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Elasticity adding (quantitative) meat to the bones of supply and demand.

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Presentation on theme: "Elasticity adding (quantitative) meat to the bones of supply and demand."— Presentation transcript:

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2 Elasticity adding (quantitative) meat to the bones of supply and demand

3 Suppose the price of gas rises by 10% over the next month. By how much will Ohio drivers cut back on their purchases of gasoline? a) 0 percent (no cut back) b) 1 to 5 percent c) 6 to 10 percent d) 11 to 20 percent e) More than 20 percent a) 0 percent (no cut back) b) 1 to 5 percent c) 6 to 10 percent d) 11 to 20 percent e) More than 20 percent 12345

4 Price Elasticity of Demand Measures the price sensitivity of buyers E d = $ Gasoline $3.50 $3.00 280300 D %ΔQ%ΔQ %ΔP%ΔP

5 Midpoint Formula E d = = E d = -[.07/.15] = -0.47 Degree of Sensitivity Elastic: |Ed| > 1 Unit: |Ed| = 1 Inelastic: |Ed| < 1 $ Gasoline $3.50 $3.00 280300 D %ΔQ%ΔQ %ΔP%ΔP

6 a) -1.81; elastic b) -0.55; inelastic c) -0.50; elastic d) -2.00; inelastic a) -1.81; elastic b) -0.55; inelastic c) -0.50; elastic d) -2.00; inelastic When the price of milk is $2 per gallon, consumers buy 500 gallons. When the price rises to $3 per gallon, consumers buy only 400 gallons. What is the elasticity of demand and how would you classify it? E d = E d = -.22/.40 = -0.55 12345

7 Determinants of Elasticity Number of substitutes The greater the # substitutes, the greater the elasticity The narrower the definition of the market, the greater the elasticity Ex: Items share of consumer budget The greater the share of budget, the greater the elasticity Ex: E housing > E salt << { "@context": "http://schema.org", "@type": "ImageObject", "contentUrl": "http://images.slideplayer.com/5/1509067/slides/slide_7.jpg", "name": "Determinants of Elasticity Number of substitutes The greater the # substitutes, the greater the elasticity The narrower the definition of the market, the greater the elasticity Ex: Items share of consumer budget The greater the share of budget, the greater the elasticity Ex: E housing > E salt << E salt <<

8 D1D1 D2D2 gasoline $ P0P0 Q0Q0 P1P1 Q1Q1 Q2Q2 short run long run Determinants of Elasticity Time The longer the time horizon, the greater the elasticity Gasoline Demand: E LR > E SR

9 Perfectly Inelastic E d = Examples? Perfectly Elastic E d = Examples? $ Q $ Q D1D1 P1P1 P2P2 Q1Q1 D1D1 P1P1 0 Extreme Cases of Price Elasticity

10 Good Price elasticity Inelastic demand Eggs - 0.10 Beef - 0.40 Stationery- 0.50 Gasoline - 0.50 Elastic demand Housing - 1.20 Restaurant meals - 2.30 Airline travel - 2.40 Foreign travel - 4.10 Good Price elasticity Inelastic demand Eggs - 0.10 Beef - 0.40 Stationery- 0.50 Gasoline - 0.50 Elastic demand Housing - 1.20 Restaurant meals - 2.30 Airline travel - 2.40 Foreign travel - 4.10 Some Estimated Price Elasticities of Demand

11 a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease. a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease. Suppose that the price elasticity of demand for a Marietta College education is estimated to be E = -0.80. Based on this information, if the college were to raise tuition by 5%, then: 12345

12 Elasticity and Total Revenue Elastic Demand P x Q = TR Inelastic Demand P x Q = TR $ Computers $1000 $800 200300 D TR = $200,000 TR = $240,000 400500 $600 $400 E = - 1.82 E = - 0.55 TR = P x Q

13 a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease. a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease. Suppose that the price elasticity of demand for a Marietta College education is estimated to be E = -0.80. Based on this information, if the college were to raise tuition by 5%, then: 12345

14 a)The demand was elastic. b)The demand was inelastic. c)The demand was perfectly elastic. d)The demand was perfectly inelastic. a)The demand was elastic. b)The demand was inelastic. c)The demand was perfectly elastic. d)The demand was perfectly inelastic. In August, 1990, East German taxicab drivers were on strike demanding lower cab fares. What must the drivers have believed about the price elasticity of demand for taxi rides? 12345

15 a)-0.71 b)-1.40 c)+1.40 d)+0.71 a)-0.71 b)-1.40 c)+1.40 d)+0.71 According to recent studies at M.I.T. and the University of Michigan, a 10% increase in the price of cigarettes leads to a 14% drop in sales to teenagers. What is the elasticity of demand for cigarettes among teenagers? Would you expect it to be this high for older smokers? Explain. 12345

16 price D1D1 S1S1 4.00 27.4 S2S2 4.40 3.40 t = $1 25.8 Cigarette Tax Revisited Assume that E D = -0.60 E D = = -0.60 %ΔQ D = - 6.0% cigarettes What happens to total consumer expenditures? What happens to total consumer expenditures? What happens to tax revenue if demand becomes more elastic? What happens to tax revenue if demand becomes more elastic? %ΔQ D = - 6% %ΔP = 10%

17 Other Demand Elasticities Cross-Price Elasticity E xy = Income Elasticity E I = Substitutes: E xy > 0 Complements: E xy < 0 Normal Goods: E I > 0 Inferior Goods: E I < 0

18 Examples of cross-price elasticities CommodityWith respect to price of Cross-Price elasticity BeefPork 0.28 ButterMargarine 0.67 ElectricityNatural gas 0.20 Natural gasFuel oil 0.44 ClothingFootwear- 0.01 Dairy productsMeat products- 0.15 EntertainmentFood- 0.72

19 Examples of income elasticities CommodityIncome elasticity Automobiles2.46 Furniture1.48 Restaurant Meals1.40 Water1.02 Tobacco0.64 Gasoline0.48 Margarine-0.20 Pork-0.20 Public transportation-0.36

20 In Marietta, the price elasticity of demand for bus rides is E D = -0.5, the income elasticity of demand for bus rides is E I = -0.1, and the cross elasticity of demand for bus rides with respect to gasoline is E xy = 0.2. a) Is the demand for bus rides elastic or inelastic with respect to the price of a bus ride? How do you know? b) Would an increase in bus fares increase the bus company's total revenue? Explain your answer. c) Describe the relationship between bus rides and gasoline. Explain your answer. d) If the price of gasoline increases by 10 percent with no change in the price of a bus ride, by what percentage will the number of bus rides change? e) If incomes in Marietta increase by 5 percent with no change in the price of a bus ride, by what percentage will the number of bus rides change? f) In Marietta, is a bus ride a normal good or an inferior good? Why?


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