Price Elasticity of Demand

Transcription

1 04 Elasticity

2 Price Elasticity of Demand Measures buyers responsiveness to price changes Elastic demand Sensitive to price changes Large change in quantity Inelastic demand Insensitive to price changes Small change in quantity LO1 4-2

3 Price Elasticity of Demand Formula Formula for price elasticity of demand E d = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product X LO1 4-3

4 Price Elasticity of Demand Formula Use the midpoint formula Ensures consistent results Change in quantity Sum of quantities/2 E d = Change in price Sum of prices/2 LO1 4-4

5 Price Elasticity of Demand Formula Use percentages Unit free measure Compare responsiveness across products Eliminate the minus sign Easier to compare elasticities LO1 4-5

6 Interpretation of Elasticity of Demand E d > 1 demand is elastic E d = 1 demand is unit elastic E d < 1 demand is inelastic Extreme cases Perfectly inelastic Perfectly elastic LO1 4-6

7 Extreme Cases P D 1 Perfectly inelastic demand (Ed = 0) 0 Perfectly inelastic demand LO1 4-7

8 Extreme Cases P D 1 Perfectly inelastic demand (Ed = 0) 0 Perfectly inelastic demand LO1 4-7

9 Extreme Cases P Perfectly elastic demand (Ed = ) D 2 0 Perfectly elastic demand LO1 4-8

10 Extreme Cases P Perfectly elastic demand (Ed = ) D 2 0 Perfectly elastic demand LO1 4-8

11 Total Revenue Test Total Revenue = Price X Quantity Inelastic demand P and TR move in the same direction Elastic demand P and TR move in opposite directions LO2 4-9

12 Total Revenue Test Lower price and elastic demand Blue gain exceeds orange loss P $3 2 a 1 b D Q LO2 4-10

13 Total Revenue Test Lower price and elastic demand Blue gain exceeds orange loss P $3 2 a 1 b D Q LO2 4-10

14 Total Revenue Test Lower price and inelastic demand Orange loss exceeds blue gain P $4 c d D Q LO2 4-11

15 Total Revenue Test Lower price and inelastic demand Orange loss exceeds blue gain P $4 c d D Q LO2 4-11

16 Total Revenue Test Lower price and unit elastic demand Blue gain equals orange loss P $3 e 2 1 f D Q LO2 4-12

17 Total Revenue Test Lower price and unit elastic demand Blue gain equals orange loss P $3 e 2 1 f D Q LO2 4-12

18 Total Revenue Test Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test (1) Total Quantity of Tickets Demanded per Week, Thousands (2) Price per Ticket (3) Elasticity Coefficient (E d ) (4) Total Revenue (1) X (2) 1 $8 $8,000 (5) Total Revenue Test ,000 Elastic ,000 Elastic ,000 Elastic ,000 Unit Elastic ,000 Inelastic ,000 Inelastic ,000 Inelastic LO2 4-13

19 Elasticity and Total Revenue Price $8 7 a 6 b 5 c 4 d 3 e 2 f 1 g h Quantity Demanded D Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 Total Revenue (Thousands of Dollars) $ Quantity Demanded TR LO2 4-14

20 Elasticity and Total Revenue Price $8 7 a 6 b 5 c 4 d 3 e 2 f 1 g h Quantity Demanded D Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 Total Revenue (Thousands of Dollars) $ Quantity Demanded TR LO2 4-14

21 Elasticity and Total Revenue Price $8 7 a 6 b 5 c 4 d 3 e 2 f 1 g h Quantity Demanded D Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 Total Revenue (Thousands of Dollars) $ Quantity Demanded TR LO2 4-14

22 Elasticity and Total Revenue Price $8 7 a 6 b 5 c 4 d 3 e 2 f 1 g h Quantity Demanded D Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 Total Revenue (Thousands of Dollars) $ Quantity Demanded TR LO2 4-14

23 Summary of Price Elasticity of Demand Price Elasticity of Demand: A Summary Absolute Value of Elasticity Coefficient Demand Is: Description Greater than 1 (E d > 1) Equal to 1 (E d = 1) Less than 1 (E d < 1) Elastic or relatively elastic Unit or unitary elastic Inelastic or relatively inelastic Q d changes by a larger percentage than does price Q d changes by the same percentage as does price Q d changes by a smaller percentage than does price Impact on Total Revenue of a: Price Increase Total Revenue decreases Total revenue is unchanged Total revenue increases Price Decrease Total Revenue increases Total revenue is unchanged Total revenue decreases LO2 4-15

