elasticity 04 mcgraw-hill/irwin copyright © 2012 by the mcgraw-hill companies, inc. all rights...
TRANSCRIPT
Elasticity
04
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Price Elasticity of Demand
• Measures buyers’ responsiveness to price changes
• Elastic demand
• Sensitive to price changes
• Large change in quantity
• Inelastic demand
• Insensitive to price changes
• Small change in quantity
LO1 4-2
Price Elasticity of Demand Formula
• Formula for price elasticity of demand
Ed =
LO1
Percentage Change in QuantityDemanded of Product X
Percentage Change in Priceof Product X
4-3
Price Elasticity of Demand Formula
• Use the midpoint formula
• Ensures consistent results
Change in quantity Change in price
Sum of quantities/2 Sum of prices/2
LO1
Ed = ÷
4-4
Price Elasticity of Demand Formula
• Use percentages
• Unit free measure
• Compare responsiveness across products
• Eliminate the minus sign
• Easier to compare elasticities
LO1 4-5
Interpretation of Elasticity of Demand
• Ed > 1 demand is elastic
• Ed = 1 demand is unit elastic
• Ed < 1 demand is inelastic
• Extreme cases
• Perfectly inelastic
• Perfectly elastic
LO1 4-6
Extreme Cases
LO1
D1P
Perfectly inelastic demand
Perfectly inelastic demand(Ed = 0)
0
4-7
Extreme Cases
LO1
Perfectly elastic demand
P
D2
Perfectly elasticdemand(Ed = ∞)
0
4-8
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
LO2 4-9
Total Revenue Test
LO2
$3
2
1
0 10 20 30 40 Q
P
a
b
D1
• Lower price and elastic demand• Blue gain exceeds orange loss
4-10
Total Revenue Test
LO2
$4
3
2
1
0 10 20 Q
P
c
d
D2
• Lower price and inelastic demand• Orange loss exceeds blue gain
4-11
Total Revenue Test
LO2
$3
2
1
0 10 20 30 Q
P
e
f
D3
• Lower price and unit elastic demand• Blue gain equals orange loss
4-12
Total Revenue Test
LO2
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
4-13
Elasticity and Total Revenue
LO2
0 1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8
Quantity Demanded
Quantity Demanded
Pri
ceT
ota
l Rev
enu
e(T
ho
usa
nd
s o
f D
olla
rs)
$201816141210
8642
$87654321
a
bc
de
fg
h
ElasticEd > 1
Unit ElasticEd = 1
InelasticEd < 1
D
TR
4-14
Summary of Price Elasticity of Demand
LO2
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
4-15
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 4-16
Price Elasticity of Demand
LO1
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 2.834-17
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
LO1 4-18
Price Elasticity of Supply
• Measures sellers’ responsiveness to price changes
• Elastic supply, producers are responsive to price changes
• Inelastic supply, producers are not responsive to price changes
LO3 4-19
Price Elasticity of Supply
• Formula to compute elasticity
• Es > 1 supply is elastic
• Es < 1 supply is inelastic
LO3
Percentage Change in QuantitySupplied of Product X
Percentage Change in Priceof Product X
Es =
4-20
Price Elasticity of Supply
• Time is primary determinant of elasticity of supply
• Time periods considered
• Market period
• Short Run
• Long Run
LO3 4-21
Elasticity of Supply: The Market Period
LO3
• Perfectly inelastic supply
D1
D2
Sm
Q0
Pm
P0
4-22
Elasticity of Supply: The Short Run
LO3
• Supply is more elastic than in market period
D1
D2
Ss
Q0
Ps
P0
Qs
4-23
Elasticity of Supply: The Long Run
LO3
• Supply is even more elastic than in the short run
D1
D2
Sl
Q0
Pl
P0
Ql
4-24
Applications of Elasticity of Supply
• Antiques
• Inelastic supply
• Reproductions
• More elastic supply
• Volatile gold prices
• Inelastic supply
LO3 4-25
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
4-26
Cross Elasticity of Demand
• Application
• Change the price?
• Allow a merger?
LO4 4-27
Income Elasticity of Demand
• Measures responsiveness of buyers to changes in income
• Normal goods – positive sign
• Inferior goods – negative sign
LO4
Percentage change in quantity demanded
Ei =
Percentage change in income
4-28
Income Elasticity Insights
• High income elasticities
• Most affected by a recession
• Low or negative income
• Least affected by a recession
LO4 4-29
Ex,y and Ei
LO4
Cross and Income Elasticities of Demand
Value of Coefficient Description Type of Good(s)
Cross elasticity: Positive (Ewz > 0)
Negative (Exy < 0)
Quantity demanded of W changes in same direction as change in price of Z
Quantity demanded of X changes in opposite direction from change in price of Y
Substitutes
Complements
Income elasticity: Positive (Ei >0)
Negative (Ei<0)
Quantity demanded of the product changes in same direction as change in income
Quantity demanded of the product changes in opposite direction from change in income
Normal or superior
Inferior
4-30
Elasticity and Pricing Power
• Charge different prices based on price elasticities
• Examples:
• Business air travelers
• Adult vs. child
4-31