5 5 demand and elasticity a high cross elasticity of demand [between two goods indicates that they]...

5

Demand and ElasticityA high cross elasticity of demand [between two goods

indicates that they] compete in the same market. [This can prevent a supplier of one of the products]

from possessing monopoly power over price.U.S. SUPREME COURT, DUPONT CELLOPHANE DECISION, 1956

● Elasticity: The Measure of Responsiveness

● Price Elasticity of Demand: Its Effect on Total Revenue and Total Expenditure

● What Determines Demand Elasticity?

● Elasticity as a General Concept

● Changes in Demand: Movements Along the Demand Curve vs Shifts in the Demand Curve

● Elasticity: The Measure of Responsiveness

● Price Elasticity of Demand: Its Effect on Total Revenue and Total Expenditure

● What Determines Demand Elasticity?

● Elasticity as a General Concept

● Changes in Demand: Movements Along the Demand Curve vs Shifts in the Demand Curve

ContentsContents

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

● The Time Period of the Demand Curve and Economic Decision Making

● Real-World Application: Polaroid versus Kodak

● Appendix: How to Find a Legitimate Demand Curve from the Statistics

● The Time Period of the Demand Curve and Economic Decision Making

● Real-World Application: Polaroid versus Kodak

● Appendix: How to Find a Legitimate Demand Curve from the Statistics

Contents (continued)Contents (continued)



● Elasticity = measure of the responsiveness of one variable to changes in another variable

● Price elasticity of demand =

● Elasticity = measure of the responsiveness of one variable to changes in another variable

● Price elasticity of demand =% quantity

% price

Elasticity: The Measure of ResponsivenessElasticity: The Measure of Responsiveness

FIGURE 5-1(a) The Hypothetical Demand Curves for Film

FIGURE 5-1(a) The Hypothetical Demand Curves for Film

4 3 0

10

$20

Quantity Demanded

Pri

ce p

er P

ack

age

DS

DS

B

A


FIGURE 5-1(b) The Hypothetical Demand Curves for Film

FIGURE 5-1(b) The Hypothetical Demand Curves for Film

4 1.5 0

10

$20

Pri

ce p

er P

ack

age

Quantity Demanded

D f

Df b

a




● Elastic demand = price elasticity of demand > 1

● Inelastic demand = price elasticity of demand < 1

● Elastic demand = price elasticity of demand > 1

● Inelastic demand = price elasticity of demand < 1



● Equation for Price Elasticity of Demand♦ % Quantity % Price

♦ [(Q1 - Q0) / (average of Q1 and Q0)] [(P1 - P0) / (average of P1 and P0)]

● Equation for Price Elasticity of Demand♦ % Quantity % Price

♦ [(Q1 - Q0) / (average of Q1 and Q0)] [(P1 - P0) / (average of P1 and P0)]


● Percentages calculated in terms of the averages of the prices and quantities

● Minus sign dropped

● Percentages calculated in terms of the averages of the prices and quantities

● Minus sign dropped


FIGURE 5-2a Sensitivity of Slope to Units of Measurement

FIGURE 5-2a Sensitivity of Slope to Units of Measurement

2,000 1,500 1,000

D

D

500 0

10 9 8

17 16 15 14 13 12 11

7 6 5 4 3 2 1

$18

(a)

Pizzas per Week

Pri

ce

pe

r P

izza

3,000 2,500 360

280

B

A


FIGURE 5-2b Sensitivity of Slope to Units of Measurement

FIGURE 5-2b Sensitivity of Slope to Units of Measurement

2,000 1,500 1,000

D

D

500 0

10 9 8

17 16 15 14 13 12 11

7 6 5 4 3 2 1

$18

(b)

Slices of Pizza per Week

Pri

ce

pe

r P

izza

2,500 3,000 2,880 2,240

A

B


● The Relationship between Elasticity and Slope♦ Slope depends upon specific units while

elasticity does not.

♦ If a demand curve has a constant slope (straight-line), the elasticity is not constant.

♦ If a demand curve has a constant elasticity (unit elastic), the slope is not constant.

● The Relationship between Elasticity and Slope♦ Slope depends upon specific units while

elasticity does not.

