Mr Barnett University High AP Economics 20122013 Elasticity We already know that if the price of a good rises consumers will buy less But how much less Economists measure the change through ID: 273051
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Slide1
Elasticity
Mr. Barnett
University High
AP Economics
2012-2013Slide2
Elasticity
We already know that if the price of a good rises, consumers will buy less
But….
how much
less?
Economists measure the change through
elasticity
Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants
Basically, a measure of
how much
buyers and sellers respond to change in market conditions Slide3
Price Elasticity
Remember the Law of demand….
A fall in the price of a good will raise the quantity demanded
Price Elasticity – measures
how much
the quantity demanded responds to a change in price
Demand is:
Elastic – if quantity demanded responds substantially to a change in price
Inelastic – if quantity demanded responds only slightly to a change in price Slide4
Influences on Price Elasticity of Demand
Availability of close substitutes
Goods with close substitutes tend to have more elastic demand because it is easier for consumer to switch from that good to another
Example
Butter goes up $0.15 in price
Price of margarine stays the same
Result: large drop in quantity of butter soldSlide5
Influences on Price Elasticity of Demand
Necessities versus luxuries
Necessities have _________ demands
Luxuries have ___________demands
Example:
When the price of a dentist visit increases, people will not drastically reduce the # of visits
When the price of video games rise, the quantity demanded of video games falls substantially
Note: Whether a good is a necessity or a luxury depends on personal preference Slide6
Influences on Price Elasticity of Demand
Definition of the market
Elasticity of demand in a market depends on its definition (how we qualify it)
Narrowly defined markets tend to have more elastic demand than broadly defined markets
Because easier to find substitutes if more narrowly defined
Food -> inelastic
Ice Cream -> elastic
Vanilla Ice Cream -> very elastic Slide7
Influences on Price Elasticity of Demand
Time Horizon
Goods have more elastic demand in the long term
Example
When the price of gasoline increases, the quantity of gasoline only falls slightly in the short term
Long term, people will set up carpools, buy more fuel efficient cars, electric cars, ride buses, move closer to workSlide8
Influences on Price Elasticity of Demand
Inexpensive
vs
expensive
Expensive items tend to have elastic demand curve
Inexpensive items tend to have inelastic demand curve
A screw doubles in price from $0.05 to $0.10
A civic doubles in price from $20,000 to $40,000Slide9
Total Revenue = Price x Quantity
TR = P x Q
Pric
e (P)
Quantity
(Q)
TR
Pric
e (P)
Quantity
(Q)
TR
Price INC, Total
Revenue INC
Price INC, Total Revenue DEC
Price
DEC, Total Revenue DEC
Price DEC, Total
Revenue INCSlide10
Elasticity Coefficient Test
The Elasticity Coefficient equals the percentage change in quantity demanded divided by the percentage change in price
Butter goes from $1.00 to $1.20
Causes 40% drop in amount bought
40 percent/20 percent = 2.0
Elasticity coefficient = 2
Note: Use absolute values so all
elasticities
are positive numbers
A larger price elasticity implies a
greater responsiveness
of quantity demanded to change in price Slide11
Computing the elasticity coefficient of demand
Make sure to use positive numbers
Make sure to start with original numbersSlide12
Figure out the elasticity of demand of both graphs above using the TR test
Figure out the elasticity of demand of both graphs above by figuring out the of elasticity coefficient
Inelastic
Elastic
Elasticity Coefficient Test
Ed <
1
Ed >
1Slide13
Influences on Price Elasticity of Demand
So 5 tests of Elasticity
Tests
Inelastic
Elastic
Substitutes
Few Substitutes
Many Substitutes
Necessity v Luxury
Necessity
Luxury
Cost
Inexpensive
Expensive
Total
Revenue
P
Inc, TR Inc
P Dec, TR Dec
P Inc, TR DecP Dec, TR IncElasticity Coefficient TestEd < 1Ed > 1Slide14
Classification of Elasticity
When the price elasticity of demand is
greater
than one, demand is defined to be
elastic
Percentage change in quantity demanded will be greater than the percentage change in price
When the price elasticity of demand is
less
than one, demand is defined to be
inelastic
Percentage change in price will be greater than the percentage change in quantity demanded
When the price elasticity of demand is
equal
to one , the demand is said to have
unit elasticity
Percentage change in price will be equal to the percentage change in quantity demanded Slide15
Elasticity of Demand Curves
Most demand curves that have a downward slope have an elastic, inelastic and unit elastic portion Slide16
Drawbacks to Coefficient Test
There are some drawbacks to using the coefficient of price elasticity of demand test
As we have seen, the PED can vary at different points along a demand curve, due to its percentage nature
Also, percentage changes are not symmetric; rather, the percentage change between any two values depends on which one is chosen as the starting value and which one as the ending value
What if a company just wants to compare the results of two different possible pricings, instead of “starting” at one price and moving to another?
