state that quantity supplied and demanded will change in response to changes in price Elasticity determines by how much quantity will change in response to a given change in price More generally ID: 548480
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Slide1
The Laws of Supply and Demand state that quantity supplied and demanded will change in response to changes in priceElasticity determines by how much quantity will change in response to a given change in priceMore generally:Elasticity = the measure of the responsiveness of a variable to changes in price or any of the variable’s determinants
What is Elasticity?Slide2
Elasticity = the measure of the responsiveness of a variable to changes in price or any of the variables determinantsWhat is Elasticity?We will study four kinds:Price elasticity of demand: responsiveness of the quantity of a good demanded to changes in
its price
Cross-price elasticity of demand
: responsiveness of the demand for a good to changes in
price of another good
Income elasticity of demand
:
responsiveness of the demand for a good to changes in
income
Price elasticity of supply
: responsiveness of the quantity of a good supplied to changes in its priceSlide3
The Law of Demand states that there is a negative relationship between quantity demanded of a good and its priceAs a good’s price rises, quantity demanded fallsPrice Elasticity of Demand (PED) is a measure of how much quantity demanded will change in response to a given change in price, along a given demand curve
PED =
What is Price Elasticity of Demand?
% change in the quantity demanded of Good X
% change in price of Good X
What will the sign of PED be (positive or negative)?Slide4
The Law of Demand states that there is a negative relationship between quantity demanded of a good and its priceAs a good’s price rises, quantity demanded fallsPrice Elasticity of Demand (PED) is a measure of how much quantity demanded will change in response to a given change in price, along a given demand curve
PED =
What is Price Elasticity of Demand?
% change in the quantity demanded of Good X
% change in price of Good X
Since
price and demand are inversely related, the sign of PED should be negative. However, common practice is to drop the minus sign. (
I
.e., Use the absolute value.)Slide5
Customers buy 500 snowboards when the price is $500 and 400 when the price is $550. What is the PED of snowboards?Price Elasticity of Demand – Example #1Slide6
Price Elasticity of Demand – Example #1PED = % change in the quantity demanded of Good X% change in price of Good X
PED =
%
Δ
Q
X
%
Δ P
X
=
(500-400) / 500
(500-550) / 500
= 0.20 / -0.10 = -2.0
PED =
Customers buy 500 snowboards when the price is $500 and 400 when the price is $550. What is the PED of snowboards?
2.0 Slide7
Price Elasticity of Demand – Example #1PED = % Δ QX% Δ P
X
=
(500-400) / 500
(500-550) / 500
= 0.20 / -0.10 = -2.0
Customers buy 500 snowboards when the price is $500 and 400 when the price is $550. What is the PED of snowboards?
2.0
When price increases by 10%, sales drop by 20%. Customers are very sensitive to the price of snowboards.
The price elasticity of demand for snowboards is high.Slide8
Price Elasticity of Demand – Example #1PED = % Δ QX% Δ P
X
=
(500-400) / 500
(500-550) / 500
= 0.20 / -0.10 = -2.0
Customers buy 500 snowboards when the price is $500 and 400 when the price is $550. What is the PED of snowboards?
2.0
I
f a store raises the price of snowboards from $500 to $550, its revenue is likely to drop from:
$500 * 500 = $250,000
to
$550 * 400 = $220,000Slide9
Price Elasticity of Demand – Example #2Customers buy 500 bottles of milk when the price is $4.00 and 475 when the price is $5.00. What is the PED of milk?Slide10
Price Elasticity of Demand – Example #2PED = % change in the quantity demanded of Good X% change in price of Good X
PED =
%
Δ
Q
X
%
Δ P
X
=
(500-475) / 500
(
4
.00-5.00) / 4.00
= 0.05 / -0.25 = -0.2
PED =
Customers buy 500 bottles of milk when the price is $4.00 and 475 when the price is $
5
.00. What is the PED of milk?
0.2 Slide11
Price Elasticity of Demand – Example #2PED = % Δ QX% Δ P
X
=
(500-475) / 500
(4.00-5.00) / 4.00
= 0.05 / -0.25 = -0.2
0.2
When price increases by 25%, sales drop by 5%. Customers are not sensitive to the price of milk.
The price elasticity of demand for milk is low.