♦ If a demand curve has a constant slope (straight-line), the elasticity is not constant.

♦ If a demand curve has a constant elasticity (unit elastic), the slope is not constant.

Price Elasticity of Demand and the Shapes of Demand CurvesPrice Elasticity of Demand and the Shapes of Demand Curves

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

TABLE 5-1 Estimates of Price Elasticities

TABLE 5-1 Estimates of Price Elasticities


FIGURE 5-3 Demand Curves with Different Elasticities

FIGURE 5-3 Demand Curves with Different Elasticities

Pri

ce

C B

A

C'

A'

B'

$6

4 3

7 5 4 2

1

Straight- line

demand curve

(c)

Quantity Demanded

0

D

D

$0.75 D D

“Perfectly elastic” demand curve

(b)

Quantity Demanded

Pri

ce

0

“Perfectly inelastic” demand curve

(a)

Quantity Demanded

Pri

ce

D

D

90 0


FIGURE 5-3(d) Unit Elastic Demand Curve

FIGURE 5-3(d) Unit Elastic Demand Curve

Unit- elastic

demand curve

U' 14 7

D

D

$30

10

20

Quantity Demanded

Pri

ce

0

(d)

S

T

U



Price Elasticity of DemandPrice Elasticity of Demand

price revenues if the demand curve is elastic

price revenues if the demand curve is inelastic

price 0 revenues if the demand curve is unit elastic

price revenues if the demand curve is elastic

price revenues if the demand curve is inelastic

price 0 revenues if the demand curve is unit elastic

FIGURE 5-4 An Elastic Demand Curve

FIGURE 5-4 An Elastic Demand Curve

5

12

Quantity Demanded

Pri

ce

$6

1

2

3

4

4 0

U

W

D

D

R

T

S

V



What Determines Demand Elasticity?What Determines Demand Elasticity?

● Nature of the good

● Availability of close substitutes

● Fraction of income absorbed

● Passage of time

● Nature of the good

● Availability of close substitutes

● Fraction of income absorbed

● Passage of time


Elasticity as a General ConceptElasticity as a General Concept

● Elasticity can be used to measure the responsiveness of anything to anything else.

● Income Elasticity♦ Income elasticity of demand = % quantity

demanded % income

● Price Elasticity of Supply♦ Price elasticity of supply = % quantity of

supply % price

● Elasticity can be used to measure the responsiveness of anything to anything else.

● Income Elasticity♦ Income elasticity of demand = % quantity

demanded % income

● Price Elasticity of Supply♦ Price elasticity of supply = % quantity of

supply % price


Elasticity as a General ConceptElasticity as a General Concept

● Cross Elasticity of Demand♦ Cross elasticity of demand (for product X to a

change in the price of product Y) = % quantity demanded of X % price of Y

♦ If two goods are substitutes (complements), their cross elasticity of demand is positive (negative).

● Cross Elasticity of Demand♦ Cross elasticity of demand (for product X to a

change in the price of product Y) = % quantity demanded of X % price of Y

♦ If two goods are substitutes (complements), their cross elasticity of demand is positive (negative).


Changes in Demand: Movements Along vs ShiftsChanges in Demand: Movements Along vs Shifts

price movement along the demand curve

any other factor that affects spending decisions shift between demand curves

price movement along the demand curve

any other factor that affects spending decisions shift between demand curves


Changes in Demand: Movements Along vs ShiftsChanges in Demand: Movements Along vs Shifts

● Demand Shifters♦ Consumer incomes rise

♦ Tastes change in favor of the good

♦ The price of substitute goods

♦ The price of complementary goods

● Demand Shifters♦ Consumer incomes rise

♦ Tastes change in favor of the good

♦ The price of substitute goods

♦ The price of complementary goods

FIGURE 5-5 Shifts in a Demand Curve

FIGURE 5-5 Shifts in a Demand Curve

D0

D0

(b) Quantity of Sweaters

Pri

ce

D1

D1

S

D0

D0

(a) Quantity of Sweaters in Thousands

Pri

ce

$35

28

60 40

R

U T

D2

D2



The Demand Curve and Economic Decision MakingThe Demand Curve and Economic Decision Making

● The demand curve shows the quantity of demand buyers would hypothetically purchase at different prices during the same time period.

