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Elasticity of Demand

Elasticity of Demand. Measurement of a good’s responsiveness to a change in price The price effect is greater for some goods than for others Examples:. Elasticity of Demand. Large Price Effect → Elastic Ex: Small Price Effect → Inelastic Ex: Other Examples?.

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Elasticity of Demand

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  1. Elasticity of Demand • Measurement of a good’s responsiveness to a change in price • The price effect is greater for some goods than for others • Examples:

  2. Elasticity of Demand • Large Price Effect → Elastic Ex: • Small Price Effect → Inelastic Ex: Other Examples?

  3. Factors Affecting Elasticity of Demand • Wants = more elastic, needs = more inelastic • Time: • Can purchase be delayed? • Time to adjust… • Longer price change persists = more elastic (long run) • Immediately after price change = more inelastic (short run) • Availability, Suitability, Price of Substitutes • More/better/cheaper substitutes = more elastic • Ex: Ibuprofen vs. Insulin • Percentage of Budget • Larger % = more elastic • Ex: New Car for me vs. LeBron James

  4. Testing for Elasticity of Demand • Graphical Comparison The flatter the curve, the more Elastic the good. The steeper the curve, the more Inelasticthe good. ***ONLY APPLICABLE WHEN COMPARING 2 CURVES Elastic Inelastic

  5. Testing for Elasticity of Demand • Total Revenue Test --- TR = P x Q • Example: • If P and TR move in the same direction, demand is inelastic • If P and TR move in opposite directions, demand is elastic • Hot Dogs? • Gas?

  6. The Total Revenue Test P $3 2 1 Q 0 10 20 30 40 • Lower price and elastic demand • Blue gain exceeds gold loss a b D1 6-7

  7. The Total Revenue Test P $4 3 2 1 Q 0 10 20 • Lower price and inelastic demand • Gold loss exceeds blue gain c d D2 6-8

  8. The Total Revenue Test P $3 2 1 Q 0 10 20 30 • Lower price and unit-elastic demand • Blue gain equals yellow loss e f D3 6-9

  9. As long as Total Revenue is increasing with every increase in price, Demand is elastic • **Marginal Revenue is positive • When Total Revenue begins to decrease with every increase in price, Demand becomes inelastic • **Marginal Revenue is negative

  10. ] ] ] ] ] ] ] ] ] ] ] ] ] ] Elasticity on a Linear Demand Curve (1) Total Quantity of Tickets Demanded Per Week, Thousands (3) Elasticity Coefficient (Ed) (4) Total Revenue (1) X (2) (5) Total-Revenue Test (2) Price Per Ticket 1 2 3 4 5 6 7 8 $8 7 6 5 4 3 2 1 $8,000 14,000 18,000 20,000 20,000 18,000 14,000 8,000 5.00 2.60 1.57 1.00 0.64 0.38 0.20 Elastic Elastic Elastic Unit Elastic Inelastic Inelastic Inelastic 6-11

  11. $8 7 6 5 4 3 2 1 a b c Price d e f g h 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 Quantity Demanded $20 18 16 14 12 10 8 6 4 2 Total Revenue (Thousands of Dollars) Quantity Demanded Elasticity and the TR Curve Elastic Ed > 1 Unit Elastic Ed = 1 Inelastic Ed < 1 D TR 6-12

  12. Price Elasticity of Demand • Price-elasticity coefficient and formula Percentage Change in Quantity Demanded of Product X Ed = Percentage Change in Price of Product X 6-13

  13. Price Elasticity of Demand • Calculate percentage change • Restate formula Change in Quantity Demanded of X Ed = Original Quantity Demanded of X Change in Price of X ÷ Original Price of X 6-14

  14. Change in Quantity Change in Price Ed = ÷ Sum of Quantities/2 Sum of Prices/2 Price Elasticity of Demand • Calculation problem • $4-$5 is 25% increase • $5-$4 is 20% decrease • Starting point matters • Midpoint formula 6-15

  15. Price Elasticity of Demand • Why use percentages? • Unit free measure • Dollars vs. pennies • Compare responsiveness across products • JBCs vs. Porsches • Elimination of the (-) sign • Extreme cases • Perfectly inelastic demand • Perfectly elastic demand 6-16

  16. .04 Ed = = 2 .02 .01 Ed = = .5 .02 .02 Ed = = 1 .02 Interpretations of Elasticity Elastic Demand Inelastic Demand Unit Elasticity 6-17

  17. Extending Elasticity of Demand • How does elasticity of demand affect us? • What do these have in common? • Government taxes inelastic goods… Why? • Why doesn’t govt. tend to tax elastic goods?

  18. “Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” -Ronald Reagan

  19. Elasticity of Supply Elastic– easy/quick to produce – lower marginal cost for each additional unit produced Inelastic– harder/slower to produce – higher marginal cost for each additional unit produced Elasticity of supply increases as producers have more time to adjust to a price change Ex: 1979Today

  20. Factors Affecting Elasticity of Supply • Ease of Production easier = more elastic • Responsiveness to price change quicker adjustment = more elastic • Time more time to adjust = more elastic

  21. Price Elasticity of Supply Responsiveness to price changes by producers Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X 6-22

  22. Elasticity of Supply changes over time • Market Period – immediately after a change in price • Perfectly inelastic supply • Short Run – up to a few months after a change in price • Inelastic orsomewhat elastic supply • Fixed plant size • Long Run – many months/years after a price change • Perfectly Elastic supply • Adjustable plant size

  23. P Q Price Elasticity of Supply The Market Period • Perfectly inelastic supply Sm Pm Greatest Price Impact P0 D1 D2 Q0 6-24

  24. P Q Price Elasticity of Supply The Short Run • Inelastic supply Ss Lower Price Impact Ps P0 Fixed land. Some fixed capital. More labor? More fertilizer? D1 D2 Q0 Qs 6-25

  25. P Q Price Elasticity of Supply The Long Run • Elastic supply Sl Least Price Impact Pl P0 D1 D2 Q0 Ql 6-26

  26. Price Elasticity of Supply • Applications • Antiques and reproductions • Limited, inelastic supply • Strong demand • Resulting high price • Volatile gold prices • Inelastic supply • Shifting demand 6-27

  27. Cross Elasticity of Demand • Responsiveness of sales to change in price of another good Percentage Change in Quantity Demanded of Product X Exy = Percentage Change in Price of Product Y 6-28

  28. Cross Elasticity of Demand • Substitute goods • Positive sign • Complementary goods • Negative sign • Independent goods • Zero or near zero • Coke and Sprite Example • Mergers 6-29

  29. Practice Problem • Let’s look at 2 goods, Widgets and Wadgets. Given the following information: 1. Calculate the price elasticity of demand for widgets. Is demand for widgets elastic, inelastic, or unit elastic? 2. Calculate the cross elasticity of demand for wadgets as they relate to widgets. Would wadgets be considered complements, substitutes, or independent of widgets?

  30. Income Elasticity of Demand Percentage Change in Quantity Demanded • Responsiveness of sales to change in income • Normal goods – positive sign • Inferior goods– negative sign • How can this help you profit from a recession? Ei = Percentage Change in Income 6-31

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