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Price Elasticity of Demand Price Elasticity of Demand

Price Elasticity of Demand - PowerPoint Presentation

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Price Elasticity of Demand - PPT Presentation

Elasticity of Demand describes the percentage change in quantity demanded that follows a price change Elasticity of Demand Demand is Elastic Demand is Inelastic Change in Price Large Change in ID: 579362

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Slide1

Price Elasticity of Demand

Elasticity of Demand describes the percentage change in quantity demanded that follows a price change.Slide2

Elasticity of Demand

Demand is Elastic

Demand is

Inelastic

Change in Price

Large Change in

Qd

Change in Price

Small/No Change in

QdSlide3

Example: Dentist Visits

If the price increases, how much change will there be in the Quantity Demanded? Elastic or Inelastic?Slide4

Example: Sailboats

Elastic or Inelastic?Slide5

Key Factor - Preferences

Decides whether something is a necessity or a luxury.************************************************Make a list of goods and services and divide them up into the two categories of Elastic and Inelastic demand.…Can you come up with any more broader categories…such as Necessities (

vs

) Luxuries?Slide6

Determinants of Elasticity

Necessities (vs) LuxuriesNecessities tend to have inelastic demand and luxuries tend to have elastic demand

Substitution possibilities

Price elasticity of demand will be relatively high if it is easy to substitute between

products

Budget ShareItems that take up a larger share of the budget tend to have higher price elasticities of demandTimeBecause substitution often takes time, price elasticity will usually be higher in the long run than in the short runDurability of GoodsComputers, cars, washers, and dryers will be in greater demand if the price drops.DrugsLegal (heart medicine antibiotics) or illegal (heroin, cocaine)Slide7

Calculating Elasticity of Demand

Price elasticity of demand is defined as:the percentage change in the quantity of a good demanded resulting from a one-percent change in its price= % change in quantity demanded / % change in price= (ΔQ/Q)/(ΔP/P)

Price Elasticity = (P/Q)*(1/slope)Slide8

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

8 Copyright © 2005 McGraw-Hill Ryerson LimitedEquation for a Straight Line Demand Curve

P is for the price of the good

Q is for the quantity demanded

b is the vertical intercept

m represents the slopeSlide9

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

9 Copyright © 2005 McGraw-Hill Ryerson LimitedFIGURE 4.6 The Market Demand Curve for Canned TunaSlide10

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

10 Copyright © 2005 McGraw-Hill Ryerson LimitedFIGURE 4.12 Graphical Interpretation of Price Elasticity of Demand

Price elasticity of demand at any point along a straight-line demand curve is the ratio of price to quantity at that point times the reciprocal of the slope of the demand curve.Slide11

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

11 Copyright © 2005 McGraw-Hill Ryerson LimitedFIGURE 4.11 Elastic and Inelastic Demand

Three Cases!Slide12

Examples.

1) Find slope given price, quantity and y-intercept.Then calculate price elasticity of demand.Determine unit elastic, elastic, inelastic?2) Using a graph, be able to do the same thing.Slide13

Special Cases.

Perfectly Elastic demandPrice elasticity of demand is infinite(ΔQ/Q)/(ΔP/P) = ∞

Slightest change in price leads consumers to find substitutes.

Horizontal demand curve

Ex: - Foreign currency market

Perfectly Inelastic demand

Price elasticity of demand is zero

(ΔQ/Q)/(Δ

P/P) = 0Consumers do not switch to substitutes even when price increases dramatically

Vertical demand curveEx: - Diabetic (insulin) - Addict (heroin)Slide14

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

14 Copyright © 2005 McGraw-Hill Ryerson LimitedFIGURE 4.14Perfectly Elastic, Perfectly Inelastic, and Unit Elastic Demand Curves

Demand Curves The horizontal demand curve in panel (a) is perfectly elastic, or infinitely elastic, at every point. Even the slightest increase in price leads consumers to desert the product in favour of substitutes. The vertical demand curve in panel (b) is perfectly inelastic at every point. Consumers do not, or cannot, switch to substitutes even in the face of large increases in price. The demand curve in panel (c) represents a case of unit elastic demand. Regardless of the price selected, total expenditure is unchanged. In this example, total expenditure is $28 no matter what price is selected.Slide15

Elasticity of Supply

Can be elastic or inelastic depending on the product and circumstances.“responsiveness of producers to price changes in their products”Key FactorsTimeInelastic – short run, elastic – long run

Perishability

Goods stored easily – More elastic

Ex: Raspberries (Perish very quickly)…no matter what the price, suppliers will not want to carry large amounts.Slide16

Practice!!!

1) Determining whether things will have an inelastic or elastic demand.2) Calculating price elasticity of demand....assignment!Slide17

Expenditure & Revenue

Total Expenditure = Total Revenue (Consumers) (Producers)Total Expenditure = (Number of Units bought) (Price) = TRSlide18

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

18 Copyright © 2005 McGraw-Hill Ryerson LimitedFIGURE 4.10 Total Expenditure as a Function of Price

For a good whose demand curve is a straight line

, total expenditure reaches a maximum at the price corresponding to the midpoint of the demand curve.Slide19

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

19 Copyright © 2005 McGraw-Hill Ryerson LimitedFIGURE 4.7The Demand Curve for Movie Tickets

An increase in price from $2 to $4 per ticket increases total expenditure on tickets.

0

1

2

3

4

5

6

2

4

6

8

10

12

D

Quantity (100s of tickets/day)

Price ($/ticket)

An increase in price from $2 to $4 per ticket increases total expenditure on

ticketsSlide20

Law of Demand & Total Expenditures

Many firms would like to know: “Will consumers spend more on my product (will I get more revenue, in total) if I sell more units at a lower price or fewer units at a higher price?”

Answer depends on the price elasticity of demand

When

price rises, total expenditure may

IncreaseDecreaseOr stay the sameSlide21

Price Elasticity and Expenditures

For a product whose demand is “price elastic”Quantity demanded is highly responsive to price changesPercentage change in quantity dominates

An increase in price will reduce total expenditure

A decrease in price will increase total expenditure

For a product whose demand is

“price inelastic”Quantity demanded is not responsive to price changesPercentage change in price dominatesAn increase in price will increase total expenditureA decrease in price will decrease total expenditureSlide22

Example

Tickets at a Blue Jays game. P X Q = TR

Old Price

$ 40 X 33,781 = $1,354,840

New Price $ 50 X 25,000 = $ 1,250,000Demand is Elastic. Price results in TR …The price resulted in a big change of attendance at the game. (Obviously, there could be other factors as well…different teams in town)Slide23

Principles of Microeconomics, 2nd Canadian Edition Slide 1-

23 Copyright © 2005 McGraw-Hill Ryerson LimitedFIGURE 4.10

Total Expenditure as a Function of Price

For a good whose demand curve is a straight line

, total expenditure reaches a maximum at the price corresponding to the midpoint of the demand curve.

Elastic side

Inelastic sideSlide24

Elasticity of Demand – Important for businesses to consider…

What happens if a florist increases the price of roses 400 % in October ? Will sales go up or down ?A. Probably, down What happens if a florist increases the price of roses on February 14

th

? Will sales go down or up?

A. Probably up

- Why? Frantic husbands and boyfriends will pay exorbitant prices for a dozen roses on Valentine’s Day – if they know what’s good for them ! ! Slide25

Practice!!!

1) Calculating Total Revenue/Total Expenditures using a graph.2) Given a change in price, calculate the change in TR/TE, then determine whether the price elasticity of demand is Elastic, Inelastic, or Unit Elastic.