chapter_6

Chapter 6

Elas%city

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

6-‐2

Price Elasticity of Demand

•  Measures buyers’ responsiveness to price changes

•  Elas%c demand •  Sensi7ve to price changes •  Large change in quan7ty

•  Inelas%c demand •  Insensi7ve to price changes •  Small change in quan7ty

LO1

6-‐3

Ed =

Price Elasticity of Demand Formula

•  Formula for price elas%city of demand

percentage change in quan7ty demanded of product X

percentage change in price of product X

LO1

6-‐4


•  Use the midpoint formula •  Ensures consistent results

Ed = ÷ Change in quan7ty

Sum of quan77es/2

Change in price Sum of prices/2

LO1

6-‐5


•  Use percentages •  Unit free measure •  Compare elas7ci7es across products

•  Eliminate the minus sign •  Easier to compare elas7ci7es

LO1

6-‐6

Interpretation of Elasticity of Demand

•  Ed > 1 demand is elas7c •  Ed = 1 demand is unit elas%c •  Ed < 1 demand is inelas7c •  Extreme cases

•  Ed = 0 demand is perfectly inelas%c •  Ed = ∞ demand is perfectly elas%c

LO1

6-‐7

Extreme Cases

D1 P

Perfectly inelas7c demand

Perfectly inelas7c demand (Ed = 0)

0

LO1

6-‐8

Extreme Cases

Perfectly elas7c demand

P

D2

Perfectly elas7c demand (Ed = ∞)

0

LO1

6-‐9

Total Revenue Test

•  Total Revenue = Price X Quan7ty •  Total Revenue Test •  Inelas7c demand

•  P and TR move in the same direc7on •  Elas7c demand

•  P and TR move in opposite direc7ons

LO2

6-‐10

Total Revenue Test

•  Lower price and elas7c demand •  Blue gain exceeds orange loss

$3

2

1

0 10 20 30 40 Q

P

a

b D1

LO2

6-‐11

Total Revenue Test

•  Lower price and inelas7c demand •  Orange loss exceeds blue gain

$4

3

2

1

0 10 20 Q

P

c

d

D2

LO2

6-‐12

Total Revenue Test

•  Lower price and unit elas7c demand •  Blue gain equals orange loss

$3

2

1

0 10 20 30 Q

P

e

f

D3

LO2

6-‐13

Total Revenue Test

(1) Total Quan%ty of Tickets Demanded

per Week, Thousands (2)

Price per Ticket

(3) Elas%city

Coefficient (Ed)

(4) Total Revenue

(1) X (2)

(5) Total-‐Revenue

Test

1 2 3 4 5 6 7 8

$8 7 6 5 4 3 2 1

5.00 2.60 1.57 1.00 0.64 0.38 0.20

$ 8,000 14,000 18,000 20,000 20,000 18,000 14,000 8,000

Elas%c Elas%c Elas%c

Unit-‐elas%c Inelas%c Inelas%c Inelas%c

] ] ] ] ] ] ]

] ] ] ] ] ] ]

Price Elas%city of Demand for Movie Tickets as Measured by the Elas%city Coefficient and the Total Revenue Test

LO2

6-‐14

Elasticity and Total Revenue

0 1 2 3 4 5 6 7 8

0 1 2 3 4 5 6 7 8

Quan%ty demanded

Quan%ty demanded

Price

Total reven

ue

(Tho

usan

ds of d

ollars) $20

18 16 14 12 10

8 6 4 2

$8 7 6 5 4 3 2 1

a b

c d

e f

g h

Elas%c Ed > 1

Unit elas%c Ed = 1

Inelas%c Ed < 1

D

TR

LO2

6-‐15

Summary of Price Elasticity of Demand

Price Elas%city of Demand: A Summary

Absolute Value of Elas%city Coefficient Demand Is: Descrip%on

Impact on Total Revenue of a:

Price Increase Price Decrease

Greater than 1 (Ed > 1)

Elas7c or rela7vely elas7c

Qd changes by a larger percentage than does price

Total Revenue decreases

Total Revenue increases

Equal to 1 (Ed = 1)

Unit or unitary elas7c

Qd changes by the same percentage as does price

Total revenue is unchanged

Total revenue is unchanged

Less than 1 (Ed < 1)

