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Elasticity

Elasticity. Claudia Garcia-Szekely. 150. 120. A movement Along. 100. A change in price. 50. 30. D. 0. 10. 20. 0. 6. 24. 30. A change in quantity demanded. Consumers barely notice. Consumers Overreact. 110. 110. Small change in Q. 100. 100. Big change in Q. 100. 130. 100.

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Elasticity

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  1. Elasticity Claudia Garcia-Szekely

  2. 150 120 A movement Along 100 A change in price 50 30 D 0 10 20 0 6 24 30 A change in quantity demanded

  3. Consumers barely notice Consumers Overreact 110 110 Small change in Q 100 100 Big change in Q 100 130 100 105

  4. Consumers barely notice Consumers Overreact 110 110 Small change in Q 100 100 Big change in Q 100 130 100 105

  5. The Price Elasticity of Demand • Measures the response of the quantity demanded to a change in price. How responsive to price changes is the quantity demanded of prescription drugs? and the quantity demanded of strawberries?

  6. % Change Quantity Demanded epd = % Change in price The Midpoint Formula Change in Quantity Average Quantity epd = Change in PriceAverage Price

  7. Elasticity Between two points Elasticity between B and C measures the response to a $0.50 change in the price: up 50 cents or down 50 cents Note that a point is a pair (p, q)

  8. Midpoint Formula • Compute the difference between the two quantities: 22-19 = 3 Compute the average of the two quantities: (22 + 19)/2 = 41/2 = 20.5 Divide the answer you got in (1) by the answer in (2). This is the percentage change in the quantity demanded: 3/20.5 = 0.146

  9. The Midpoint Formula • Compute the difference between the two prices: (1-0.5) = 0.5 Compute the average of the two prices: (1+0.5)/2 = 0.75 Divide the answer in (4) by the answer in (5). This is the percentage change in the price: 0.5/0.75 =0.667.

  10. Compute the difference between the two prices: (1-0.5) = 0.5 Compute the difference between the two quantities: 22-19 = 3 Compute the average of the two prices: (1+0.5)/2 = 0.75 Compute the average of the two quantities: (22 + 19)/2 = 41/2 = 20.5 Divide the answer in (4) by the answer in (5). This is the percentage change in the price: 0.5/0.75 =0.667. Divide the answer you got in (1) by the answer in (2). This is the percentage change in the quantity demanded: 3/20.5 = 0.146 • Divide the percentage change in the quantity demanded: the answer you got in (3), by the percentage change in the price: the answer you got in (6). • The answer is the Price Elasticity of Demand between B and C. • 0.146 / 0.667 = 0.21

  11. Price Elasticity of Demand • Measures the responsiveness of the quantity demanded to a change in price. • There is a negative relationship between the price and the quantity demanded. • The price elasticity of demand is ALWAYS NEGATIVE.

  12. Change in Quantity/Average Quantity Change in Price/Average Price Price elasticity of demand isALWAYS NEGATIVE Always write a negative sign in front! epd =

  13. Elasticity of Demand Between Points A and E Midpoint formula gives you the elasticity at the Midpoint 10 A 7 6 E 5 18 24 30

  14. Elasticity of Demand at Point A Make A the Midpoint 10 8 A 7 6 Use a point above A and a point below A 12 18 24

  15. % Change in Quantity Elasticity = % Change in Price < 1 = 1 > 1 < The steeper Demand is, the more Inelastic The flatter Demand is, the more Elastic > % Change in Quantity = % Change in Quantity % Change in Quantity % Change in Price % Change in Price % Change in Price Consumers Under-react: Demand is Inelastic Consumers Over-react: Demand is Elastic Demand is UNIT Elastic

  16. Example Elasticity has no units! It has been observed that a 20% decrease in the price of good X, caused a 5% increase in the quantity demanded of X. epd = 5% / -20% = - 0.25 Elasticity of Demand is less than one: Inelastic

  17. Example It has been observed that a 5% increase in the price, caused a 10% reduction in the quantity demanded. epd = -10% / 5% = - 2 Elasticity of Demand is greater than one: Elastic

