micro l10 elasticity of demand
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Elasticity of Demand and Supply
Price Elasticity of Demand (Ep)
Calculating Percentage Change Significance of Price Elasticity of Demand (Ep)
Determinants of Price Elasticity of Demand (Ep)
For Next Time
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Price Elasticity of Demand A measure of the extent to which the quantity
demanded of a good changes when the price of the
good changes, ceteris paribus. We know if we raise a price, the Qd will decline, but
we dont know how much.
Elasticity answers the how much question.
In Business, we want to know the relationshipbetween Qd and Price
Ep = % Change in Quantity Demanded
% Change in Price
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Price of Latte
Suppose a retail gourmet coffee outlet is selling itspremium Latte for $3/cup. The store generally is
selling 15 cups of Latte per hour, and the storemanager is thinking seriously of raising the price to$5/cup. He knows he will lose some sales but thinksthat most of his customers are willing to pay more.Help him quantify his decision by determining how
many fewer cups he can sell and still generate morerevenue per hour.
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Calculating Percentage Change
Percentage Change measures how much a value haschanged from one time period to another
For Example, if a firms sales for the current monthamounted to $100 million and the previous month,the same firms sales were $90 million. What wasthe percentage change?
There are two methods of calculating the percentagechange
Simple Method
Midpoint Method
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Calculating Percentage Change
Simple Method
Percentage Change = Current Value-Previous Value
Previous Value
or, = $100m - $90 m = $10m = 11.1%
$90m $90m
Very Common Usage, especially in the business world
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Calculating Percentage Change
Midpoint Method
Percentage Change = Current Value Previous Value
(Current Value + Previous Value)/ 2
Or, = $100m -$90m = $10m = 10.5%
($100m + $90m)/2 $95m
The midpoint method is the better method because itgives similar results whether we are measuringforward or backward
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Price Elasticity of Demand
From Formula Ep = % Change in Qd
% Change in Price
If Price Elasticity of Demand > 1, demand is elastic
If Price Elasticity of Demand = 1, demand is unitelastic
If Price Elasticity of Demand < 1, demand isinelastic
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Demand Elasticity Elastic Demand When % Change in Quantity
Demanded > % Change in Price
Unit Elastic Demand When % Change in QuantityDemanded = % Change in Price
Inelastic Demand When % Change in QuantityDemanded < % Change in Price
Perfectly Elastic Demand When Quantity Demanded
Changes by a very large percentage in response toan almost zero Change in Price
Perfectly Inelastic Demand When the QuantityDemanded remains constant as Price changes
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18-10Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Perfectly Elastic Demand Curve
Quantity
D
14
8
6
4
2
10 15 20 25 305
12
10
The elasticity of a perfectly elastic demand curve is infinity
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18-11Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Perfectly Inelastic Demand Curve
Quantity
D
30
25
20
15
10
5
5 10 15 20 25
The elasticity of a perfectly inelastic demand curve is 0
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18-12Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Relativity Elasticity of Demand Curves
Quantit
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18-14Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Elasticity of Straight Line Demand Curve
Quantit
9
7
V er elastic
e = .
Slightl elastic
Unit elastic
Slightl inelastic
Ver
inelastic
e = . 9
e = .
7 9
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Significance of Price Elasticity of Demand
Profit maximization requires that business set a pricethat will maximize the firms profit
Elasticity tells the firm how much control it has overusing price to raise profit
If Ep > 1, then the % Change in Qd > % Change isPrice and demand is said to be elastic
An increase in price will reduce total revenue
A decrease in price will increase total revenue
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Significance of Price Elasticity of Demand
If Ep < 1, then the % change in Qd < % change inprice, and demand is said to be inelastic
An increase in price will increase total revenue A decrease in price will decrease total revenue
If Ep = 1, then the % change in Qd = % change inPrice, and demand is said to be unit elastic
An increase in price will have no impact on total revenue
A decrease in price will have no impact on total revenue
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Price Elasticity of Demand Influences Substitute Product Availability (key determinant)
-- Luxury or Necessity (Ep for luxury items is >)-- How narrowly it is defined (coffee is inelastic but latte
may have more substitutes and therefore is more elastic)
-- Time elapsed since price change (>time, >elasticity;more time to find substitutes or manage consumption)
Income Effects-- The greater the proportion of income spent
on the good, greater a price change impactsQuantity Demanded
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Advertising
Purpose Product Differentiation (Branding)
To make the demand for a product greater
To make the demand for a product more inelastic
D D
18-18Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Elasticity Thoughts
Demand Curve Slope and Elasticity (Steeper the slope, lower theelasticity)
A Units-Free Measure (% Change Absolute Value)
Elasticity Along a Linear Demand Curve-- Slope is constant but elasticity varies
Elasticity and Total Revenue-- Price and Total Revenue change in opposite directions, demand is elastic
-- Price Change leaves Total Revenue unchanged, demand is unit elastic-- Price and Total Revenue change in same direction, demand is inelastic
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Price Elasticity of Supply
A measure of the extent to which the
quantity supplied of a good changes whenthe price of the good changes, and all otherinfluences on sellers plans remain the same(cateris paribus)
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Price Elasticity of Supply Perfectly Elastic Supply When the quantity supplied
changes by a very large percentage in response to analmost zero increase in price
Elastic Supply When the % change in the quantitysupplied > the % change in the price
Unit Elastic Supply When the % change in thequantity supplied = the % change in price
Inelastic Supply When the % change in thequantity demanded is < the % change in price
Perfectly Inelastic Supply When the quantitysupplied remains the same as the price changes
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Influences on Price Elasticity of
Supply
Production Possibilities page 124
-- Opportunity Costs
constant or gently rising opportunity costs
= elastic price elasticity
-- Fixed Production = inelastic price elasticity
-- Time Elapse longer time, > priceelasticity
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Influences of Price Elasticity of
Supply
Storage Possibilities
The better the storability, the more elastic isthe price elasticity of supply
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Computing Price Elasticity of Supply
Percentage change in quantity supplied
Percentage change in price
If Price Elasticity of Supply > 1, Supply is elastic
If Price Elasticity of Supply = 1, Supply is unit elastic
If price elasticity of supply< 1, Supply is inelastic
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Cross Elasticity of Demand
A measure of the extent to which the demandfor a good changes when the price of a
substitute or complement changes, ceterisparibus
% Change in Quantity Demanded
% Change in Price of one of its
substitutes or complements
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Income Elasticity of Demand
A measure of the extent to which thedemand for a good changes whenincome changes, ceteris paribus
% Change in Quantity Demanded
% Change in Income
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Income Elasticity of Demand
If income elasticity of demand > 1 thedemand for the good is income elastic
If income elasticity of demand is between
0 and 1, the demand is income inelastic
* If income elasticity of demand < 0 the
demand is negative income elastic
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For Next Time
Define the term Price Elasticity of Supply. Whatdoes this concept tell us?
What are the main determinants of supply elasticity?How do they impact supply?
If government taxes a product (excise tax), how canwe determine how much of the tax will be passed onto the buyer and how much will have to be paid bythe seller?