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Elasticity Elasticity

Elasticity - PowerPoint Presentation

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Elasticity - PPT Presentation

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

elasticity price demand quantity price elasticity quantity demand supply demanded change elastic increase revenue good 100 inelastic percentage figure

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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.Slide33
Slide34

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 suppliesSlide45
Slide46

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?