Elasticity and Its Applications

1
Chapter 5

• Elasticity and Its Applications

2
Snack Time
3
Deriving Market Demand

• Price Moe Larry Curly Total
• 3 0 1 2 3
• 2 1 2 3 6
• 1 2 4 5 11

4
Market Demand
Price
3 2 1
1 2 3 4 5 6 7 8 9 10 11 12
Q
5
EC105 Demand For Milano Cookies

• Price/Cookie Quantity
• .50 008
• .45 013
• .40 022.5
• .35 036.5
• .30 055
• .25 081
• .20 101
• .15 129
• .10 174

6
EC106 Demand For Milano Cookies
Price
.50 .45 .40 .35 .30 .25 .20 .15
.10 .05 0
Demand Curve
Supply Curve
Quantity
10 20 30 40 50 60 70 80 90
7
Ch 5 Outline

• Price Elasticity of Demand
• Cross Price Elasticity
• Income Elasticity
• Elasticity of Supply

8
Freeze Frame What A Bounce!
9
wimpy bounce
10
PRICE
ELASTICITY
Start the Show!
OF
DEMAND
11
Operating Deficit for NYC Subway

• Train Schedules and All Costs Have Been Incurred
  for 1999 Operation --24.5 million
• When Price Lowered from 6 to 4 Still Deficit
• Your Job Reduce Defict

12
Operation Deficit TR 13
Demand For Subway
Price Per Day Pass
10
6
TR 24M
10
4
Millions of Riders Per Day
14
Operating Deficit

• TR - TC 24M - 24.5M
• TR - TC -0.5M
• ..Hence the Operating Deficit

15
Demand For Subway
Price Per Day Pass
10
6
4
6
10
4
Millions of Riders Per Day
16
Demand For Subway
Price Per Day Pass
10
6
4
TR24M
6
10
4
Millions of Riders Per Day
17
Demand For Subway
Price Per Day Pass
10
6
5
4
6
10
4
5
Millions of Riders Per Day
18
Demand For Subway
Price Per Day Pass
10
6
5
TR25M
4
6
10
4
5
Millions of Riders Per Day
19
Demand For Subway
Price Per Day Pass
10
6

5
4
6
10
4
5
Millions of Riders Per Day
20
Demand For Subway
Price Per Day Pass
10
6
t
5
4
6
10
4
5
Millions of Riders Per Day
21
Demand For Subway
Price Per Day Pass
10
6
t
24M
5
25M
4
24M
6
10
4
5
Millions of Riders Per Day
22
Demand For Subway
Price Per Day Pass
When Price Falls TR First Rises. Then Falls...
10
6
t
24M
5
25M
4
24M
6
10
4
5
Millions of Riders Per Day
23
Change From 10 to 12
12 - 10



X 100
10
2
X 100

10

20
24
Price Elasticity of Coefficient
Percentage Change in Quantity Demanded
Ed

Percentage Change in Price
25
Looking at Top of Ed Formula
Qd
Percent Change in Quantity Demanded
X 100

Qd
Looking at Bottom of Ed Formula
P
Percent Change in Price

X 100
P
26
Price Elasticity of Demand
Qd
X 100
Qd
Ed

P
X 100
P
27
Price Elasticity of Demand
Qd
X 100
Qd
Ed

P
X 100
P
28
Price Elasticity of Demand
Qd
Qd
Ed

P
P
29
P
10
8 6 3 1
2 4 7 9
10
Q
30
Price Elasticity of Demand
Qd
(4 - 2)
Qd
?
?
Ed


(6 - 8)
P
P
?
31
P
10
Which Is Base Point? Left point or Right Point?
8 6 3 1
2 4 7 9
10
Q
32
P
10
Use Midpoint (Called Arc or Midpoint Formula)_
8 6 3 1
7

2 3 4 7 9
10
Q
33
P
10
Use Midpoint (Called Arc or Midpoint Formula)_
8 6 3 1
7

2 3 4 7 9
10
Q
34
Price Elasticity of Demand
Qd
(4 - 2)
Qd
(42)/2
Ed


(6 - 8)
P
P
(68)/2
35
Price Elasticity of Demand Simplidied
Difference in Q
(4 - 2)
Average Q
(42)/2
Ed


