L04. Chapter 6: Elasticity: The Responsiveness of Demand and Supply

Transcription

1 L04 Chapter 6: Elasticity: The Responsiveness of Demand and Supply

2 Elasticity Demand shows us the relationship between price and quantity demanded, all else constant Does quantity respond to price changes in the same way for all goods?

3 Elasticity Price Elasticity of Demand The responsiveness of quantity to a change in price How people respond to a change in price Simply measuring a behavioral response to price changing.

4 Calculating Elasticity: The Midpoint Formula The twos cancel out leaving:

5 Example: Calculate Elasticity from Point A to B Price per 10 8 P 1 =, P 2 =, Q 1 =5, Q 2 =10 A Ed = B = = -( 5 15 )( 18 2 )= (- 1 3 )9 = C D D Quantity

6 Example: Calculate Elasticity from Point C to D P 1 =_, P 2 =_, Q 1 =_, Q 2 =_ Price per 10 8 A Ed = B = = -( 5 55 )( )= (- 11 ) 3= C D D Quantity

7 Elasticity Notice that the linear demand curve had the same slope all over the entire curve, but the ELASTICITY CHANGED

8 $ Price P* Elastic ε > -1 Elasticity changes as we move along a demand curve Elastic demand % Q is greater than % P so the elasticity is greater than 1 in absolute value. Quantity responds strongly Unit-Elastic ε = -1 ε = Unit-Elastic Demand % Q is equal to the % P so the elasticity is equal to 1 in absolute value. Quantity responds equally Inelastic ε < -1 Inelastic demand % Q is less than % P so the elasticity is less than than 1 in absolute value. Quantity responds weakly Demand Q* Quantity

9 Examples of Price Elasticities Price Elasticity of Demand for: Marijuana among HS Seniors -0.3 What is the interpretation of this number? When price goes up by 1 percent, quantity demand goes down percent Motor Vehicles Beer Shoes Green Peas -2.8 What do the negative signs indicate? When price goes up, quantity goes down.

10 Elasticity and Slope Slope and elasticity are not the same thing (two different numbers), BUT Comparing slopes of two demand curves allows you to compare elasticity

11 Question: Which is more elastic, the demand for cigarettes or the demand for potato chips? Price per Unit $4 3 2 D (a) Price per Unit $4 3 2 (b) 1 1 D Quantity Quantity Key Point: When comparing two demand curves: The steeper one is more The flatter one is more

12 Extreme Cases of Demand No change (think Zero) Some change Huge Percent Change Super Small Percent Change Price per Unit $4 3 2 D Demand, Ed = 0 Price per Unit $4 3 2 (b) Demand Ed = D Quantity Quantity

13 Determinants of Price Elasticity of Demand 1. Availability of Close Substitutes More Substitutes 2. Passage of time More time 3. Luxury vs Necessities Luxury Goods 4. Definition of the Market Narrower the market CEREAL PRICE ELASTICITY OF DEMAND Post Raisin Bran -2.5 All family breakfast cereals -1.8 All types of breakfast cereals -0.9

14 Determinants of Price Elasticity of Demand 5. Share of a Consumers Budget Smaller share Bigger share

15 Revenue and Elasticity Revenue = Price * Quantity If we lower price, what happens to revenue? Does it depend on the resulting change in quantity? Does it depend on people s behavioral response to a change in price? Does it depend on elasticity?

16 Revenue and Elasticity Key Point: Price and revenue move in the direction for region of the demand curve Price and revenue move in the direction in the Region

17 $ Price P* Elastic ε > -1 Elastic demand: When price decreases, quantity responds so strongly that revenue goes up. Price and Revenue move in directions Unit-Elastic ε = -1 Demand ε = Unit-Elastic Demand :When price decreases, quantity responds to exactly offset the change. Revenue does not change Inelastic ε < -1 Inelastic demand: When Price decreases, quantity responds so weakly that revenue goes down. Price and revenue move in the direction Q* Quantity

18 $ Price Elastic When Price goes down, revenue goes. Total Revenue Q* Inelastic When Price Goes down revenue goes Demand Quantity Q* is the middle of the demand curve Relates to Elastic Demand Relates to Inelastic Demand Total Revenue Curve Quantity

19 Other Elasticities 1. Price Elasticity of Demand 2. Cross Price Elasticity of Demand 3. Income Elasticity of Demand 4. Price Elasticity of Supply

20 Wii Cross-Price Elasticity Quantity of Xbox sold goes up goes up Quantity of Donuts sold Goes down For Substitutes: Price of one goes up, what happens to demand (and quantity demanded) for its substitute? Key Point: Cross Price Elasticity for Substitutes is For Complements Price of one goes up, what happens to demand (and quantity demanded) for its Complement? Key Point: Cross Price Elasticity for complements is Price of PS3 goes up Price of Coffee goes up

21 Income Elasticity of Demand Quantity demand of Ramen Goes down Increase in income For Inferior goods What happens to demand (and thus quantity demanded) when income goes up? Key point: For inferior goods, the income elasticity of demand is. For Normal Goods What happens to demand (and thus quantity demanded) when income goes up? Key Point: For normal goods, the income elasticity of demand is Quantity demanded of Steak Goes up

22 Income Elasticity of Demand Normal Goods Necessity Imagine your income goes down, are your purchases of necessities going to be affected that much? Income Elasticity is between 0 and 1 Luxury Imagine your income goes down, what are the first things your are going to cut back? Income elasticity of demand is greater than 1 Why do we spend so much on health care? When our incomes go up, do we want more health care? In other words, what do you think is the income elasticity of demand for health care?

23 Some Elasticity Examples Cross-price elasticity of demand between beer and wine 0.31 Cross-price elasticity of demand between beer and spirits 0.15 Income elasticity of demand for beer Income elasticity of demand for wine 5.03 Income elasticity of demand for spirits 1.21

24 Price Elasticity of Supply Recall: Price Elasticity of Demand the responsiveness of quantity demanded to a change in price Price Elasticity of Supply? Responsiveness of quantity supplied to a change in price Behavior of Producers

25 Review Price Elasticity of Demand

26 Review

27 Review