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Elasticity
6
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Price Elasticity of Demand
• Measures buyers’ responsiveness to price changes
LO1
• Formula for price elasticity of demand
Ed =
Percentage Change in QuantityDemanded of Product X
Percentage Change in Priceof Product X
Price Elasticity of Demand
• Elastic demand, Ed > 1
• Sensitive to price changes
• Large change in quantity for small price change
• Inelastic demand, Ed < 1
• Insensitive to price changes
• Small change in quantity for large price change
• Unit elastic demand, Ed = 1–Equal changes in quantity and price
LO1
Price Elasticity of Demand
• Can not use slope to determine elasticity
• Can use slope to determine relative elasticity.
LO2
Total Revenue Test
• Total Revenue = Price X Quantity
• Inelastic demand• P and TR move in the same direction
• Elastic demand• P and TR move in opposite directions
• Unit elastic demand• TR doesn’t change when P changes
LO2
Total Revenue Test
LO2
Table 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test
(1)Total Quantity of
Tickets Demanded per Week, Thousands
(2)Price per Ticket
(3)Elasticity
Coefficient (Ed)
(4)Total
Revenue(1) X (2)
(5)Total
Revenue Test
1 $8 $8,000
2 7 5.00 14,000 Elastic
3 6 2.60 18,000 Elastic
4 5 1.57 20,000 Elastic
5 4 1.00 20,000 Unit Elastic
6 3 0.64 18,000 Inelastic
7 2 0.38 14,000 Inelastic
8 1 0.20 8,000 Inelastic
Summary of Price Elasticity of Demand
LO2
Table 6.2 Price Elasticity of Demand: A Summary
Absolute Value of Elasticity Coefficient Demand Is: Description
Impact on Total Revenue of a:
Price Increase Price Decrease
Greater than 1(Ed > 1)
Elastic or relatively elastic
Qd changes by a larger percentage than does price
Total Revenue decreases
Total Revenue increases
Equal to 1(Ed = 1)
Unit or unitary elastic
Qd changes by the same percentage as does price
Total revenue is unchanged
Total revenue is unchanged
Less than 1(Ed < 1)
Inelastic or relatively inelastic
Qd changes by a smaller percentage than does price
Total revenue increases
Total revenue decreases
Determinants of Elasticity of Demand
• Substitutability• More substitutes, demand is more elastic
• Proportion of Income• Higher proportion of income, demand is more
elastic
• Luxuries vs. Necessities• Luxury goods, demand is more elastic
• Time• More time available, demand is more elastic
LO1
Price Elasticity of Demand
LO1
Table 6.3 Selected Price Elasticities of Demand
Product or ServicePrice Elasticity of Demand (Ed) Product or Service
Price Elasticity of Demand (Ed)
Newspapers .10 Milk .63
Electricity (household) .13 Household appliances .63
Bread .15 Liquor .70
MLB Tickets .23 Movies .87
Telephone Service .26 Beer .90
Cigarettes .25 Shoes .91
Sugar .30 Motor vehicles 1.14
Medical Care .31 Beef 1.27
Eggs .32 China, glassware 1.54
Legal Services .37 Residential land 1.60
Automobile repair .40 Restaurant meals 2.27
Clothing .49 Lamb and mutton 2.65
Gasoline .60 Fresh peas 2.83
Applications of Ed
• Large Crop Yields• Inelastic demand, lower total revenue
• Excise Taxes• Inelastic demand, more total revenue
• Decriminalization of Illegal Drugs• Inelastic demand, more total revenue
• Decrease street crime
LO1
Price Elasticity of Supply
• Measures sellers’ responsiveness to price changes
• Elastic supply (Es > 1 ), producers are responsive to price changes
• Inelastic supply (Es < 1), producers are not responsive to price changes
LO3
Percentage Change in QuantitySupplied of Product X
Percentage Change in Priceof Product X
Es =
Price Elasticity of Supply
• Time is primary determinant of elasticity of supply
• Time periods considered
• Immediate Market period•Can’t adjust any resources
• Short Run•Able to adjust some resources
• Long Run•Able to adjust all resources
LO3
Applications of Elasticity of Supply
• Antiques
• Inelastic supply
• Reproductions
• More elastic supply
• Volatile gold prices
• Inelastic supply
LO3
Cross Elasticity of Demand
• Measures responsiveness of sales to change in the price of another good
• Substitutes – positive sign
• Complements – negative sign
• Independent goods - zero
LO4
Percentage change in quantity demanded of product X
Ex,y = Percentage change in price of product Y