unit 3 - elasticity n price elasticity of demand price elasticity of demand m easures the...

Unit 3 - ElasticityUnit 3 - Elasticity

Price Elasticity of DemandPrice Elasticity of Demand

Price elasticity of demand mPrice elasticity of demand measures the easures the responsiveness of buyers’ purchasing habits to a responsiveness of buyers’ purchasing habits to a price change.price change.

Microeconomics



Definition:Definition:

Ep = the percentage change in a product’s Ep = the percentage change in a product’s quantity demanded divided by the quantity demanded divided by the percentage change in its price. percentage change in its price.

Microeconomics



Formula:Formula:

(change in Qd / average Qd) (change in Qd / average Qd) (change in Pr / average Pr)(change in Pr / average Pr)

Where Qd = quantity demanded, and Pr = price.Where Qd = quantity demanded, and Pr = price.

Microeconomics

Ep =



Example 1Example 1Let’s say that a grocery store observes that at $2.00 Let’s say that a grocery store observes that at $2.00

per gallon of milk, buyers purchase 800 gallons per gallon of milk, buyers purchase 800 gallons per day. The next week, the grocery store per day. The next week, the grocery store increases its price to $3.00 per gallon and buyers increases its price to $3.00 per gallon and buyers purchase 700 gallons per day.purchase 700 gallons per day.

What is the price elasticity of demand for milk?What is the price elasticity of demand for milk?

Microeconomics



Example 1 answerExample 1 answer the change in quantity demanded = 100the change in quantity demanded = 100 the average quantity demanded = 750the average quantity demanded = 750 the change in pricethe change in price = $1 = $1 the average pricethe average price = $2.50 = $2.50

100/750100/750 .133.133 $1/$2.50 $1/$2.50 .4.4

MicroeconomicsEp = = .3325



Example 1 answerExample 1 answerOfficially, the answer is - . 3325, because Officially, the answer is - . 3325, because the quantity demanded decreased (change the quantity demanded decreased (change of -100). However, because price elasticity of -100). However, because price elasticity of demand is always negative, we ignore of demand is always negative, we ignore the negative sign. the negative sign.

Microeconomics



If a product’s elasticity is less than 1, then we say If a product’s elasticity is less than 1, then we say that it is that it is inelasticinelastic. . If a product’s elasticity is greater than 1, then we If a product’s elasticity is greater than 1, then we say that it is say that it is elasticelastic. . If a product’s elasticity is equal to 1, then we say If a product’s elasticity is equal to 1, then we say that it is that it is unit elasticunit elastic..

Microeconomics

A product with a price elasticity A product with a price elasticity of demand equal to 3.5 is:of demand equal to 3.5 is:

1.1. InelasticInelastic

2.2. Unit elasticUnit elastic

3.3. ElasticElastic

4.4. None of the aboveNone of the above

A product with a price elasticity A product with a price elasticity of demand equal to 3.5 is:of demand equal to 3.5 is:

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1.1. InelasticInelastic

2.2. Unit elasticUnit elastic

3.3. ElasticElastic




Example 2Example 2A movie theatre sells 1,800 tickets when it charges A movie theatre sells 1,800 tickets when it charges a price of $11. After it lowers its price to $9, it a price of $11. After it lowers its price to $9, it sells 2,600 tickets. sells 2,600 tickets.

What is the price elasticity of demand for tickets What is the price elasticity of demand for tickets for this movie theatre? for this movie theatre?

Microeconomics

In the previous example (1,800 and In the previous example (1,800 and 2,600 tickets, and price of $11 and $9), 2,600 tickets, and price of $11 and $9), what is the price elasticity of demand?what is the price elasticity of demand?

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1.1. .55.55

2.2. 1.8181.818

3.3. 1.551.55

4.4. 2.832.83

5.5. 5.1515.151



Example 2 answerExample 2 answer800/2200 800/2200 .3636.36362/102/10 .2.2

Because the value is greater than 1, movie tickets Because the value is greater than 1, movie tickets at this theatre are price elastic.at this theatre are price elastic.

Microeconomics

Ep = = 1.818



Determinants of price elasticity of demand are:Determinants of price elasticity of demand are: The availability of close substitutes. The more The availability of close substitutes. The more

substitutes, the greater the elasticity.substitutes, the greater the elasticity. The product’s expense to the consumer relative to The product’s expense to the consumer relative to

her/his income or wealth. The higher the expense, the her/his income or wealth. The higher the expense, the greater the elasticity.greater the elasticity.

The period of time under consideration. The longer the The period of time under consideration. The longer the time period, the greater the elasticity.time period, the greater the elasticity.

Microeconomics

Unit 3 - ElasticityUnit 3 - Elasticity Price Elasticity of DemandPrice Elasticity of Demand

Price elasticity determinants of gasolinePrice elasticity determinants of gasoline The availability of close substitutes. Gasoline does not The availability of close substitutes. Gasoline does not

have many substitutes. This makes gasoline inelastic.have many substitutes. This makes gasoline inelastic. The product’s expense to the consumer relative to The product’s expense to the consumer relative to

her/his income or wealth. For many people gasoline is a her/his income or wealth. For many people gasoline is a considerable expense. This makes gasoline elastic.considerable expense. This makes gasoline elastic.

