Chapter 4 Elasticity

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Chapter 4Elasticity
Additional Questions 1-9 End-of Chapter Ex. 4, 8
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Elasticity

• It represents the ratio of the change in one
  variable to the change in another variable
• 1) Price Elasticity of Demand
• - measures the responsiveness of quantity
  demanded for good x to a change in price of good
  x
• change in Qx
• change in Px
• 2) Price Elasticity of Supply
• - measures the responsiveness of quantity
  supplied for good x to a change in price of good
  x
• change in Qx
• change in Px

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Elasticity

• Elastic
• -the change in quantity demanded is larger
  than the change in price
• - If elasticity is between -1 and infinity
• Inelastic
• -the change in quantity demanded is less than
  the change in price
• -If elasticity is between 0 and -1

Unit elastic
Elastic
Inelastic
-1
-2
-3
-0.5
0
-4
-5
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Elasticity

• Unit Elastic,
• - Elasticity -1
• - the change in quantity demanded equals to
  the change in price

P
Unit Elastic
Q
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Elasticity

• Perfectly Inelastic Demand/Supply
• Ex. Tamiflu, Insulin

• Perfectly Elastic Demand/Supply
• Ex. Pepsi, coke

P
P
Elasticity 0
Elasticity infinitely
Q
Q
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Elasticity and TE / TR

• If demand is elastic, ( change in quantity
  demanded is larger than the change in price)
• Decrease in price will increase TR
• Increase in price will decrease TR

If Price decrease change in Q 3 change in
P -0.5 Elasticity -6 (Elastic) TR increases
P
10
5
D
Q
20
5
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Elasticity and TE / TR

• If demand is inelastic, ( change in quantity
  demanded is less than the change in price)
• Decrease in price will decrease TR
• Increase in price will increase TR

P
If Price decrease change in Q 0.4 change
in P -0.5 Elasticity -0.8 (Inelastic) TR
decreases
10
5
D
5
7
Q
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Elasticity and TE / TR

• If Demand is Elastic, ( change in quantity
  demanded is larger than the change in price), Q
  and PQ move in the same direction, similarly to
  increase in price
• If Demand in Inelastic, ( change in quantity
  demanded is less than the change in price), P
  and PQ move in the same direction, similarly to
  increase in price

P
X
Q

PQ
P
X
Q

PQ
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Elasticity

• 3) Cross-Price Elasticity of Demand
• - measure the responsiveness of quantity
  demanded for good y to a change in price of good
  x
• change in Qy
• change in Px
• Substitute goods Elasticity is positive
  (Increase in price of good x will result in an
  increase in demand of good y)
• Complement goods Elasticity is negative
  (Increase in price of good x will result in a
  decrease in demand of good y)

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Elasticity

• 4) Income Elasticity of Demand
• - measure the responsiveness of quantity
  demanded for good x to a change in income
• change in Qx
• change in I
• Normal goods Elasticity is positive (Increase in
  income will result in an increase in demand of
  good x) i.e., Mercedes Benz
• Inferior goods Elasticity is negative (Increase
  in income will result in a decrease in demand of
  good x) i.e., 2nd hand clothing

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When the price of hot dog is 1.50 each, 500 hot
dogs are sold every day. After lowering the
price to 1.35 each, 510 hot dogs are sold every
day. At the original price, what is the price
elasticity of demand for hot dogs?
Chapter 4, Additional Question 1

• 66.67
• 5
• 1
• 0.2
• 0.015

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Calculating Price Elasticity of Demand
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Price Elasticity of Demand for Hot Dogs
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For which of the following products is demand
likely to be least price elastic?
Chapter 4, Additional Question 2

• Frozen Food
• Soft Drinks
• Groceries
• Diet Coke
• Not enough information provided to answer this
  question

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What affects Price Elasticity of Demand?

• One major factor is the availability of
  substitutes.
• If there are many substitutes for Good X
  available in the market, people tend to be very
  responsive to changes in PX, and hence, higher
  elasticity.
• In this question, we check out which option is
  the most difficult to be substituted, i.e.,
  necessity good.

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• (A) Frozen food can easily be replaced by fresh
  food.
• (B) Soft drinks and (D) Diet coke can easily find
  substitutes, e.g. orange juice, coffee, tea, Zero
  coke, Diet Pepsi
• (C) Groceries are the hardest to be replaced as
  they are necessities.

