Chapter 5 price elasticity
- 1. CChhaapptteerr 55 ELASTICITY OF DEMAND AND SUPPLY
- 2. Price Elasticity of Demand Price elasticity of demand allows us to measure the relative size of changes in the price and the quantity demanded The price elasticity of demand formula is used to measure the degree of consumer responsiveness, or sensitivity to a change in price. The idea is to take a closer look at how sensitive quantity is to the changes.
- 3. Price Elasticity of Demand Question: “Is the response a little or a lot?” What does it measure? The price elasticity of demand measures HOW RESPONSIVE CONSUMERS ARE TO A CHANGE IN PRICE!!!!
- 4. The elasticity formula percentage change in quantity demanded percentage change in price Ed =
- 5. Price Elasticity of Demand LO1 E = % D q % p ¸ D p p p D D E = D q q q + + ( ') / 2 ( ') / 2 D Law of demand ED negative Absolute value of ED positive
- 6. The elasticity formula So, what does the percentage change in quantity demanded and the percentage change in price mean?? percentage change in Q = newQ -old Q d d d old Q d new P old P old P percentage change in P - =
- 7. LO1 Demand Curve for Tacos D $1.10 0.90 0 95 105 Thousands per day Price per taco b a If the price of tacos drops from $1.10 to $0.90, the quantity demanded increases from 95,000 to 105,000. Exhibit 1
- 8. Categories of ED LO1 If %Δq < %Δp – ED between 0 and 1 – Inelastic D If %Δq > %Δp – ED greater than 1 – Elastic D If %Δq = %Δp – ED = 1 – Unit elastic D
- 9. Elasticity and Total Revenue LO1 Total revenue = price * quantity demanded at this price TR= p * q As p decreases If D elastic, TR increases If D inelastic, TR decreases If D unit elastic, TR unchanged
- 10. Price Elasticity and the Linear D Curve LO1 Linear D curve – Constant slope – Different elasticity – D becomes less elastic as we move downward D upper half: elastic D lower half: inelastic D midpoint: unit elastic
- 11. LO1 Demand, Price Elasticity, and Total Revenue Where D is elastic, a lower P increases TR Where D is inelastic, a lower P decreases TR TR reaches a maximum at the rate of output where D is unit elastic Exhibit 2 (a) Demand and price elasticity Elastic, ED >1 Unit elastic, ED =1 Inelastic, ED c <1 D $100 90 80 Price per unit 70 60 50 40 30 20 10 b a d e 0 100 200 500 800 900 1,000 Quantity per period 25,000 Total revenue (b) Total revenue Total revenue 0 500 1,000 Quantity per period
- 12. Constant-Elasticity Demand Curves LO1 Perfectly elastic D curve – Horizontal; ED = ∞ – Consumers don’t tolerate P increases Perfectly inelastic D curve – Vertical; ED = 0 – ‘Price is no object’ Unit-elastic D curve – %Δp causes an exact opposite %Δq
- 13. LO1 Constant-Elasticity Demand Curves (a) Perfectly elastic Price per unit 0 Quantity per period p ED = ∞ D (b) Perfectly inelastic Price per unit ED’’ = 0 (c) Unit elastic ED ’’ = 1 D’ 0 Quantity per period Q Price per unit $10 6 b 0 Quantity per period 60 100 D’’ a Consumers demand all quantity offered for sale at p, but demand nothing at a price above p Consumers demand Q regardless of price Total revenue is the same for each p-q combination Exhibit 3
- 14. LO1 Exhibit 4 Summary of Price Elasticity of Demand Effects of a 10 Percent Increase in Price
- 15. Determinants of Price Elasticity of D ED is greater: – The greater the availability of substitutes, and the more similar the substitutes – The more important the good as a share of the consumer’s budget – The longer the period of adjustment (time) LO2
- 16. LO2 Demand Becomes More Elastic over Time Dw: one week after the price increase Dm: one month after the price increase Dy: one year after the price increase Dw Price per unit $1.25 1.00 Dm Dy Exhibit 5 e 0 50 75 95 100 Quantity per day Dy is more elastic than Dm , which is more elastic than Dw