The period of time under consideration. Within a short The period of time under consideration. Within a short period of time, people cannot change their driving period of time, people cannot change their driving behavior much. This makes gasoline inelastic when behavior much. This makes gasoline inelastic when looking at a short-run demand curve.looking at a short-run demand curve.

Overall, especially in the short run, gasoline is probably Overall, especially in the short run, gasoline is probably inelastic.inelastic.

Microeconomics


Elasticity and RevenueElasticity and Revenue

Revenue = quantity demanded x priceRevenue = quantity demanded x price

If quantity demanded increases by 10%, and price If quantity demanded increases by 10%, and price decreases by 5% (this means that the product is elastic), decreases by 5% (this means that the product is elastic), then revenue increases. then revenue increases.

Microeconomics

If a product is elastic and its price If a product is elastic and its price decreases, then the supplier’s total decreases, then the supplier’s total

revenue:revenue:1.1. DecreasesDecreases

2.2. IncreasesIncreases

3.3. Stays the sameStays the same


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If a product is inelastic and its price If a product is inelastic and its price decreases, then the supplier’s total decreases, then the supplier’s total

revenue:revenue:1.1. DecreasesDecreases




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If a product is unit elastic and its price If a product is unit elastic and its price decreases, then the supplier’s total decreases, then the supplier’s total revenue:revenue:

1.1. DecreasesDecreases




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Elasticity and Revenue SummaryElasticity and Revenue Summary If a product is elastic and price increases, then revenue If a product is elastic and price increases, then revenue

decreases.decreases. If a product is inelastic and price increases, then If a product is inelastic and price increases, then

revenue increases. revenue increases. If a product is elastic and price decreases, then revenue If a product is elastic and price decreases, then revenue

increases.increases. If a product is inelastic and price decreases, then If a product is inelastic and price decreases, then

revenue decreases.revenue decreases. If a product is unit elastic and price changes, then If a product is unit elastic and price changes, then

revenue stays the same.revenue stays the same.

Microeconomics

When you graph a demand curve, you notice When you graph a demand curve, you notice that a flatter (closer to horizontal) demand that a flatter (closer to horizontal) demand curve is associated with a:curve is associated with a:

1.1. Higher price Higher price elasticity of demandelasticity of demand

2.2. Lower price Lower price elasticity of demandelasticity of demand

3.3. Perfectly inelastic Perfectly inelastic demand situationdemand situation


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Price

Quantity

D1 (inelastic demand curve)

$9.00

60

D2 (elastic demand curve)

$8.00

68 100



Elasticity and CompetitionElasticity and Competition

A perfectly competitive firm faces a demand A perfectly competitive firm faces a demand curve which is perfectly elastic (horizontal).curve which is perfectly elastic (horizontal).

The more elastic the product, the flatter the The more elastic the product, the flatter the curve.curve.

Microeconomics

Price

Quantity

D1 (Perfectly Elastic Demand Curve)

$9.00

60

D2 (Perfectly Inelastic Demand Curve)



Income Elasticity of DemandIncome Elasticity of Demand

Income elasticity of measures the Income elasticity of measures the responsiveness of buyers’ purchasing habits in responsiveness of buyers’ purchasing habits in response to an response to an incomeincome change. change.

Microeconomics



Definition:Definition:

Ei = the percentage change in a Ei = the percentage change in a product’s product’s quantity demanded divided by the quantity demanded divided by the

percentage percentage change in buyers’ incomes.change in buyers’ incomes.

The value can be positive (normal good) or The value can be positive (normal good) or negative (inferior good). negative (inferior good).

Microeconomics



Formula:Formula:

(change in Qd / average Qd) (change in Qd / average Qd) (change in Y / average Y)(change in Y / average Y)

Where Qd = quantity demanded, and Y = income.Where Qd = quantity demanded, and Y = income.

Microeconomics

Ei =

Unit 3 - ElasticityUnit 3 - Elasticity Cross Price Elasticity of DemandCross Price Elasticity of Demand

The price change of a substitute or complementary The price change of a substitute or complementary product affects the quantity demanded of the other product affects the quantity demanded of the other substitute or complementary product.substitute or complementary product.

Substitutes have a positive cross price Substitutes have a positive cross price elasticity of demand. Complements elasticity of demand. Complements have a negative cross price elasticity of demand.have a negative cross price elasticity of demand.

Microeconomics

Unit 3 - ElasticityUnit 3 - Elasticity Cross Price Elasticity of DemandCross Price Elasticity of Demand

The formula for cross price elasticity of The formula for cross price elasticity of demand is:demand is:

the % change in the quantity demanded of the % change in the quantity demanded of

product A product A

the % change in the price of related product Bthe % change in the price of related product B

Microeconomics

Ecp =

unit 3 - elasticity n price elasticity of demand price elasticity of demand m easures the...

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