Ans C
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Chapter 4, Additional Question 3

• If the price is 2 in both locations, the Price
  Elasticity of Demand for a candy bar at an
  airport is likely to be the price
  elasticity for a candy bar in a grocery store.
• A) Less than
• B) Equal to
• C) Greater than
• D) The reciprocal of
• E) Not enough information to determine

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What affects Price Elasticity of Demand?

• Number of sellers within reach.
• Suppose there exists only one kind of candy bar.
• In busy areas where you can find grocery stores,
  it is more likely that you can find more than one
  shop selling candy bars.
• However, in isolated areas such as airports,
  there may only be one seller.

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• In other words, one will find it difficult to
  locate an alternative seller of a certain goods
  (e.g. candy bars) at the airport.
• A person will still have to buy candy bars from
  that seller at the airport even if prices are
  raised.
• Hence, quantity demanded is less responsive to
  price changes compared to shops at other
  locations.
• Ans a

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Chapter 4, Additional Question 4

• The Price Elasticity of Demand for apartments is
  1.3, while the Price Elasticity of Demand for
  toothpicks is 0.4. The likely reason for the
  difference is because
• There are few substitutes for toothpicks
• Apartments are chosen over a long period of time
• The fraction of income spent on toothpicks is
  minuscule
• Toothpicks are a necessity
• Apartments are a luxury

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• Demand for apartments are more price elastic than
  that for toothpicks. Why?
• (A D) are not true because there exist good
  substitutes for toothpicks, e.g. dental floss and
  fingernails.
• (B) is true for many consumers, but is
  irrelevant, as we are comparing the Price
  Elasticity at the same point of time.
• (E) is relevant only if we are talking about
  Income Elasticity.

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What affects Price Elasticity of Demand?

• Budget share the smaller the budget share of
  your income, the smaller the incentive to look
  for other substitute goods thus, smaller the
  price elasticity of demand.
• People tend not to respond to changes in price of
  toothpicks because they are too cheap. 0.20 a
  dozen and 0.40 a dozen do not bother consumers
  as they probably do not even notice the
  difference.
• - the share of your budget is very small in
  buying toothpick.
• However, buying an apartment is a major choice in
  life. People spend most of their savings on
  acquiring their own homes, and changes in price
  of properties are certainly noticeable. As a
  result, consumers are more responsive to changes
  in prices of apartments.
• - the share of your budget is very large in
  buying a house.
• Ans C

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Chapter 4, Additional Question 5

• Assume the price of gasoline doubles tonight and
  remains at that price the next 2 years. The
  Demand for gasoline measured tomorrow will be
  _____ when compared with the demand for gasoline
  measured 2 years from now.
• More Elastic
• Larger in Absolute Value
• The Same
• More Inelastic
• Less Inelastic

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What affects Price Elasticity of Demand?

• Time
• It takes time for people to react to changes in
  price.
• People wake up tomorrow and find out price of
  gasoline is doubled, but they do not have enough
  time to find substitutes for gasoline, and hence,
  the amount of usage will be more or less the
  same.
• But, given more time, people can explore other
  alternatives (e.g. public transport)
• Ans D

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Chapter 4, Additional Question 6

• The Cross Price Elasticity for cable TV and
  satellite TV is estimated to be -0.3. This
  implies cable and satellite TV are
• Normal Goods
• Substitutes
• Elastic Goods
• Complements
• Unrelated

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• Cross Price Elasticity measures the
  responsiveness of quantity demanded for a good to
  a change in price of the other good .
• For complement goods, if Px? , Qx?, and Qy also ?
• - The Cross Price Elasticity is negative
• For substitute goods, if Px? , Qx?, and Qy will ?
• - The Cross Price Elasticity if positive
• Ans d

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Chapter 4, Additional Question 7

• In surveying their alumni, State Us economics
  department discovered that ramen noodle
  consumption declined as soon as students
  graduated and found jobs. One conclusion the
  survey team might draw from this result is that
• There is Excess Demand for ramen noodles.
• Equilibrium Price for ramen noodles is too high.
• College graduates have a high reservation price
  for ramen noodles.
• Ramen noodles are an inferior good.
• Ramen noodles are not nutritious.

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• (AB) are not the correct answers No price
  adjustments were mentioned.
• (C) is not relevant at all because we are not
  calculating consumer surplus.
• (E) is not even economics.

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• The question talks about Income Elasticity of
  Demand for ramen noodles.
• - measures the responsiveness of quantity
  demanded for a good to the change in income.
• - For normal goods, if Income ?, Qd ?
• - For inferior goods, if Income ?, Qd ?
• Graduates graduating and finding a job implies an
  increase in real income.
• The survey relates real income and quantity
  demanded for noodles.
• Income ?, causing Qd ? --- inferior good
• Ans D

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Chapter 4, Additional Question 8
a) Given the above information. Calculate the
Income Elasticity of y. Is Good y normal or
inferior?

