harcourt, inc. items and derived items copyright © 2001 by harcourt, inc. elasticity... u demand...

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Elasticity . . .

Demand elasticity is a measure of how much buyers respond to changes price, income, and other things.Supply elasticity is a measure of how much sellers respond to changes in price and other things.


Flavors of elasticity

Price Elasticity of Demand Income Elasticity of Demand Advertising Elasticity of Demand Price Elasticity of Supply


Price Elasticity of Demand

• Price elasticity of demand: • the percent change in quantity

demanded in response to a percent change in price.


Price Elasticity of Demand

Demand tends to be more elastic :

The larger the number of close substitutes.

• the longer the time period.

• the more narrowly defined the market. If the good is a luxury.


Computing the Price Elasticity of Demand: A First Approach

price inchange Percentage

demandedquatity inchange Percentagedemand of elasticityPrice

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 price elasticity of demand is:

210

20

10000.2

)00.220.2(

10010

)108(

percent

percent


Computing the Price Elasticity of Demand: Mid Point Method

Demand is price elastic

$5

4 Demand

Quantity1000

Price

50

-3percent 22-

percent 67

5.00)/2(4.005.00)-(4.00

50)/2(10050)-(100

ED


Perfectly Inelastic DemandQty demanded doesn’t respond to price

Elasticity=0

Quantity

Price

4

$5

Demand

1002. ...leaves the quantity demanded unchanged.

1. Anincreasein price...


Inelastic DemandA large percent change in price A small

percent change in quantity demanded Elasticity < 1

Quantity

Price

4

$51. A 22%increasein price...

Demand

100902. ...leads to a 11% decrease in quantity.


Unit Elastic DemandEach 1% increase in price a 1% decrease in

quantity demanded Elasticity = 1

Quantity

Price

4


Demand



Elastic DemandSmall increase in price big decrease in

quantity demandedElasticity > 1

Quantity

Price

4


Demand



Perfectly Elastic DemandThe smallest change in price Huge

change in quantity demanded Elasticity is INFINITE

Quantity

Price

Demand$4

At exactly $4, consumers will buy any quantity…and they won’t pay a cent more…they’ll buy something else if price rises at all.Demand facing a competitive firm.


Price Elasticity and Total Revenue

Total revenue is the price of a good multiplied by the quantity sold.

TR = P x Q


$4

Demand

Quantity

P

0

Price

P x Q = $400 (total revenue)

100Q

Total Revenue: A Picture


Elasticity and Total Revenue

With inelastic demand, an increase in price leads to a small decrease in quantity demanded.

Total revenue increases when price rises.

P x Q Increases when P rises


Elasticity and Total RevenueWith elastic demand, a small

increase in price leads to a big decrease in quantity demanded. Total revenue decreases

when price rises.P x Q decreases when P rises


Elasticity and Total Revenue: Elastic Demand

Demand

Quantity0

Price

$4

50

Demand

Quantity0

Price

Revenue = $100

$5

20

Revenue = $200

An increase in price from $4 to $5...

…leads to a decrease in total revenue

from$200 to $100


Income Elasticity of Demand

Quantity demanded responds to consumer income.

Income elasticity of demand: percentage change in quantity

demanded divided by the percentage change in income.


Computing Income Elasticity

Income Elasticity

of Demand

Percentage Change in Quantity Demanded

Percentage Change in Income

=


Income Elasticity- Types of Goods -

Necessities are income inelasticExamples: food, fuel, clothing, utilities, medical care.

Luxuries are income elastic.Examples: sports cars, jewelry, gourmet foods.


• Use the midpoint method to calculate your price elasticity of demand as the price of compact discs increases from $8 to $10 if (i) your income is $10,000, and (ii) your income is $12,000.

• [(40 – 32)/36] / [(8-10)/9] = [2/9]/[2/9] = 1

• [(50-45)/47.5]/ [(8-10)/9] = 10.5% / 22.2% = .47• Calculate your income elasticity of demand as your income increases

from $10,000 to $12,000 if (i) the price is $12, and (ii) the price is $16.

• [(30 – 24)/27]/[(10-12)/11] = 22.2% / 18.2 % = 1.22

• [(12 – 8)/10 ]/[(10-12)/11] = 40% / 18.2 % = 2.2


Price Elasticity of Supply

Quantity supplied responds to price. Price elasticity of supply

the percentage change in quantity supplied resulting from a percent change in price.


Computing the Price Elasticity of Supply

The percentage change in quantity supplied divided by the percentage

change in price.

Elasticity of Supply=

Percentage Change in Quantity Supplied

Percentage Change in Price

Elasticity of Supply=

Percentage Change in Quantity Supplied

Percentage Change in Price


Perfectly Inelastic SupplyElasticity equals 0

Quantity

Price

4

$5

Supply

1002. ...leaves the quantity supplied unchanged.



Inelastic SupplyElasticity < 1

Quantity

Price

4


110100

Supply

2. ...leads to a 9 ½ % increase in quantity supplied.


Unit Elastic SupplyElasticity equals 1

Quantity

Price

4


125100

Supply

2. ...leads to a 22% increase in quantity.


Elastic SupplyElasticity > 1

Quantity

Price

4


200100

Supply



Perfectly Elastic SupplyElasticity equals infinity

Quantity

Price

Supply$4

At exactly $4,producers willsupply any quantity.


Determinants of Elasticity of Supply

Ability of sellers to change the amount they produce

• Beach-front land is inelastic.• Books, cars, or manufactured goods are elastic.

Time period

• Supply is more elastic in the long run than in the short run.

An Increase in Supply in the Market for Wheat

$3

Quantity of Wheat1000

Price ofWheat

Demand

S1


3. ...and a proportionately smallerincrease in quantity sold. As a result,revenue falls from $300 to $220.

An Increase in Supply in the Market for Wheat

$3

Quantity of Wheat1000

Price ofWheat 1. When demand is inelastic,

an increase in supply...

Demand

S1 S2

2

110

2. ...leadsto a large fall in price...



Summary

Price elasticity of demand measures how much the quantity demanded responds to changes in the price.

If a demand curve is elastic, total revenue falls when the price rises.

If it is inelastic, total revenue rises as the price rises.


Summary

The price elasticity of supply measures how much the quantity supplied responds to changes in the price.

In most markets, supply is more elastic in the long run than in the short run.


Graphical Review


Computing the Price Elasticity of Demand

Demand is price elastic

$5

4 Demand

Quantity1000

Price

50

-3percent 22-percent 67

5.00)/2(4.005.00)-(4.00

50)/2(10050)-(100

ED


Elasticity and Total Revenue: Inelastic Demand Qd doesn’t change much when price rises

$3

Quantity0

Price

80

Revenue = $240

Demand$1 Demand

Quantity0

Revenue = $100

100

Price


…leads to an increase in total revenue

from$100 to $240


Elasticity and Total Revenue Elastic Demand Qd changes

a lot when price rises

Demand

Quantity0

Price

$4

50

Demand

Quantity0

Price

Revenue = $100

$5

20

Revenue = $200


…leads to a decrease in total revenue

from$200 to $100


Perfectly Inelastic Supply- Elasticity equals 0

Quantity

Price

4

$5

Supply

1002. ...leaves the quantity supplied unchanged.



Inelastic Supply- Elasticity is less than 1

Quantity

Price

4


110100

Supply



Unit Elastic Supply- Elasticity equals 1

Quantity

Price

4


125100

Supply



Elastic Supply- Elasticity is greater than 1

Quantity

Price

4


200100

Supply


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