  18. If the price elasticity of demand for good X is 0.5. In order to induce a 10% reduction in consumption of this good, the government would need to tax this good until the price rises by how much? edp= % D Q / % D P -0.5= -10%/ % D P -10 /-0.5 =+% D P 20 =+% D P

  19. Calculate price elasticity e = -1 In order to induce a 5% increase in consumption of this good, the price would have to (rise/fall) ________ by _____%

  20. Price Elasticity of Demand e = - 0.75 If we want to increase quantity demanded by 10% what is the necessary change in price? Price must _________________ by _______% (Increase/decrease) If we increase the price by 10% how would the quantity demanded change? Quantity demanded_______________ by _______% (Increase/decrease)

  21. Calculate price elasticity e = -1.2 If we increase the price by 10% how would the quantity demanded change? Quantity demanded_______________ by _______% (Increase/decrease) If we want to increase quantity demanded by 10% what is the necessary change in price? Price must _________________ by _______% (Increase/decrease)

  22. |e| > 1 |e| < 1 The Elasticity Changes Along the Demand Curve For high prices (at the top of the demand curve) demand is relatively elastic |e| = 1 As you move along a demand curve -as price changes- the elasticity changes in absolute value. At the midpoint, |e| = 1 As Price Increases Elasticity Increases For low prices (at the bottom of the demand curve) demand is relatively inelastic

  23. |e| > 1 |e| < 1 The Elasticity Changes Along the Demand Curve |e| = 1 0 100 0 1000 100/2 = 50 1000/2 = 500 Midpoint

  24. Is the elasticity at A > B? A < B? A=B? Is the elasticity at E = 1? Is the elasticity at F > 1? F < 1? F=1? F E

  25. |e| = 8 % Change in Quantity e = % Change in Price Demand is Perfectly Elastic > 1 0.61 > 0.60 % Change in Quantity % Change in Price Almost no change in P Demand is Elastic 0 Units 10,000 Units Very large change in Q

  26. |e| = 0 % Change in Quantity e = % Change in Price 3.61 < 1 Demand is Perfectly Inelastic < % Change in Quantity % Change in Price 0.60 Demand is Inelastic Large change in P No change in Q

  27. |e| = 1 % Change in Quantity e = % Change in Price Demand is UNIT Elastic Everywhere = 1 % Change in Quantity = % Change in Price Demand is UNIT Elastic

  28. M The demand curve with the smallest elasticity at point M is___ The demand curve with the largest elasticity at point M is ___ Demand curve _______ is perfectly elastic Demand curve _______ is perfectly inelastic

  29. Both Elastic Po Midpoint B A The demand curve with the largest elasticity at price Po is ___ Elasticity is NOT the same as slope

  30. What Determines the Elasticity?

  31. The number of Substitutes Available. The more substitutes, the easier it is for consumers to switch. The more sensitive (elastic) demand would be to price changes

  32. All other flavors All Other Brands All other desserts Definition of the market. Common mistake: The more specific the more inelastic because only Ben and Jerry’s chocolate ice cream “will do” The more specific the description of the good, the more alternatives are available and thus the more elastic Narrowly defined markets have more elastic demands. Ben and Jerry’s Chocolate Ice Cream |epd |> 1

  33. The Definition of the market. Common mistake: The larger the set the more elastic because there are lots of “choices” Broadly defined markets have less elastic demands Food HDz | epd |< 1

  34. 2. Which product will be more elastic? Why? 2. Which product has more substitutes? All frozen desserts Ice cream Chocolate ice cream Ben and Jerry’s chocolate ice cream

  35. The Amount of Time to React • The longer the time allowed, the easier it is for consumers to find an alternative or modify their behavior. • Goods have more elastic demands over longer time horizons. Example: Gasoline.

  36. Two ways to increase revenue • Increase price, in order to make more per unit • Decrease price, in order to sell more units.