If quantity demanded increases from 10 to 15 units, the percentage change is 50%...... (15-10)/10
If quantity demanded decreases from 15 to 10 units, the percentage change is 33.3%....(10-15)/10Slide17
Midpoint Method
Thus, we can use the midpoint method to avoid those problems. Also known as Arc Elasticity
Involves calculating the percentage change in either P or
Qd
by dividing the change in the variable by the midpoint between the initial and final levels rather than by the initial value itself
Formula:
Note: Use averages for quantities and prices. Avoids having to deal with beg and ending values
Example:
Price of hamburgers rise from $4 to $6
Quantity demanded falls from 120 to 80
% change in quantity demanded = (120-80)/
100
= 40%
% change in price = (6-4)/
5
x 100% = 40%
Price elasticity of demand = 40/40 = 1 Slide18
Figure 1 The Price Elasticity of Demand
Copyright©2003 Southwestern/Thomson Learning
(a) Perfectly Inelastic Demand: Elasticity Equals 0
$5
4
Quantity
Demand
100
0
1. An
increase
in price . . .
2. . . . leaves the quantity demanded unchanged.
PriceSlide19
Figure 1 The Price Elasticity of Demand
(b) Inelastic Demand: Elasticity Is Less Than 1
Quantity
0
$5
90
Demand
1. A 22%
increase
in price . . .
Price
2. . . . leads to an 11% decrease in quantity demanded.
4
100Slide20
Figure 1 The Price Elasticity of Demand
Copyright©2003 Southwestern/Thomson Learning
2. . . . leads to a 22% decrease in quantity demanded.
(c) Unit Elastic Demand: Elasticity Equals 1
Quantity
4
100
0
Price
$5
80
1. A 22%
increase
in price . . .
DemandSlide21
Figure 1 The Price Elasticity of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Demand
Quantity
4
100
0
Price
$5
50
1. A 22%
increase
in price . . .
2. . . . leads to a 67% decrease in quantity demanded.Slide22
Figure 1 The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Quantity
0
Price
$4
Demand
2. At exactly $4,
consumers will
buy any quantity.
1. At any price
above $4, quantity
demanded is zero.
3. At a price below $4,
quantity demanded is infinite.Slide23
Total Revenue = Amount paid by buyers and received by sellers of a good
= price of the good times the quantity soldSlide24
Review
Even though slope is constant, elasticity is not
Slope is the ratio of changes in the 2 variables
Elasticity is the ratio of percentage changes in the two variables
At points with a high price and low quantity, the demand curve is ____
At points with a
low price
and
high quantity
,
the demand curve is ____Slide25
Elasticity
When the price is $1, demand is inelastic
An increase in price to $2 will increase total revenue
When the price is $5, demand is elastic,
A price increase to $6 will reduce total revenue
At $3.50, demand is unit elastic, and consumers will buy any quantitySlide26
Figure 3 How Total Revenue Changes When Price Changes: Inelastic Demand
Demand
Quantity
0
Price
Revenue = $100
Quantity
0
Price
Revenue = $240
Demand
$1
100
$3
80
An Increase in price from $1
to $3 …
… leads to an Increase in total revenue from $100 to $240Slide27
Figure 4 How Total Revenue Changes When Price Changes: Elastic Demand
Demand
Quantity
0
Price
Revenue = $200
$4
50
Demand
Quantity
0
Price
Revenue = $100
$5
20
An Increase in price from $4
to $5 …
… leads to an decrease in total revenue from $200 to $100Slide28
Midpoint MethodSlide29
Midpoint example
Example: If the price of
Hello Kitty pencil toppers increases
from $2.00 to $2.20 and the amount you buy falls from 10 to 8
toppers,
then your elasticity of demand, using the midpoint formula,
would
be calculated
as…Slide30
Income Elasticity
Income elasticity of
demand
measures
how much the quantity demanded of a good responds to a change in consumers’ incomeSlide31
Income Elasticity
Normal goods have ______income
elasticities
Inferior goods have ______income
elasticities
Higher
income
raises the quantity demanded for normal goods but lowers the quantity demanded for inferior
goods
Necessities tend to have _____income
elasticities
, whereas luxuries tend to have ______income
elasticities
Slide32
Important Side Note
We use the absolute value when figuring out price
elasticity of
demand because
the value is always negative
(because
when price changes in one direction, quantity demanded
always
changes in the
other).
But
this isn't true for income. When income changes, people might want to buy more
or less of the good.Slide33Slide34
Income Elasticity
After irrevocably destroying symbols borrowed from the American West, PSY’s income rises from $100,000 to 1,000,000. The quantity of hamburger he buys each week rises from two pounds to four pounds.
