Change in Quantity Supplied
Percentage Change in Price
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Applications of 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?
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Apply Comparative Statics (Chapter 4)
Examine whether the supply or demand curve shifts.
Consider the direction the curve shifts.Use supply-and-demand diagram to
see how the market equilibrium changes.
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Examine whether the supply or demand curve shifts.
SA
DA
Price
Quantity
$4.00
2000
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Consider which direction the curve shifts.
SA
DA
Price
Quantity
$4.00
2000
SB
Technologycauses an increase
in supply.
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Use Supply-and-Demand diagram to see how the market changes.
SA
DA
Price
Quantity
$4.00
2000
SB
2400
$2.60
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Compute Elasticity
ED =(2400 - 2000) / (2000)
($2.60 - $4.00) / ($4.00)
ED = 0.57 (Inelastic)
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Observe the Change in Total Revenue
SA
DA
Price
Quantity
$4.00
2000
SB
2400
$2.60
TRSA = $8,000
TRSB = $5,760!