  37. Inelastic Demand Increase Price Decrease Price Quantity sold increase Increase in Q is SMALLER than decrease in price Quantity increase a little, price drops a lot Total Revenue decrease • Quantity sold drops • Decrease in Q is SMALLER than increase in price • Quantity drops a little, price increase a lot • Total Revenue increase. If demand is Inelastic, increase price to increase TR

  38. Elastic Demand Increase Price Decrease Price Quantity sold increase Increase in Q is LARGERthan decrease in price Quantity increase alot, price drop a little Total Revenue increase • Quantity sold drops • Decrease in Q is LARGER than increase in price • Quantity drops a lot, price increase little • Total Revenue decrease. If demand is Elastic, decreaseprice to increase TR 38

  39. Demand is Inelastic If total Revenues increase as price increase If total Revenues decrease as price increase Demand is elastic

  40. Total Revenues Decrease. Then the effect of higher prices, was completely offset by the drop in quantities sold. Total Revenues Increase. Then the quantity sold did not drop enough to offset the increase in price. If a company increases prices and as a result: Demand is Elastic Demand is Inelastic

  41. 3. Is this demand elastic or inelastic? Demand is Inelastic

  42. |e| > 1 |e| < 1 The Elasticity Changes Along the Demand Curve Decrease Price to Increase TR |e| = 1 An increase/decrease in price would leave TR unchanged Increase Price to Increase TR Midpoint

  43. When Demand is Inelastic S1 S0 Inelastic P1 > Gain Gain Loss P0 Loss Midpoint TR increase D0 Q1 Q0

  44. When Demand is Inelastic S0 S1 Inelastic P0 > Loss Loss Gain P1 Midpoint Gain TR decrease D0 Q1 Q0

  45. When Demand is Elastic Gain S0 > S1 Loss P0 Elastic P1 Loss Gain D0 Midpoint TR Increase Q1 Q0

  46. When Demand is Elastic S1 S0 Loss > Gain P1 Elastic Gain P0 Loss D0 Midpoint TR Decrease Q1 Q0

  47. Questions to prepare for the Quiz • Assume that currently, a book publisher charges one price for a novel by author B. • An economist determines that the price elasticity of demand for die hard fans of this author is – 0.4 and that the price elasticity of demand for regular buyers is –3. • The advertising department comes up with the idea of publishing the same book in a hard cover version to be published first, and a soft cover version to be released two months after the release of the hard cover version. This would allow the publisher to charge different prices to these two groups. • How would you advise them to set prices in order to increase total revenues?

  48. Assume that currently, all customers pay the same price for a packet of cigarettes “Generic” brand D. An economist determines that the price elasticity of demand by adults is –0.4 and that the price elasticity of demand by teenagers is –3. The advertising department comes up with the idea of packaging cigarettes differently to target different groups: Target teenagers with “Cool” brand A and adults with “less tar” brand B. How would you adjust prices in order to increase your total revenues? You must provide a clear explanation for your answer.

  49. Determine whether demand is elastic, inelastic, unit elastic, perfectly elastic/inelastic or can’t tell: Chapped Hands Community College’s tuition increased from $20 per unit to $25 per unit. Enrollment dropped from 8,000 to 7,200 students. Washington apple growers sell a 10% larger crop than last year’s , but the revenue they earned is unchanged. Honda offers a $100 rebate on its largest rider lawn mowers, and their sales rise 5%. The price of doctor services falls and your family’s total expenditures are less on doctor services and more on other things. The price of carnations rises by 15%. Florists substitute daisies and ferns and the quantity used of carnations drop by 25%. The price of coffee drops by 25 cents per pound, but you continue to drink the same amount as before. • Inelastic 0.47 • Unit elastic • Can’t tell • Inelastic • Elastic 1.67 • Perfectly Inelastic E=0

  50. The price of coffee drops by 25 cents per pound, but total revenue remains the same. The price of natural gas falls and as a result, revenues drop. The price of strawberries fall, and as a result, revenues for strawberry farmers rise. The price of Tylenol rise and as a result, revenues rise. The price of Pert shampoo rises and as a result, revenues drop.

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