• Recall that Income Elasticity refers to the
  responsiveness of quantity demanded for y to a
  change in Income.

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• Mathematically, Income Elasticity of y can be
  calculated as ?Qy / ?I.
• To calculate the Income Elasticity of y,
• ?Qy / ?I
• (?Qy / original Qy) x (original I / ?I)
• (-4 / 40) x (8000 / 1000) -0.8

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• a) Is Good y normal or inferior?
• Normal goods Demand for normal goods increases
  when income increases.
• - Mathematically, the Income Elasticity of a
  normal good is positive. (Quantity changes in
  the same direction as income)
• Inferior goods Demand for inferior goods drops
  as Income increases.
• - Mathematically, the Income Elasticity of an
  inferior good is negative. (Quantity changes in
  an opposite direction as Income)
• Since the Income Elasticity of y is negative, Qy
  drops as Income increases.
• Therefore, Good y is inferior.

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• Given the above information. Calculate the Cross
  Price Elasticity of y with respect to a change in
  Px. Are Good x and y complements or substitutes?
• Cross Price Elasticity measures the
  responsiveness of the quantity demanded for y
  with respect to a change in Px.

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• Mathematically, ?Qy / ?Px.
• Hence, the Cross Price Elasticity of Demand for y
  is
• ?Qy / ?Px
• (?Qy / original Qv) x (original Px / ? Px)
• (-6 / 36) x (24 / -3) 4/3

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• b) Are Goods x and y complements or
  substitutes?
• For complement goods, if Px? , Qx?, and Qy also ?
• - The Cross Price Elasticity is negative
• For substitute goods, if Px? , Qx?, and Qy will ?
• - The Cross Price Elasticity if positive
• In this case, the Cross Price Elasticity of y
  with respect to a change in price of x is
  positive.
• Therefore, Goods x and y are substitutes.

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Chapter 4, Additional Question 9

• If the Price Elasticity of demand for good X is
  -3, your goal is to maximize the revenue, should
  you raise or lower the price of good X?
• Recall that whether total revenue increases or
  decreases when the price of the good changes
  depends on the elasticity of demand.

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• If demand is elastic, ( change in quantity
  demanded is larger than the change in price)
• Increase in price will decrease TR
• Decrease in price will increase TR
• You should decrease the price of good X in order
  to maximize Total Revenue.

P
X
Q

PQ
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Chapter 4, Problem 4

• Is the demand for a particular brand of car,
  like a Chevrolet, likely to be more or less
  price-elastic than the demand for all cars?
  Explain.
• Price elasticity of a good increases, as more
  close substitutes are readily available.

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Solution to Problem 4(1)

• Demand for all cars (i.e. Motorcycle, bus, van)
  hard to find other substitutes for cars if price
  of all cars rises, for ex., it is hard to
  substitute motorcycle for a car. Highly
  insensitive to price change.
• Demand for specific brand of cars if price of
  Chevrolet rises, people will switch to other
  brand, say, Toyota. Highly sensitive to price
  change.
• Thus, it is easier to substitute Toyota for
  Chevrolet than it is to substitute a motorcycle
  for a car.
• Therefore, the market demand curve for cars is
  likely to be less elastic than the market demand
  curve for Chevrolets.

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Chapter 4, Problem 8

• Suppose that the ingredients required to bring a
  slice of pizza to market and their respective
  costs are as listed in the table
• If these proportions remain the same no matter
  how many slices are made, and the inputs can be
  purchased in any quantities at the stated prices,
  draw the supply curve of pizza slices and compute
  its price elasticity.

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Solution to Problem 8(1)

• The proportions and prices of the ingredients
  are the same no matter how many slices are made,
  meaning that,
• The price of input cost is fixed at 120 cents
  or 1.2.
• Therefore, the marginal cost of producing an
  additional unit of pizza is constant at 1.2.

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Solution to Problem 8(2)
1.2

• The price elasticity of supply of pizza is
  infinite ---- Perfectly Elastic Supply Curve.
• Highly sensitive to price change - A small change
  in price, quantity supplied drops to zero
• Usually occurs when there is a larger number of
  perfectly substitute goods
• i.e., If the price of an input increases, sellers
  will switch to another available substitute goods
  

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End of Chapter 4