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Elasticity Discussion2727 unread replies.2727 replies.Two parts:Part 1: Tell us about a good or service for which you have VERY Inelastic demand (you would buy almost the same amount even if the price doubled). Be honest, but creative.Part 2: Tell us about a good or service for which you have Elastic demand (you would buy a lot less of it if the price increased even a little). https://openstax.org/books/principles-economics-2e…

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A scenario

You are an economics tutor

You charge $20 per hour, and currently work 12

hours per week.

Your costs are rising (the price of your rent and

gas are increasing), so you consider raising the

price to $25 per hour.

The law of demand says that you wont sell as

many hours of tutoring if you raise your price.

Will you make more money or less?

0

Elasticity

? Basic idea:

Elasticity measures how much one variable

responds to changes in another variable.

11

Price Elasticity of Demand

Price elasticity

of demand

Percentage change in Qd

=

Percentage change in P

? Price elasticity of demand measures how

much Qd responds to a change in P.

? Loosely speaking, it measures the pricesensitivity of buyers demand.

22

Price Elasticity of Demand

Price elasticity

of demand

Example:

Price elasticity

of demand

equals

-15%

= -1.5

10%

Percentage change in Qd

=

Percentage change in P

P

P rises

P2

by 10%

P1

D

Q2

Q1

Q

Q falls

by 15%

33

Price Elasticity of Demand

Price elasticity

of demand

Percentage change in Qd

=

Percentage change in P

Along a D curve, P and Q

move in opposite directions,

which would make price

elasticity negative.

We will drop the minus sign

and report all price

elasticities as

positive numbers.

P

P2

P1

D

Q2

Q1

Q

44

Calculating Percentage Changes

? We will use the midpoint method:

end value start value

x 100

midpoint

? The midpoint is the number halfway between

the start & end values, the average of those

values.

? It doesnt matter which value you use as the

start and which as the end you get the

same answer either way!

? **more info about this on the last slide

55

Calculating Percentage Changes

Please calculate the price

elasticity of demand using

the midpoint method.

Demand for

your tutoring

P

$25

B

A

$20

D

8

12

Q

6

Calculating Percentage Changes

? Using the midpoint method, the % change

in P equals

$25 $20

$22.5

x 100

= 22.2%

? The % change in Q equals

12 8

x 100

10

= 40.0%

? The price elasticity of demand equals

40/22.2 = 1.8

77

Calculate an elasticity

Use the following

information to

calculate the

price elasticity

of demand

for hotel rooms:

if P = $70, Qd = 5000

if P = $90, Qd = 3000

8

Calculate an elasticity

Use the following information to calculate the price

elasticity of demand for hotel rooms:

if P = $70, Qd = 5000

if P = $90, Qd = 3000

9

Practice

? When a street vendor reduces the price of hot

dogs from $1.75 to $1.50, the number of hot

dogs sold per day rises from 500 to 600. What is

the price elasticity of demand for hot dogs in this

range?

10

More Practice

? If the price elasticity of demand for houses, in

absolute value, is 0.8, by what percentage will

the quantity of houses demanded rise if housing

prices fall by 10%?

11

What determines price elasticity?

If the prices of both of these goods rise by 20%,

which good does Qd drop the most? Why?

1. Rice Krispies vs. Sunscreen

2. Insulin vs. Caribbean Cruises

3. Jeans vs. Clothing

4. A New Camera vs. A pack of Gum

5. Gas in the Short Run vs. Gas in the Long Run

12

The Determinants of Price Elasticity:

A Summary

The price elasticity of demand depends on:

? the extent to which close substitutes are

available

? whether the good is a necessity or a luxury

? how broadly or narrowly the good is defined

? the percentage of a persons budget

? the time horizon: elasticity is higher in the

long run than the short run

13

Cigarettes (US)[37]

o

-0.3 to -0.6 (General)

o

-0.6 to -0.7 (Youth)

Cinema visits (US)

o

Alcoholic beverages (US)[38]

Live Performing Arts (Theater, etc.)

o

-0.87 (General)[42]

-0.4 to -0.9 [45]

o

-0.3 or -0.7 to -0.9 as of 1972 (Beer)

o

-1.0 (Wine)

o

-0.20 (Bus travel US)[42]

o

-1.5 (Spirits)

o

-2.80 (Ford compact automobile)[46]

Airline travel (US)[39]

Transport

Soft drinks

o

-0.3 (First Class)

o

-0.8 to -1.0 (general)[47]

o

-0.9 (Discount)

o

-3.8 (Coca-Cola)[48]

o

-1.5 (for Pleasure Travelers)

o

-4.4 (Mountain Dew)[48]

Car fuel[41]

o

-0.25 (Short run)

o

-0.64 (Long run)

Medicine (US)

o

-0.31 (Medical insurance)[42]

o

-.03 to -.06 (Pediatric Visits) [43]

Steel

o

-0.2 to -0.3[49]

Marijuana

-1.0[50]

Oil (World)

o

-0.4

14

Elasticity Vs. Slope

? Rule of thumb:

The flatter the curve, the larger the

elasticity.