(6 - 8)
Difference in P
Average P
(68)/2
36
Time for Calculator...
Qd
(4 - 2)
.667
Qd
3
Ed



(6 - 8)
-.286
P
P
7
37
Time for Calculator...
Qd
.667
Qd
Ed



-
2.333
-.286
P
P
finally, drop that MINUS
38
P
10
Use Midpoint (Called Arc or Midpoint Formula)_
8 6 3 1
7

2 3 4 7 9
10
Q
39
P
10
8 6 3 1
TR 16
2 4 7 9
10
Q
40
P
Ed 1, Demand Elastic
10
8 6 3 1
TR 16
TR 24
2 4 7 9
10
Q
41
Elasticity and Total Revenue
ED 1 then
P
Q
TR
and
42
P
10
8 6 3 1
2 4 7 9
10
Q
43
P
10
8 6 3 1
2
2 4 7 9
10
Q
8
44
Price Elasticity of Demand
Qd
(9-7)
Qd
(97)/2
Ed


(1-3)
P
P
(13)/2
45
Price Elasticity of Demand Simplidied
Difference in Q
(9-7)
Average Q
(97)/2
Ed


(1-3)
Difference in P
Average P
(13)/2
46
Price Elasticity of Demand
Qd
(9-7)
Qd
8
Ed


(1-3)
P
P
2
47
Time for Calculator...
Qd
(2)
.25
Qd
8

Ed


(-2)
-1
P
P
2
48
Time for Calculator...
Qd
.25
Qd
Ed



-
.250
-1
P
P
finally, drop that MINUS
49
P
10
8 6 3 1
2 4 7 9
10
Q
50
P
10
8 6 3 1
TR 21
2 4 7 9
10
Q
51
P
10
8 6 3 1
TR 21
TR 9
2 4 7 9
10
Q
52
Elasticity and Total Revenue
ED P
Q
TR
and
53
P
10
6 4
4 6
Q
54
Calculate Price Elasticity as Price Falls from
6 to 4 and Quantity Demanded Rises from 4
to 6
55
Your Turn!
ED
ED
56
P
10
6 4
4 6
Q
57
P
10
Ed1 Price , TR
6 4
5
4 6
Q
5
58
P
10
Ed 1 Price , TR
6 4
5
4 6
Q
5
59
P
10
6 4
Ed1 P TR
5
4 6
Q
5
60
Linear Demand Curves Have Three Elasticity Ranges

• Ed 1 (Demand Elastic),
• P falls, TR rises
• Ed 1 (Demand Unit Elastic),
• P falls, TR stays same
• Ed
• P falls, TR falls

61
P
Ed1 Demand Elastic
10

Q
62
P
Ed
10

Q
63
Demand For Subway
Price Per Day Pass
When Price Falls TR First Rises. Then Falls...
10
6
t
24M
5
25M
4
24M
6
10
4
5
Millions of Riders Per Day
64
Ranges of Elasticity . . . (Figure 5-1)

• Perfectly Inelastic Consumers are extremely
  unresponsive to price changes.
• Perfectly Elastic Consumers are extremely
  responsive to price changes.
• Unit Elastic Response is equal to change in
  price.

65
Elasticity of Demand Illustrated
Perfectly Inelastic
Perfectly Elastic
66
Price Elasticity of Demand
Qd
Qd
Ed

P
P
67
Demand Elastic for Good When

• Few Substitutes (e.g., necessities)
• Very Narrowly Defined
• Longer the Time Period
• Large Share of Budget

68
By What Does Qd change?

• Given Ed 2
• Given Price Rises 10
• Ed Change Qd / Change P
• 2 x / 10
• 2 x 10 x
• 20 x
• So Qd FALLS by 20

69
P
10
Ed of Curved Line at Point Same as Straight Line
6 4
4 6
Q
70
Thats It For Powerpoint Today, FOLKS!!!
71
Determinants of Price Elasticity of Demand

• Demand tends to be more elastic
• if the good is a luxury
• the longer the time period
• the greater the number of close substitutes and
• the more narrowly defined the market.

72
Determinants of Price Elasticity of Demand

• Demand tends to be more inelastic
• if the good is a necessity
• the shorter the adjustment time
• if there are few good substitutes and
• the more broadly defined the market.

