Inelastic Demand Discussion

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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 won’t 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 doesn’t 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 person’s 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 won’t 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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