Customers buy 500 bottles of milk when the price is $4.00 and 475 when the price is $
5
.00. What is the PED of milk?Slide12
Price Elasticity of Demand – Example #2If a store raises the price of milk from $4.00 to $5.00, its revenue is likely to rise from:$4.00 * 500 = $2,000to$5.00 * 475 = $2,375
PED =
%
Δ
Q
X
%
Δ
PX
=
(500-475) / 500
(4.00-5.00) / 4.00
= 0.05 / -0.25 = -0.2
0.2
Customers buy 500 bottles of milk when the price is $4.00 and 475 when the price is $
5
.00. What is the PED of milk?Slide13
Price Elasticity of Demand – Two Common Cases[ ]Inelastic DemandElastic Demand0 < PED < 1
1 < PED <
∞
% ΔQ < %ΔP
Consumers
are relatively
insensitive
to price changes
Demand curve is relatively
steep
% ΔQ > %ΔP
Consumers are relatively
sensitive
to
price changes
Demand curve is relatively flatSlide14
Price Elasticity of Demand – Two Common Cases[ ]Inelastic DemandElastic Demand0 < PED < 1
1 < PED <
∞
% ΔQ < %ΔP
Consumers
are relatively
insensitive
to price changes
Demand curve is relatively
steep
% ΔQ > %ΔP
Consumers are relatively
sensitive
to
price changes
Demand curve is relatively flat
These are five different ways to say the same thing.Slide15
Price Elasticity of Demand – Three Special Cases[ ]Perfectly Inelastic DemandUnit Elastic DemandPerfectly
Elastic Demand
PED = 0
PED = 1
PED =
∞
Quantity
demanded is
completely unresponsive
to price
Percentage change
in quantity demanded equals the percentage change in price
Quantity
demanded is
infinitely sensitive
to price
I.e., Any increase in price will result in zero demandSlide16
Price Elasticity of Demand - Diagraming
The more elastic the demand for a product, the flatter the slope of the demand curve …Slide17
PED– Changes Along the Same Curve The more elastic the demand for a product, the flatter the slope of the demand curve …However, PED will vary along a straight line demand curveSlide18
PED– Changes Along the Same Curve Note: the PED and the slope of a given demand curve are not equivalent: Slope =
Δ
Q
Δ
P
PED =
%
Δ
Q
%
Δ
PSlide19
The following factors influence the PED of goods:Number and closeness of substitutes: If there are close substitutes for a good, people can easily switch in response to a price increase Price Elasticity of Demand – Determinants Slide20
The following factors influence the PED of goods:Number and closeness of substitutes: If there are close substitutes for a good, people can easily switch in response to a price increase Note that this factor depends on how narrowly or broadly the product is defined. For example: PEDAPPLES > PEDFRUIT > PED
FOOD
Price Elasticity of Demand
– Determinants
Closest substitutes
:
Pears, oranges, bananas
Closest substitutes
:
Chips, vegetables
Closest substitute
:
IV nutrient dripSlide21
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuries: Since we can do without luxuries sooner than necessities, demand for luxury goods tends to be more price elastic PEDICE CREAM
>
PED
MILK
PED
COSMETIC DRUGS > PEDASTHMA
DRUGS
Price Elasticity of Demand
– Determinants Slide22
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuries Length of time: If a consumer must buy immediately, his demand is likely to be less elastic
PED
TUITION FEES
(LT)
> PED
TUITION
FEES (ST)
Price Elasticity of Demand
– Determinants
No real choice other than staying home from school
Can find an alternative schoolSlide23
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuries Length of timeProportion of income spent on a good
The greater the proportion of income a consumer must spend on a good, the more elastic its demand
PED
FUR
COAT > PEDSOCKS
PEDCAVIAR > PED
CARROTS
Price Elasticity of Demand
– Determinants Slide24
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuries Length of timeProportion of income spent on a good
Addictiveness
If people are addicted to a product (e.g., cigarettes), they will tend to buy that product regardless of price
Price Elasticity of Demand
– Determinants Slide25
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuriesLength of timeProportion of income spent on a goodAddictiveness
Price Elasticity of Demand
– Determinants
For example:
Primary commodities
(e.g., agricultural, fishing, mining) usually have less elastic demand curves than
manufactured goods
.
Why?Slide26
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuriesLength of timeProportion of income spent on a goodAddictiveness
Price Elasticity of Demand
– Determinants
For example:
Primary commodities
(e.g., agricultural, fishing, mining) usually have less elastic demand curves than
manufactured goods
.
Can be either necessities or luxuries
More likely to have substitutes
Often necessities (e.g., food, oil, copper)
Often have few or no substitutesSlide27
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuriesLength of timeProportion of income spent on a goodAddictiveness
Price Elasticity of Demand
– Determinants
Another example:
The daughter of rich parents is severely allergic to bee stings and gets stung. She needs epinephrine (which combats allergic reactions) or she will lapse into a coma in five minutes. There is only one store that carries the drug anywhere nearby.
Slide28
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuriesLength of timeProportion of income spent on a goodAddictiveness
Price Elasticity of Demand
– Determinants
Another example:
The daughter of rich parents is severely allergic to bee stings and gets stung. She needs epinephrine (which combats allergic reactions) or she will lapse into a coma in five minutes. There is only one store that carries the drug anywhere nearby.
PED
epinephrine
= very inelastic (close to zero)
A poor orphan has received ten dollars from a kind stranger. He lives on a block with two candy stores and and ice cream parlor.
Slide29
The following factors influence the PED of goods:Number and closeness of substitutes Necessities versus luxuriesLength of timeProportion of income spent on a goodAddictiveness
Price Elasticity of Demand
– Determinants
Another example:
The daughter of rich parents is severely allergic to bee stings and gets stung. She needs epinephrine (which combats allergic reactions) or she will lapse into a coma in five minutes. There is only one store that carries the drug anywhere nearby.
