Chapter 6 - PBworksmorolda.pbworks.com/w/file/fetch/88770218/Chap006.pdf · 634 * Cross and Income Elasticities CrossandIncomeElasciesofDemand ’ ValueofCoeﬃcient’ Descripon’

Chapter 6 Elas%city

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6-‐2

Price Elasticity of Demand

•  Measures buyers’ responsiveness to price changes

•  Elas%c demand •  Sensi%ve to price changes •  Large change in quan%ty

•  Inelas%c demand •  Insensi%ve to price changes •  Small change in quan%ty

LO1

6-‐3

Ed =

Price Elasticity of Demand Formula

•  Formula for price elas%city of demand

percentage change in quan%ty demanded of product X

percentage change in price of product X

LO1

6-‐4


•  Use the midpoint formula •  Ensures consistent results

Ed = ÷ Change in quan%ty

Sum of quan%%es/2

Change in price Sum of prices/2

LO1

6-‐5


•  Use percentages •  Unit free measure •  Compare elas%ci%es across products

•  Eliminate the minus sign •  Easier to compare elas%ci%es

LO1

6-‐6

Interpretation of Elasticity of Demand

•  Ed > 1 demand is elas%c •  Ed = 1 demand is unit elas%c •  Ed < 1 demand is inelas%c •  Extreme cases

•  Ed = 0 demand is perfectly inelas%c •  Ed = ∞ demand is perfectly elas%c

LO1

6-‐7

Extreme Cases

D1 P

Perfectly inelas%c demand

Perfectly inelas%c demand (Ed = 0)

0

LO1

6-‐8

Extreme Cases

Perfectly elas%c demand

P

D2

Perfectly elas%c demand (Ed = ∞)

0

LO1

6-‐9

Total Revenue Test

•  Total Revenue = Price X Quan%ty •  Total Revenue Test •  Inelas%c demand

•  P and TR move in the same direc%on •  Elas%c demand

•  P and TR move in opposite direc%ons

LO2

6-‐10

Total Revenue Test

•  Lower price and elas%c demand •  Blue gain exceeds orange loss

$3

2

1

0 10 20 30 40 Q

P

a

b D1

LO2

6-‐11

Total Revenue Test

•  Lower price and inelas%c demand •  Orange loss exceeds blue gain

$4

3

2

1

0 10 20 Q

P

c

d

D2

LO2

6-‐12

Total Revenue Test

•  Lower price and unit elas%c demand •  Blue gain equals orange loss

$3

2

1

0 10 20 30 Q

P

e

f

D3

LO2

6-‐13

Total Revenue Test

(1) Total Quan%ty of Tickets Demanded

per Week, Thousands (2)

Price per Ticket

(3) Elas%city

Coefficient (Ed)

(4) Total Revenue

(1) X (2)

(5) Total-‐Revenue

Test

1 2 3 4 5 6 7 8

$8 7 6 5 4 3 2 1

5.00 2.60 1.57 1.00 0.64 0.38 0.20

$ 8,000 14,000 18,000 20,000 20,000 18,000 14,000 8,000

Elas%c Elas%c Elas%c

Unit-‐elas%c Inelas%c Inelas%c Inelas%c

] ] ] ] ] ] ]

] ] ] ] ] ] ]

Price Elas%city of Demand for Movie Tickets as Measured by the Elas%city Coefficient and the Total Revenue Test

LO2

6-‐14

Elasticity and Total Revenue

0 1 2 3 4 5 6 7 8

0 1 2 3 4 5 6 7 8

Quan%ty demanded

Quan%ty demanded

Price

Total reven

ue

(Tho

usan

ds of d

ollars) $20

18 16 14 12 10

8 6 4 2

$8 7 6 5 4 3 2 1

a b

c d

e f

g h

Elas%c Ed > 1

Unit elas%c Ed = 1

Inelas%c Ed < 1

D

TR

LO2

6-‐15

Summary of Price Elasticity of Demand

Price Elas%city of Demand: A Summary

Absolute Value of Elas%city Coefficient Demand Is: Descrip%on

Impact on Total Revenue of a:

Price Increase Price Decrease

Greater than 1 (Ed > 1)

Elas%c or rela%vely elas%c

Qd changes by a larger percentage than does price

Total Revenue decreases

Total Revenue increases

Equal to 1 (Ed = 1)

Unit or unitary elas%c

Qd changes by the same percentage as does price

Total revenue is unchanged

Total revenue is unchanged

Less than 1 (Ed < 1)