The steeper the curve, the smaller

the elasticity.

? The elasticity is not equal to the slope

? Five different classifications of D

curves.

15

Inelastic demand

< 10%
% change in Q
Price elasticity
1
=
=
of demand
10%
% change in P
P
D curve:
relatively flat
P1
Consumers
price sensitivity:
relatively high
Elasticity:
>1

P2

P falls

by 10%

D

Q1

Q2

Q

Q rises more

than 10%

17

Perfectly inelastic demand (one extreme case)

% change in Q

Price elasticity

=

=

of demand

% change in P

P

D curve:

vertical

A life-saving medicine

10%

=0

D

P1

Consumers

price sensitivity:

0

Elasticity:

0

0%

P2

P falls

by 10%

Q1

Q

Q changes

by 0%

18

Unit elastic demand

% change in Q

Price elasticity

=

=

of demand

% change in P

10%

=1

P

D curve:

intermediate slope

P1

Consumers

price sensitivity:

intermediate

Elasticity:

1

10%

P2

P falls

by 10%

D

Q1

Q2

Q

Q rises by 10%

19

Perfectly elastic demand (the other extreme)

any %

% change in Q

Price elasticity

= undefined

=

=

of demand

0%

% change in P

P

D curve:

horizontal

Consumers

price sensitivity:

extreme

Elasticity:

undefined

D

P

P changes

by 0%

Q1

Example: commodities (i.e. wheat) Extreme price

sensitivity. all identical so can buy from anyone. If raise

your price, no one will buy. If lower your price EVERYONE

will buy.

Q2

Q

Q changes

by any %

20

Practice

? If the price of a good increases by 8% and the

quantity demanded decreases by 12%, what is

the price elasticity of demand? Is it elastic,

inelastic or unitary elastic? What will the slope of

the demand curve look like (flat or steep)?

21

Price Elasticity and Total Revenue

Revenue = P x Q

? A price increase has two effects on revenue:

Price Effect after a price increase, each unit sold

sells at a higher price, which tends to raise revenue

Quantity Effect after a price increase, fewer units

are sold, which tends to lower revenue

? Which of these two effects is bigger?

It depends on the price elasticity of demand.

22

Price Elasticity and Total Revenue

Price elasticity

=

of demand

Percentage change in Q

Percentage change in P

? If demand is elastic, then

price elast. of demand > 1

% change in Q > % change in P

? The fall in revenue from lower Q is greater

than the increase in revenue from higher P,

so revenue falls.

23

Price Elasticity and Total Revenue

Elastic demand

(elasticity = 1.8)

If P = $20,

Q = 12 and

revenue = $240.

If P = $25,

Q = 8 and

revenue = $200.

P

increased

revenue due

to higher P

$25

lost

revenue

due to

lower Q

$20

When D is elastic,

a price increase

causes revenue to fall.

D

8

12

Q

24

Price Elasticity and Total Revenue

Price elasticity

=

of demand

Percentage change in Q

Percentage change in P

? If demand is inelastic, then

Revenue = P x Q

price elast. of demand < 1
% change in Q < % change in P
? The fall in revenue from lower Q is smaller
than the increase in revenue from higher P,
so revenue rises.
? In our example, suppose that Q only falls to 10
(instead of 8) when you raise your price to $250.
25
25
Price Elasticity and Total Revenue
Now, demand is
inelastic:
elasticity = 0.82
If P = $20,
Q = 12 and
revenue = $240
If P = $25,
Q = 10 and
revenue = $250.
P
increased
revenue due
to higher P
$25
lost
revenue
due to
lower Q
$20
When D is inelastic,
a price increase
causes revenue to rise.
D
10
12
Q
26
Summary of Elasticity and Total
Revenue (TR)
? Elastic Demand:
Price increase ? Decrease in TR
Price decrease ? Increase in TR
(lose a lot of sales)
? Inelastic Demand:
Price increase ? Increase in TR
Price decrease ? Decrease in TR
(gain extra $ per sale)
(gain a lot of sales)
(lose $ per sale)
27
Practice
? Anna owns the Sweet Alps Chocolate store. She
charges $10 per pound for her hand made
chocolate. You, the economist, have calculated
the elasticity of demand for chocolate in her
town to be 2.5. If she wants to increase her total
revenue, what advice will you give her and
why? Be able to explain your answer.
28
Answer
? She should lower her price. When demand is
elastic, people are very sensitive to a change in
price. If the price is lowered, people will buy so
much more that total revenue will increase.
29
Elasticity and expenditure/revenue
A. Pharmacies raise the price of insulin by 10%.
Does total spending on insulin rise or fall?
B. As a result of a fare war, the price of a luxury
cruise falls 20%. Does luxury cruise
companies total revenue rise or fall?
30
30
Elasticity and expenditure/revenue
A. Pharmacies raise the price of insulin by 10%. Does
total spending on insulin rise or fall?
Total spending will increase because demand for
insulin is inelastic. People will pay the higher price
and continue to buy almost as much.
B. As a result of a fare war, the price of a luxury cruise
falls 20%. Does luxury cruise companies total revenue
rise or fall?
Revenue will increase because demand is elastic.
People will buy so many more tickets when the
price falls that revenue will increase.
31
31
Price Elasticity of Supply
Price elasticity
of supply
Percentage change in Qs
=
Percentage change in P
? Price elasticity of supply measures how much
Qs responds to a change in P.
? Loosely speaking, it measures the pricesensitivity of sellers supply.
? Again, use the midpoint method to compute the
percentage changes.
32
The Variety of Supply Curves
? The slope of the supply curve is closely related
to price elasticity of supply.
? Rule of thumb:
The flatter the curve, the bigger the elasticity.
The steeper the curve, the smaller the elasticity.
? Five different classifications.
33
Perfectly inelastic (one extreme)
0%
% change in Q
Price elasticity
=
=
of supply
% change in P
P
S curve:
vertical
S
P2
Sellers
price sensitivity:
0
Elasticity:
0
10%
=0
P1
P rises
by 10%
Beach front property, cell phone frequencies
Q1
Q
Q changes
by 0%
34
Inelastic
< 10%
% change in Q
Price elasticity
1
=
=
of supply
10%
% change in P
P
S curve:
relatively flat
S
P2
Sellers
price sensitivity:
relatively high
Elasticity:
>1