PED
epinephrine
= very inelastic (close to zero)
A poor orphan has received ten dollars from a kind stranger. He lives on a block with two candy stores and and ice cream parlor.
PED
SNICKERS
BARS
=
very elastic (well above one)Slide30
Price Elasticity of DemandEstimated PED’s: Eggs – 0.1 Milk – 0.2
Housing
– 1.2
Beef – 0.4
Restaurant Meals – 2.3
Stationary – 0.5 Air travel – 2.4
Petrol – 0.5 Foreign travel – 4.1
The following factors influence the PED of goods:
Number and closeness of substitutes
Necessities versus luxuries
Length of time
Proportion of income spent on a good
AddictivenessSlide31
A product’s PED determines whether or not a price increase will lead to greater or lesser total revenueApplications of PED – Firm Decision-Making Total revenue = price x quantityFor a given price increase:Inelastic demand (PED < 1) will lead to higher revenue because: %
Δ
Q
<
%
Δ
P Elastic demand (PED > 1) will
lead to lower revenue because: % Δ Q > % Δ P
The opposite is true for a price decrease:Lowering price could lead to greater revenue if demand is elastic (since the price change would lead to more units sold)Slide32
Joe’s Good Food sells fast food. Joe needs to raise his prices in response to higher costs of ingredients and wages. However, he is concerned about losing customers. After experimenting with various pricing strategies for a short period, Joe observed the following: When the price of pizza is $16, 100 pizzas are sold, but when the price is $12, 120 are sold. When the price of a hamburger is $6, 200 are sold, but when the price is $5, 250 are sold. What should Joe do?Applications of PED – Firm Decision-Making (Example #3)Slide33
When the price of pizza is $16, 100 pizzas are sold, but when the price is $12, 120 are sold. When the price of a hamburger is $6, 200 are sold, but when the price is $5, 250 are sold. PEDP = % Δ QP
%
Δ
P
P
=
(100-120) / 100
(16-12) / 16
=
-
0.20 / 0.25 = -0.80
0.80
PED
H
=
%
Δ
Q
H
%
Δ
P
H
=
(200-250) / 200
(
6
-5) /
6
= -0.25 / 0.167 = -1.50
1.50
The demand for pizza has a
lower
price elasticity than the demand for hamburgers. Therefore, Joe is likely to be better off raising the price of pizza rather than price of hamburgers.
Applications of PED – Firm Decision-Making
(Example #3)Slide34
Why are the prices of primary commodities usually more volatile than the prices of manufactured goods?Applications of PED – Commodity Price VolatilitySlide35
Since primary commodities are are generally less price elastic than manufactured goods, we can expect their prices to be more volatile (small changes in quantity demanded lead to large price changes)Applications of PED – Commodity Price VolatilityPrimary Commodities(Inelastic Demand)Manufactured
Goods
(Elastic Demand)Slide36
If a government wants to maximize its tax revenue, should it tax cigarettes or televisions? Applications of PED – TaxationSlide37
Governments tend to tax goods with inelastic demands because the increased price (original price + tax) will have a lesser effect on quantity demanded (thus maximizing the tax revenue)Applications of PED – TaxationInelastic Demand (e.g., cigarettes, petrol)Elastic Demand
(e.g., consumer electronics)
Tax Revenue = (P
T
– P
1
) x Q
TSlide38
Inelastic DemandElastic Demand0 < PED < 11 < PED < ∞
PED Problems – Page 58, Question 1 Slide39
[ ]Perfectly Inelastic DemandUnit Elastic DemandPerfectly Elastic DemandPED = 0
PED = 1
PED =
∞
Quantity
demanded is
completely unresponsive
to price
Percentage change
in quantity demanded equals the percentage change in price
Quantity
demanded is
infinitely sensitive
to price
I.e., Any increase in price will result in zero demand
PED Problems – Page 58, Question 1 Slide40
PED Problems – Page 58, Question 2 If a product’s demand is price elastic (PED >1), then raising the price by 10% will lead to a >10% reduction in units sold. Therefore, revenue will fall.If a product’s demand is price inelastic (PED <1), then raising price by 10% will lead to a <10% reduction in units sold. Therefore, revenue will rise.The opposite is true of price cuts.PED
P
=
%
Δ
Q
P
% Δ
PP
=
(100-120) / 100
(16-12) / 16
=
-
0.20 / 0.25 = -0.80
0.80
PED
H
=
%
Δ
Q
H
%
Δ
P
H
=
(200-250) / 200
(
6
-5) /
6
= -0.25 / 0.167 = -1.50
1.50 Slide41
PED Problems – Page 58, Question 3 Supply and Demand For Wine Grapes Slide42
Since primary commodities are are generally less price elastic than manufactured goods, because they often have fewer substitutes and are more often necessitiesPED Problems – Page 58, Question 4 Primary Commodities(Inelastic Demand)
Manufactured
Goods
(Elastic Demand)