What is PSY’s income elasticity?
What kind of good is hamburger for PSY?Slide35
Cross-Price Elasticity
Cross-Price Elasticity of demand: A measure of how much the quantity demanded of one good responds to a change in the price of another good
Cross-Price Elasticity = % change in quantity demanded of good 1
___________________________________
% change in price of good 2
Substitutes have ______ cross price
elasticities
, whereas complements have ________cross-price
elasticities
Slide36
The
sign
matters
for cross-price elasticity.
When the price of one good changes, people might want to buy more of the other good, or less.Slide37
Cross Price Elasticities
The price of Kris-
Kross
cassette tapes rise from $8 to $10. As a result, the quantity of Kris-
Kross
trading cards demanded falls from 8,000 per week to 9,500.
What is the cross-price elasticity?
What is the relationship between the two goods?Slide38
Elasticity of Supply
Price elasticity of supply
is a measure of how much the quantity supplied of a good responds to a change in the price of that good
.
Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in priceSlide39
Figure 6 The Price Elasticity of Supply
Copyright©2003 Southwestern/Thomson Learning
(a) Perfectly Inelastic Supply: Elasticity Equals 0
$5
4
Supply
Quantity
100
0
1. An
increase
in price . . .
2. . . . leaves the quantity supplied unchanged.
PriceSlide40
Figure 6 The Price Elasticity of Supply
Copyright©2003 Southwestern/Thomson Learning
(b) Inelastic Supply: Elasticity Is Less Than 1
110
$5
100
4
Quantity
0
1. A 22%
increase
in price . . .
Price
2. . . . leads to a 10% increase in quantity supplied.
SupplySlide41
Figure 6 The Price Elasticity of Supply
Copyright©2003 Southwestern/Thomson Learning
(c) Unit Elastic Supply: Elasticity Equals 1
125
$5
100
4
Quantity
0
Price
2. . . . leads to a 22% increase in quantity supplied.
1. A 22%
increase
in price . . .
SupplySlide42
Figure 6 The Price Elasticity of Supply
Copyright©2003 Southwestern/Thomson Learning
(d) Elastic Supply: Elasticity Is Greater Than 1
Quantity
0
Price
1. A 22%
increase
in price . . .
2. . . . leads to a 67% increase in quantity supplied.
4
100
$5
200
SupplySlide43
Figure 6 The Price Elasticity of Supply
Copyright©2003 Southwestern/Thomson Learning
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Quantity
0
Price
$4
Supply
3. At a price below $4,
quantity supplied is zero.
2. At exactly $4,
producers will
supply any quantity.
1. At any price
above $4, quantity
supplied is infinite.Slide44
Determinants of Price Elasticity of Supply
Flexibility of Sellers
Goods that are somewhat fixed in supply have inelastic supplies
Goods that are not (books, cars,
tamagotchi
pets) have elastic suppliesSlide45Slide46
Determinants of Price Elasticity of Supply
Time Period
Supply is usually more inelastic in the short run
Supply is usually more elastic in the long runSlide47
The price of chocolate milk increases from $2.85 per gallon to $3.15 per gallon and the quantity supplied rises from 9,000 to 11,000 gallons per month
Price elasticity of supply is ?Slide48
APPLICATION of ELASTICITY
Can good news for farming be bad news for farmers?
What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?Slide49
THE APPLICATION OF SUPPLY, DEMAND, AND ELASTICITY
Examine whether the supply or demand curve shifts.
Determine the direction of the shift of the curve.
Use the supply-and-demand diagram to see how the market equilibrium changes.Slide50
Figure 8 An Increase in Supply in the Market for Wheat
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Wheat
0
Price of
Wheat
3. . . . and a proportionately smaller
increase in quantity sold. As a result,
revenue falls from $300 to $220.
Demand
S
1
S
2
2. . . . leads
to a large fall
in price . . .
1. When demand is inelastic,
an increase in supply
. . .
2
110
$3
100Slide51
Compute the Price Elasticity of Supply
Supply is inelasticSlide52
Supply
Supply _____, price _____, quantity demanded ______
If demand is
ineastic
, the fall in price is greater than the increase in quantity demanded and total revenue ______
Demand for basic foodstuffs is usually inelastic
Less revenue for farmers
Because farmers are price takers they still have incentive to adopt new hybrid so they can produce and sell more wheat
Explains why number of farms has declined so much over the past 200 years
Also explains why some
gov
policies encourage farmers to decrease the
amuont
of crops planted Slide53
In the 1970s and 1980s, OPEC reduced the amount of oil it was willing to supply to world markets. The decrease in supply led to an increase in the price of oil and a decrease in quantity demanded. The increase in price was much larger in the short run than the long run. Why?