Chapter 4 Demand Elasticity

1. Chapter 4 Demand Elasticity

2. elasticity endogenous variables exogenous variables point elasticity arc elasticity price elasticity of demand elastic demand unitary elasticity inelastic demand KEY CONCEPTS

3. optimal price formula • substitute • complement • cross‑price elasticity • income elasticity • normal goods • inferior goods. • counter-cyclical • noncyclical normal goods • cyclical normal goods

4. OVERVIEW • Measuring Market Demand • Demand Sensitivity Analysis: Elasticity • Price Elasticity of Demand • Price Elasticity and Marginal Revenue • Price Elasticity and Optimal Pricing Policy • Cross-price Elasticity of Demand • Income Elasticity

6. 一. General meaning of Elasticity 1.Definetion Elasticity: the responsiveness of dependent variable to a given change in one of its determinants. • Y=f(x1,x2,x3……xn)

7. 2. calculation Point elasticity reflects sensitivity of Y to small changes in X, Ex = ∂Y/Y ÷ ∂X/X Arc elasticity reflects sensitivity of Y to big changes in X, EX = (Y2–Y1)/(Y2+Y1) ÷ (X2-X1)/(X2+X1).

8. 3. types of elasticity

9. 二. Price Elasticity of Demand 1.Definetion: the responsiveness of Qd to a given change in the price of that good. εP=%△Qd/ %△P εP < 0

10. 2.Formula • Point price elasticity, εP = ∂Q/Q ÷ ∂P/P.

11. _ ARC elasticity of D ?Fill the blanks ?Draw the D curve

12. 3.Classification of εP with Graphs 1. │εP│> 1, D is elastic. 2. │εP│< 1, D is inelastic. 3. │εP│= 1, D is unit elastic 4. │εP│= 0, D is perfectly inelastic. 5. │εP│= ∞, D is perfectly elastic

13. 4. The εPof a linear D curve: Ⅰ：At upper part of the D curve, │εP│> 1 .. Ⅱ：At lower part of the D curve, │εP│< 1 . Ⅲ：At mid point of the D curve, │εP│= 1 .

15. Price Elasticity and TR TR= P*Q ?? How to increase TR by changing price? if │εP│> 1. if │εP│= 1. if │εP│< 1. if │εP│= 0 if │εP│= ∞

17. 四.Price Elasticity and MR If Qd=6-P ??Demand curve ?? Total revenue curve ?? P= 2,3,5 elasticity=? ??Relation between elasticity and MR

20. MR > 0 if │εP│> 1. • MR = 0 if │εP│= 1. • MR < 0 if │εP│< 1.

22. 五.Price Elasticity and Optimal Pricing Policy P87 1. Optimal Price Formula MR = P/[1+(1/ εP)]. Optimal P* = MC/[1+(1/ εP)]. • 2.Optimal Pricing Policy Example

23. 六.Determinants of Price Elasticity • Essential goods have low│εP│. • Nonessential goods have high│εP│.

24. 1.The number and closeness of substitutes. 2.Definition of the market Example: beef and meat. 3.Luxury versus necessity Necessities: poor substitutes Luxuries: many substitutes 4.Proportion of income spent on that good 5.The time period. Example: SR │εP│for gasoline = 0.2; LR│εP│ =0.7

25. │εP│ for selected goods

26. Applications of price elasticity of D 1. Bumper crops Can Good News for Farming Be Bad News for Farmers? (Ed for farm products is between 0.2—0.25) 2.Eexcise taxes What goods should be taxed? 3.Decriminalization of drug dealing Proponents: Ed ﹤1 Opponents: Ed﹤1 for addicts; Ed﹥1 for dabbler

27. 七.Cross-price Elasticity of Demand Definition: demand sensitivity to changes in other prices. • εPX = ∂QY/QY÷ ∂PX/PX.

28. Substitutes have εPX > 0. • Complements have εPX > 0. • Independent goods have εPX > 0. • Cross-price Elasticity Example

29. 八. Income Elasticity Definition: Income elasticity shows demand sensitivity to changes in income. εI = ∂Q/Q ÷ ∂I/I.

30. Types of Goods: Normal goods:εI > 0. Inferior goods:εI < 0. • Types of Normal Goods • Noncyclical goods: 0 < εI < 1. • Cyclical goods: εI > 1.