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Price Elasticities of Demand

Price Elasticities of Demand. Definition:. Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers’ plans remain the same

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Price Elasticities of Demand

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  1. Price Elasticities of Demand

  2. Definition: • Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers’ plans remain the same • To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price

  3. New price – Initial price Percent change in price = x 100 Initial Price Percentage Price in Change • Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price?

  4. New price – Initial price Percent change in price = x 100 Initial Price Percentage Change in Price • Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price?

  5. Percentage Change in Price • Elasticity compares the percentage change in the quantity demanded with the percentage change in price • Midpoint Method -- To calculate the percentage change that does not depend on the direction of the price change

  6. New price – Initial price Percent change in price = x 100 (New Price + Initial Price) ÷ 2 Percentage Price in Change • Midpoint Method Calculation • Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price.

  7. Percentage Change in Price • Average price is the same regardless of whether the price rises or falls

  8. New price – Initial price Percent change in price = x 100 (New Price + Initial Price) ÷ 2 Percentage Change in Quantity Demanded • Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. • Uses the midpoint formula again

  9. Percentage Change in Quantity Demanded • When the price of a good rises, the quantity demanded of it decreases • A positive change in price bring a negative change in the quantity demanded • When the price of a good falls, the quantity demanded of it increases • Negative change in price brings a positive change in the quantity demanded

  10. Elastic and Inelastic Demand • Elastic Demand – when the percentage change in the quantity demanded exceeds the percentage change in price • Unit Elastic Demand – percentage change in the quantity demanded equals the percentage change in price • Inelastic Demand – percentage change in the quantity demanded is less than the percentage change in price

  11. Elastic Demand • Perfectly Elastic Demand – an almost zero percentage change in the price brings a very large percentage change in the quantity demanded • Consumers are willing to buy any quantity of the good at a given price but none at a higher price

  12. Perfectly Elastic Demand

  13. Elastic Demand • A percentage change in the quantity demanded exceeds the percentage change in price

  14. Unit Elastic Demand • The percentage change in the quantity demanded equals the percentage change in price

  15. Inelastic Demand • Percentage change in the quantity demanded is less than the percentage change in price

  16. Perfectly Inelastic Demand • Percentage change in the quantity demanded is zero for any percentage change in price

  17. Influences on Price Elasticity of Demand • Two influences: • Availability of substitutes • Proportion of income spent

  18. Influences on Price Elasticity of Demand • Demand for good is elastic if a substitute is easy to find • Soft drink containers • Demand for good is inelastic if a substitute is hard to find • Oil substitutes?

  19. Influences on Price Elasticity of Demand • Three factors that influence the ability to find a substitute for a good: • Whether good is a luxury or a necessity • How narrowly it is defined • Amount of time available to find a substitute for it

  20. Price Elasticity of Demand • The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good • Toothpaste?

  21. Percentage change in quantity demanded Price elasticity of demand = Percentage change in the price Computing Price Elasticity of Demand • If the price elasticity of a demand is greater than 1, the demand is elastic • If the price elasticity of demand equals 1, demand is unit elastic • If the price elasticity of demand is less than 1, demand is inelastic

  22. Computing Price Elasticity of Demand

  23. Elasticity Along a Linear Demand Curve • Slope measures responsiveness. But slope and elasticity are not the same thing! • Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies. • Along a linear demand curve, demand is: • Unit elastic at the midpoint of the curve. • Elastic above the midpoint of the curve. • Inelastic below the midpoint of the curve.

  24. Elasticity Along a Linear Demand Curve

  25. Total Revenue and the Price Elasticity of Demand • Total revenue is the amount spent on a good and received by its sellers and equals the price of the good multiplied by the quantity sold • Starbucks Latte -- $3 • Demand is 15 cups an hour • Total Revenue is $45 an hour • Total Revenue Test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change

  26. Total Revenue and the Price Elasticity of Demand • If demand is elastic: • A given percentage rise in price brings a larger percentage decrease in the quantity demanded. • And total revenue decreases. • If demand is inelastic: • A given percentage rise in price brings a smaller percentage decrease in the quantity demanded. • And total revenue increases.

  27. Total Revenue Test Total revenue test: • If price and total revenue change in the opposite directions, demand is elastic. • If a price change leaves total revenue unchanged, demand is unit elastic. • If price and total revenue change in the same direction, demand is inelastic.

  28. Total Revenue Test • At $3 a cup, the quantity demanded is 15 cups an hour. • Total revenue is $45 an hour. • When the price rises to $5 a cup, the quantity demanded decreases to 5 cups an hour. • Total revenue decreases to $25 an hour. • Demand is elastic.

  29. Total Revenue Test • At $50 a book, the quantity demanded is 5 million books. • Total revenue is $250 million. • When the price rises to $75 a book, the quantity demanded decreases to 4 million books. • Total revenue increases to $300 million. • Demand is inelastic.

  30. Addiction and Elasticity • Nonusers’ demand for addictive substances is elastic. • So a moderately higher price leads to a substantially smaller number of people trying a drug. • Existing users’ demand for addictive substances is inelastic. • So even a substantial price rise brings only a modest decrease in the quantity demanded.

  31. Price Elasticities of Demand Notes

  32. Definition: • Price elasticity of demand is • To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price

  33. – = x Percentage Price in Change • Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price?

  34. – = x Percentage Change in Price • Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price?

  35. Percentage Change in Price • Elasticity compares the percentage change in the quantity demanded with the percentage change in price • Midpoint Method --

  36. – = x ( + ) ÷ 2 Percentage Price in Change • Midpoint Method Calculation • Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price.

  37. Percentage Change in Price

  38. New price – Initial price Percent change in price = x 100 (New Price + Initial Price) ÷ 2 Percentage Change in Quantity Demanded • Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. • Uses the midpoint formula again

  39. Percentage Change in Quantity Demanded • When the price of a good rises, the quantity demanded of it decreases • When the price of a good falls, the quantity demanded of it increases

  40. Elastic and Inelastic Demand • Elastic Demand – • Unit Elastic Demand – • Inelastic Demand –

  41. Elastic Demand • Perfectly Elastic Demand – • Consumers are willing to buy any quantity of the good at a given price but none at a higher price

  42. Perfectly Elastic Demand

  43. Elastic Demand

  44. Unit Elastic Demand

  45. Inelastic Demand

  46. Perfectly Inelastic Demand

  47. Influences on Price Elasticity of Demand • Two influences: • Availability of ________________ • Proportion of ___________spent

  48. Influences on Price Elasticity of Demand • Demand for good is elastic if a substitute is easy to find • Demand for good is inelastic if a substitute is hard to find

  49. Influences on Price Elasticity of Demand • Three factors that influence the ability to find a substitute for a good:

  50. Price Elasticity of Demand • The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good

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