73
Computing Elasticity Coefficient
Percentage Change in Quantity Demanded
Price Elasticity of Demand

Percentage Change in Price

• Computed as the percentage change in the quantity
  demanded divided by the percentage change in
  price.

74
Computing Elasticity Coefficient
Demand for Ice Cream
ED

(8 - 10) / 10
2.20
(2.20 - 2.00) / 2.00
2.00
10
8
75
Computing Elasticity Coefficient
Demand for Ice Cream
ED

(20)
2.20
(10)
2.00
10
8
76
Computing Elasticity Coefficient
Demand for Ice Cream
ED
2

2.20
2.00
10
8
77
Computing Elasticity Coefficient
Demand for Ice Cream
Demand is Elastic
ED
2

2.20
2.00
10
8
78
Elasticity and Total Revenue

• Over the Elastic Range of
• prices and quantity
• the relationship between price and total
  revenue is
• INDIRECT or OPPOSITE

79
Elasticity and Total Revenue

• Over the Inelastic Range of prices and quantity
• the relationship between price and total
  revenue is
• DIRECT or THE SAME

80
Elasticity and Total Revenue
ED P
Q
TR
and
81
Income Elasticity of Demand

• The percentage change in the quantity demanded
• given a one percent change in income.

82
Computing Income Elasticity
Percentage Change in Quantity Demanded
Income Elasticity of Demand

Percentage Change in Income

• Computed as the percentage change in the quantity
  demanded divided by the percentage change in
  Income.

83
Income Elasticity... Types

• YD 0 Normal Goods
• YD
• YD 0 Income-neutral Goods

84
Income Elasticity... Types

• Goods consumers regard as necessities tend to
  be income inelastic...
• Examples include food, fuel, clothing,
  utilities, medical services.

85
Income Elasticity... Types

• Goods consumers regard as luxuries tend to be
  income elastic...
• Examples include Sports cars, furs, and
  expensive foods.

86
Quick Quiz!

• Define the price elasticity of demand.
• Explain the relationship between total revenue
  and elasticity of demand

87
Price Elasticity of Supply
Price

• The percentage change in quantity supplied
• resulting from a one (1) percent change in
  price.

B
A
Quantity
88
Ranges of Elasticity

• Perfectly Elastic infinite
• Relatively Elastic 1
• Unitary or Unit 1
• Relatively Inelastic
• Perfectly Inelastic 0

89
Elasticity of Supply illustrated
Perfectly Inelastic
Perfectly Elastic
90
Determinants of Elasticity of Supply

• Flexibility or ability of sellers to change the
  amount of the good they produce.
• Beachfront land verses books, cars, manufactured
  goods, etc.
• More elastic in the long run.

91
Computing Elasticity Coefficient
Percentage Change in Quantity Supplied
Elasticity of Supply

Percentage Change in Price

• Computed as the percentage change in the quantity
  supplied divided by the percentage change in
  price.

92
Quick Quiz!

• Define the elasticity of supply.
• Explain why the price elasticity of supply might
  be different in the long run than in the short
  run.

93
Applications 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?

94
Apply Comparative Statics (Chapter 4)

• Examine whether the supply or demand curve
  shifts.
• Consider the direction the curve shifts.
• Use supply-and-demand diagram to see how the
  market equilibrium changes.

95
Examine whether the supply or demand curve shifts.
SA
Price
4.00
DA
Quantity
2000
96
Consider which direction the curve shifts.
SA
Price
SB
Technology causes an increase in supply.
4.00
DA
Quantity
2000
97
Use Supply-and-Demand diagram to see how the
market changes.
SA
Price
SB
4.00
2.60
DA
Quantity
2000
2400
98
Compute Elasticity
(2400 - 2000) / (2000)
ED
(2.60 - 4.00) / (4.00)
ED
0.57 (Inelastic)
99
Observe the Change in Total Revenue
SA
Price
SB
TRSA 8,000
4.00
2.60
TRSB 5,760!
DA
Quantity
2000
2400
100
Conclusion

• Elasticity is defined as. . .
• Price Elasticity of demand is. . .
• Income Elasticity of demand is. . .
• Price Elasticity of supply is. . .
• What are the relationships between elasticity and
  total revenue or total consumer expenses?