● It does not show the quantity actually bought at different prices at different times.

● The demand curve shows the quantity of demand buyers would hypothetically purchase at different prices during the same time period.

● It does not show the quantity actually bought at different prices at different times.

Expected Demand at Various Six-Month Prices

Expected Demand at Various Six-Month Prices



Real-World Application: Polaroid versus KodakReal-World Application: Polaroid versus Kodak

● In 1989, Polaroid vs Kodak—copyright infringement

● Key issue: how much profit Polaroid lost?● Price elasticity of demand

♦ growth in instant camera sales due to ■Kodak competition (lower price) OR■Kodak’s reputation (Polaroid might have benefited

from Kodak increasing potential number of customers)

● In 1989, Polaroid vs Kodak—copyright infringement

● Key issue: how much profit Polaroid lost?● Price elasticity of demand

♦ growth in instant camera sales due to ■Kodak competition (lower price) OR■Kodak’s reputation (Polaroid might have benefited

from Kodak increasing potential number of customers)



● Cross elasticity of demand♦ After 1980, decline in sales due to

■decreasing cost of 35-mm photography ● then Kodak not to blame

■Kodak’s infringement● Kodak damages due increase

● Cross elasticity of demand♦ After 1980, decline in sales due to

■decreasing cost of 35-mm photography ● then Kodak not to blame

■Kodak’s infringement● Kodak damages due increase



● Third issue: How much could Polaroid’s total revenue increased if Kodak not infringe?♦ Polaroid claimed lots! $9 billion or more

♦ Kodak claimed neighborhood of $450 million (very close to judge’s verdict)

● Third issue: How much could Polaroid’s total revenue increased if Kodak not infringe?♦ Polaroid claimed lots! $9 billion or more

♦ Kodak claimed neighborhood of $450 million (very close to judge’s verdict)

Appendix:

How Can We Find a Legitimate Demand

Curve from the Statistics?


Finding a Legitimate Demand CurveFinding a Legitimate Demand Curve

● In the real world we usually only observe historical price-quantity combinations, so it is often difficult to distinguish between movement along a demand curve and shifts between demand curves.

● In the real world we usually only observe historical price-quantity combinations, so it is often difficult to distinguish between movement along a demand curve and shifts between demand curves.



● Prices and quantities observed at different times in the real world may result from shifting demand curves and not movement along a demand curve.

● Prices and quantities observed at different times in the real world may result from shifting demand curves and not movement along a demand curve.

TABLE 5-2 Historical Data on Price and Quantity

TABLE 5-2 Historical Data on Price and Quantity




● Simply connecting the points may not give a good estimate of a demand curve.

● Simply connecting the points may not give a good estimate of a demand curve.

FIGURE 5-6 Plot of Historical Data on Price and Quantity

FIGURE 5-6 Plot of Historical Data on Price and Quantity

Ave

rag

e P

rice

Quantity Demanded in Thousands

98 97 96 95 94 93 92 91 90 0

7.00

7.20

7.40

7.60

7.80

8.00

$8.20

T

T

S

April

Jan.

March

R

May

Feb.


FIGURE 5-7 Plot of Historical Data and True Demand Curves

FIGURE 5-7 Plot of Historical Data and True Demand Curves

T

T

98

M M

F

F

Av

era

ge

Pri

ce

Quantity Demanded in Thousands

97 96 95 94 93 92 91 90 0

7.00

7.20

7.40

7.60

7.80

8.00

$8.20

J

J

Jan.

March

Feb. R W

S


TABLE 5-3 Annual Rainfall in St. Louis, 1993-2001

TABLE 5-3 Annual Rainfall in St. Louis, 1993-2001


FIGURE 5-8 Legitimate Demand Curve Est. from Statistical Data

FIGURE 5-8 Legitimate Demand Curve Est. from Statistical Data

1998

1997 2001

1999

1995

1996 1993

2000

S00

S

S93

S

S96

S

1994 S95

S D

D

Pri

ce

Quantity of Umbrellas Sold


5 5 demand and elasticity a high cross elasticity of demand [between two goods indicates that they]...

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