Inelas%c or rela%vely inelas%c

Qd changes by a smaller percentage than does price

Total revenue increases

Total revenue decreases

6-‐16

Determinants of Price Elasticity of Demand

•  Subs%tutability • More subs%tutes, demand is more elas%c

•  Propor%on of income •  Higher propor%on of income, demand is more elas%c

LO3

6-‐17

Determinants of Price Elasticity of Demand

•  Luxuries versus necessi%es •  Luxury goods, demand is more elas%c

•  Time • More %me available, demand is more elas%c

LO3

6-‐18

Price Elasticity of Demand Selected Price Elas%ci%es of Demand

Product or Service Price Elas%city of Demand (Ed) Product or Service

Price Elas%city of Demand (Ed)

Newspapers .10 Milk .63

Electricity (household) .13 Household appliances .63

Bread .15 Liquor .70

MLB Tickets .23 Movies .87

Telephone Service .26 Beer .90

Cigarebes .25 Shoes .91

Sugar .30 Motor vehicles 1.14

Medical Care .31 Beef 1.27

Eggs .32 China, glassware 1.54

Legal Services .37 Residen%al land 1.60

Automobile repair .40 Restaurant meals 2.27

Clothing .49 Lamb and mubon 2.65

Gasoline .60 Fresh peas 2.83

6-‐19

Applications of Price Elasticity of Demand

•  Large crop yields •  Inelas%c demand, lower total revenue

•  Excise taxes •  Inelas%c demand, more total revenue

•  Decriminaliza%on of illegal drugs •  Inelas%c demand, more total revenue

LO3

6-‐20

Price Elasticity of Supply

•  Measures sellers’ responsiveness to price changes

•  Elas%c supply, producers are responsive to price changes

•  Inelas%c supply, producers are not as responsive to price changes

LO4

6-‐21


•  Formula for price elas%city of supply

LO4

percentage change in quan%ty supplied of Product X

percentage change in price of product X

Es =

6-‐22


•  Es > 1 supply is elas%c •  Es = 1 supply is unit elas%c •  Es < 1 supply is inelas%c •  Addi%onally,

•  Es = 0 supply is perfectly inelas%c

LO4

6-‐23


•  Time is primary determinant of elas%city of supply

•  Time periods considered •  Immediate market period •  Short run •  Long run

LO4

6-‐24

Es: The Immediate Market Period

•  Perfectly inelas%c supply P

Q D1

D2

Sm

Q0

Pm

P0

LO4

6-‐25

The Short Run

•  Short run supply is more elas%c than in the immediate market period

P

Q D1

D2

Ss

Q0

Ps

P0

Qs LO4

6-‐26

The Long Run

•  Long run supply is even more elas%c than in the short run

LO4

P

Q D1

D2

SL

Q0

Pl

P0

Ql

6-‐27

Applications of Elasticity of Supply

•  An%ques •  Inelas%c supply

•  Reproduc%ons • More elas%c supply

•  Vola%le gold prices •  Inelas%c supply

LO4

6-‐28

Cross Elasticity of Demand

•  Formula for cross elas%city of demand

Ex,y =

percentage change in quan%ty demanded of product X

percentage change in price of product Y

LO5

6-‐29


•  Measures responsiveness of purchases of one good to change in the price of another good

•  Subs%tute goods if elas%city is posi%ve •  Complement goods if elas%city is nega%ve •  Independent goods if elas%city is 0

LO5

6-‐30


•  Applica%ons of cross elas%city of demand •  Should a company change a price? •  Should the government allow a merger?

LO5

6-‐31

Income Elasticity of Demand

•  Formula for income elas%city of demand

LO5

Ei = percentage change in quan%ty demanded

percentage change in income

6-‐32

Income Elasticity of Demand

•  Measures responsiveness of buyers to changes in their income

•  Normal goods if elas%city is posi%ve •  Inferior goods if elas%city is nega%ve

LO5

6-‐33

Income Elasticity Insights

•  High income elas%ci%es • Most affected by a recession

•  Low or nega%ve income elas%city •  Not affected that much by a recession

LO5

6-‐34

Cross and Income Elasticities

Cross and Income Elas%ci%es of Demand

Value of Coefficient Descrip%on Type of Good(s)

Cross elas%city: Posi%ve (Ewz > 0) Nega%ve (Exy < 0)

Quan%ty demanded of W changes in same direc%on as change in price of Z Quan%ty demanded of X changes in opposite direc%on from change in price of Y

Subs%tutes Complements

Income elas%city: Posi%ve (Ei >0) Nega%ve (Ei<0)

Quan%ty demanded of the product changes in same direc%on as change in income Quan%ty demanded of the product changes in opposite direc%on from change in income

Normal or superior Inferior

LO5

6-‐35

Elasticity and Pricing Power

•  Charge different prices to different buyers based on price elas%ci%es

•  Business air travelers •  Children discounts •  College tui%on

Documents

Chapter 6 - PBworksmorolda.pbworks.com/w/file/fetch/88770218/Chap006.pdf · 634 * Cross and Income Elasticities CrossandIncomeElasciesofDemand ’ ValueofCoeﬃcient’ Descripon’