24 Determinants of Elasticity of Demand Substitutability More substitutes, demand is more elastic Proportion of Income Higher proportion of income, demand is more elastic Luxuries vs. Necessities Luxury goods, demand is more elastic Time More time available, demand is more elastic LO1 4-16

25 LO1 Price Elasticity of Demand Selected Price Elasticities of Demand Product or Service Price Elasticity of Demand (E d ) Product or Service Price Elasticity of Demand (E d ) Newspapers.10 Milk.63 Electricity (household).13 Household appliances.63 Bread.15 Liquor.70 MLB Tickets.23 Movies.87 Telephone Service.26 Beer.90 Cigarettes.25 Shoes.91 Sugar.30 Motor vehicles 1.14 Medical Care.31 Beef 1.27 Eggs.32 China, glassware 1.54 Legal Services.37 Residential land 1.60 Automobile repair.40 Restaurant meals 2.27 Clothing.49 Lamb and mutton 2.65 Gasoline.60 Fresh peas

26 Applications of E d Large Crop Yields Inelastic demand, lower total revenue Excise Taxes Inelastic demand, more total revenue Decriminalization of Illegal Drugs Inelastic demand, more total revenue LO1 4-18

27 Price Elasticity of Supply Measures sellers responsiveness to price changes Elastic supply, producers are responsive to price changes Inelastic supply, producers are not responsive to price changes LO3 4-19

28 Price Elasticity of Supply Formula to compute elasticity E s > 1 supply is elastic E s < 1 supply is inelastic E s = Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X LO3 4-20

29 Price Elasticity of Supply Time is primary determinant of elasticity of supply Time periods considered Market period Short Run Long Run LO3 4-21

30 Elasticity of Supply: The Market Period Perfectly inelastic supply S m P m P 0 D 2 Q 0 D 1 LO3 4-22

31 Elasticity of Supply: The Market Period Perfectly inelastic supply S m P m P 0 D 2 Q 0 D 1 LO3 4-22

32 Elasticity of Supply: The Short Run Supply is more elastic than in market period S s P s P 0 D 2 Q 0 D 1 Q s LO3 4-23

33 Elasticity of Supply: The Short Run Supply is more elastic than in market period S s P s P 0 D 2 Q 0 D 1 Q s LO3 4-23

34 P 0 D 2 Elasticity of Supply: The Long Run Supply is even more elastic than in the short run S l P l Q 0 D 1 Q l LO3 4-24

35 P 0 D 2 Elasticity of Supply: The Long Run Supply is even more elastic than in the short run S l P l Q 0 D 1 Q l LO3 4-24

36 Applications of Elasticity of Supply Antiques Inelastic supply Reproductions More elastic supply Volatile gold prices Inelastic supply LO3 4-25

37 Cross Elasticity of Demand Measures responsiveness of sales to change in the price of another good Substitutes positive sign Complements negative sign Independent goods - zero E x,y = Percentage change in quantity demanded of product X Percentage change in price of product Y LO4 4-26

38 Cross Elasticity of Demand Application Change the price? Allow a merger? LO4 4-27

39 Income Elasticity of Demand Measures responsiveness of buyers to changes in income Normal goods positive sign Inferior goods negative sign E i = Percentage change in quantity demanded Percentage change in income LO4 4-28

40 Income Elasticity Insights High income elasticities Most affected by a recession Low or negative income Least affected by a recession LO4 4-29

41 E x,y and E i Cross and Income Elasticities of Demand Value of Coefficient Description Type of Good(s) Cross elasticity: Positive (E wz > 0) Quantity demanded of W changes in same direction as change in price of Z Substitutes Negative (E xy < 0) Income elasticity: Positive (E i >0) Negative (E i <0) Quantity demanded of X changes in opposite direction from change in price of Y Quantity demanded of the product changes in same direction as change in income Quantity demanded of the product changes in opposite direction from change in income Complements Normal or superior Inferior LO4 4-30

42 Elasticity and Pricing Power Charge different prices based on price elasticities Examples: Business air travelers Adult vs. child 4-31