P1

P rises

by 10%

Q1

Q2

Q

Q rises more

than 10%

37

Perfectly elastic (the other extreme)

any %

% change in Q

Price elasticity

= undefined

=

=

of supply

0%

% change in P

P

S curve:

horizontal

Sellers

price sensitivity:

extreme

Elasticity:

undefined

S

P2 = P1

P changes

by 0%

Q1

Example: Google stock costs are the same for all

producers, so wont lower the price. If increase the price, no

one will buy.

Q2

Q

Q changes

by any %

38

The Determinants of Supply Elasticity

? The more easily sellers can change the quantity

they produce, the greater the price elasticity of

supply.

Example: Supply of beachfront property is

harder to vary and thus less elastic than

supply of new cars.

? For many goods, price elasticity of supply

is greater in the long run than in the short run,

because firms can build new factories,

or new firms may be able to enter the market.

39

Income Elasticity of Demand

? The income elasticity of demand measures the

response of Qd to a change in consumer income.

Percent change in Qd

Income elasticity

=

of demand

Percent change in income

? What does it mean if it is a positive number?

? What does it mean if it is a negative number?

40

Income Elasticity of Demand

? The income elasticity of demand measures the

response of Qd to a change in consumer income.

? What does it mean if it is a positive number?

It is a normal good (they move in the same

direction). When income goes up, we buy more.

When income goes down, we buy less.

? What does it mean if it is a negative number?

It is an inferior good (they move in opposite

directions). When income goes up, we buy less.

When income goes down, we buy more.

41

Practice

? A 10 percent increase in income brings about a

15 percent decrease in the demand for a good.

What is the income elasticity of demand and is

the good a normal good or an inferior good? Be

able to explain your answer.

42

Answer

43

Cross-Price Elasticity

? The cross-price elasticity of demand measures

the response of demand for one good to changes

in the price of another good.

% change in Qd for good 1

Cross-price elast.

=

of demand

% change in price of good 2

? What does it mean if it is a negative number?

? What does it mean if it is a positive number?

44

Cross-Price Elasticity

? The cross-price elasticity of demand measures

the response of demand for one good to changes

in the price of another good.

? What does it mean if it is a negative number?

Complements. When the price of one

increases, demand for the other decreases.

? What does it mean if it is a positive number?

Substitutes. When the price of one increases,

demand for the other increases.

45

Practice

? If the cross elasticity of demand between peanut

butter and jelly is -1.11, then are they substitutes

or complements? Be able to explain your

answer.

46

Practice

? If the cross elasticity of demand between peanut

butter and jelly is -1.11, then are they substitutes

or complements? Be able to explain your

answer.

Complements. When the price of peanut

butter increases, the demand for jelly

decreases.

47

More Practice

? Suppose that a 10% increase in the price of one

good causes a 20% decrease in the quantity of

another good. Then cross-elasticity equals ___?

These two goods are (substitutes/complements).

48

Answer

49

Calculating Percentage Changes

? In this chapter we use the Midpoint Method to

calculate percentage changes instead of the

standard method.

? We do this so we will get the same the answer

regardless of which way the price is moving

When price increases causing a decrease in the

quantity demanded AND

When price decreases causing an increase in

the quantity demanded

? The standard method of calculating percentage

changes would give us different answers

50

Why we use the Midpoint Method

Problem:

The standard method gives

different answers depending

on where you start.

Demand for

your tutoring

P

$25

From A to B,

P rises 25%, Q falls 33%,

elasticity = 33/25 = 1.33

B

A

$20

From B to A,

P falls 20%, Q rises 50%,

Q

elasticity = 50/20 = 2.50

D

8

12

51

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