- 17. Elasticity Estimates Short run – Consumers have little time to adjust Long run – Consumers can fully adjust to a price change Demand is more elastic in the long run LO2
- 18. LO2 Selected Price Elasticities of Demand (Absolute Values) Exhibit 6
- 19. Price Elasticity of Supply Elasticity – Responsiveness Price elasticity of supply – Producers’ responsiveness to a change in price – Percentage change in quantity supplied divided by percentage change in price LO3
- 20. Price Elasticity of Supply E = % D q % p S D E = D q q q Law of supply ES positive LO3 p ¸ D p p ( ') / 2 ( ') / 2 S + +
- 21. LO3 Exhibit 7 Price Elasticity of Supply S Price per unit p’ p If the price increases from p to p’, the quantity supplied increases from q to q’. Price and quantity supplied move in the same direction, so the price elasticity of supply is a positive number. 0 q q’ Quantity per period
- 22. Categories of ES LO3 If %Δq < %Δp – ES between 0 and 1 – Inelastic S If %Δq > %Δp – ES greater than 1 – Elastic S If %Δq = %Δp – ES = 1 – Unit elastic S
- 23. Constant-Elasticity Supply Curves Perfectly elastic S curve LO3 – Horizontal; ES = ∞ – Producers supply 0 at a price below P Perfectly inelastic S curve – Vertical; ES = 0 – Goods in fixed supply Unit-elastic S curve – %Δp causes an exact opposite %Δq – S curve is a ray from the origin
- 24. LO3 Constant-Elasticity Supply Curves (a) Perfectly elastic 0 Quantity per period Price per unit p ES = ∞ S (b) Perfectly inelastic Price per unit ES’ = 0 (c) Unit elastic ES’’ = 1 S’ 0 Quantity per period Q Price per unit $10 5 0 Quantity per period 10 20 S’’ Firms supply any amount of output demanded at p, but supply 0 at prices below p. Quantity supplied is independent of the price Any %Δp results in the same %Δq supplied. Exhibit 8
- 25. Determinants of Supply Elasticity ES is greater: LO3 – If the marginal cost rises slowly as output expands – The longer the period of adjustment (time)
- 26. LO3 Exhibit 9 Supply Becomes More Elastic over Time Sw Price per unit $1.25 1.00 Sm Sy Sw: one week after the price increase Sm: one month after the price increase Sy: one year after the price increase 0 100 110 140 200 Quantity per day Sw is less elastic than Sm, which is less elastic than Sy
- 27. Income Elasticity of Demand Demand responsiveness to a change in consumer income Percentage change in demand divided by the percentage change in income that caused it Inferior goods LO4 – Negative income elasticity Normal goods – Positive income elasticity
- 28. Other Elasticity Measures Income Elasticity Measure: Def: Income elasticity of demand is the ratio of the percentage change in quantity demanded of a good or service to a given percentage change in income. E Q Q I + I I 2 1 1 2 = - 2 1 1 2 I I Q Q ¸ - +
- 29. Income Elasticity of Demand Normal goods LO4 – Income inelastic • Elasticity between 0 and 1 • Necessities – Income elastic • Elasticity > 1 • Luxuries
- 30. LO4 Exhibit 10 Selected Income Elasticities of Demand
- 31. Cross-Price Elasticity of Demand Responsiveness of D for one good to changes in P of another good %Δ in demand for one good divided by %Δ in price of another good LO4 – If positive: substitutes – If negative: complements – If zero: unrelated
- 32. Cross-Price Elasticity of Demand Def: The ratio of the percentage change in the quantity demanded of a good or service to a given percentage change in the price of another good or service - y y 2 1 E = Q - Q c P P 1 2 x x 2 1 1 2 y y x x P P Q Q + ¸ +