Inelas7c or rela7vely inelas7c

Qd changes by a smaller percentage than does price

Total revenue increases

Total revenue decreases

6-‐16

Determinants of Price Elasticity of Demand

•  Subs7tutability • More subs7tutes, demand is more elas7c

•  Propor7on of income •  Higher propor7on of income, demand is more elas7c

LO3

6-‐17

Determinants of Price Elasticity of Demand

•  Luxuries versus necessi7es •  Luxury goods, demand is more elas7c

•  Time • More 7me available, demand is more elas7c

LO3

6-‐18

Price Elasticity of Demand Selected Price Elas%ci%es of Demand

Product or Service Price Elas%city of Demand (Ed) Product or Service

Price Elas%city 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

Cigarebes .25 Shoes .91

Sugar .30 Motor vehicles 1.14

Medical Care .31 Beef 1.27

Eggs .32 China, glassware 1.54

Legal Services .37 Residen7al land 1.60

Automobile repair .40 Restaurant meals 2.27

Clothing .49 Lamb and mubon 2.65

Gasoline .60 Fresh peas 2.83

6-‐19

Applications of Price Elasticity of Demand

•  Large crop yields •  Inelas7c demand, lower total revenue

•  Excise taxes •  Inelas7c demand, more total revenue

•  Decriminaliza7on of illegal drugs •  Inelas7c demand, more total revenue

LO3

6-‐20

Price Elasticity of Supply

•  Measures sellers’ responsiveness to price changes

•  Elas7c supply, producers are responsive to price changes

•  Inelas7c supply, producers are not as responsive to price changes

LO4

6-‐21


•  Formula for price elas%city of supply

LO4

percentage change in quan7ty supplied of Product X

percentage change in price of product X

Es =

6-‐22


•  Es > 1 supply is elas%c •  Es = 1 supply is unit elas%c •  Es < 1 supply is inelas%c •  Addi7onally,

•  Es = 0 supply is perfectly inelas%c

LO4

6-‐23


•  Time is primary determinant of elas7city of supply

•  Time periods considered •  Immediate market period •  Short run •  Long run

LO4

6-‐24

Es: The Immediate Market Period

•  Perfectly inelas7c supply P

Q D1

D2

Sm

Q0

Pm

P0

LO4

6-‐25

The Short Run

•  Short run supply is more elas7c than in the immediate market period

P

Q D1

D2

Ss

Q0

Ps

P0

Qs LO4

6-‐26

The Long Run

•  Long run supply is even more elas7c than in the short run

LO4

P

Q D1

D2

SL

Q0

Pl

P0

Ql

6-‐27

Cross Elasticity of Demand

•  Formula for cross elas%city of demand

Ex,y =

percentage change in quan7ty demanded of product X

percentage change in price of product Y

LO5

6-‐28


•  Measures responsiveness of purchases of one good to change in the price of another good

•  Subs7tute goods if elas7city is posi7ve •  Complement goods if elas7city is nega7ve •  Independent goods if elas7city is 0

LO5

6-‐29


•  Applica7ons of cross elas7city of demand •  Should a company change a price? •  Should the government allow a merger?

LO5

6-‐30

Income Elasticity of Demand

•  Formula for income elas%city of demand

LO5

Ei = percentage change in quan7ty demanded

percentage change in income

6-‐31

Income Elasticity of Demand

•  Measures responsiveness of buyers to changes in their income

•  Normal goods if elas7city is posi7ve •  Inferior goods if elas7city is nega7ve

LO5

6-‐32

Income Elasticity Insights

•  High income elas7ci7es • Most affected by a recession

•  Low or nega7ve income elas7city •  Not affected that much by a recession

LO5

6-‐33

Cross and Income Elasticities

Cross and Income Elas%ci%es of Demand

Value of Coefficient Descrip%on Type of Good(s)

Cross elas7city: Posi7ve (Ewz > 0) Nega7ve (Exy < 0)

Quan7ty demanded of W changes in same direc7on as change in price of Z Quan7ty demanded of X changes in opposite direc7on from change in price of Y

Subs7tutes Complements

Income elas7city: Posi7ve (Ei >0) Nega7ve (Ei<0)

Quan7ty demanded of the product changes in same direc7on as change in income Quan7ty demanded of the product changes in opposite direc7on from change in income

Normal or superior Inferior

LO5

6-‐34

Elasticity and Pricing Power

•  Charge different prices to different buyers based on price elas7ci7es

•  Business air travelers •  Children discounts •  College tui7on

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