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Price Elasticities of Demand

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Definition: Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers plans remain the same Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers plans remain the same To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price

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Percentage Price in Change Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price? Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price? Percent change in price = New price – Initial price Initial Price x 100

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Percentage Change in Price Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price? Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price? Percent change in price = New price – Initial price Initial Price x 100

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Percentage Change in Price Elasticity compares the percentage change in the quantity demanded with the percentage change in price Elasticity compares the percentage change in the quantity demanded with the percentage change in price Midpoint Method -- To calculate the percentage change that does not depend on the direction of the price change Midpoint Method -- To calculate the percentage change that does not depend on the direction of the price change

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Percentage Price in Change Midpoint Method Calculation Midpoint Method Calculation Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price. Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price. x 100Percent change in price = New price – Initial price (New Price + Initial Price) ÷ 2

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Percentage Change in Price Average price is the same regardless of whether the price rises or falls Average price is the same regardless of whether the price rises or falls

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Percentage Change in Quantity Demanded Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. Uses the midpoint formula again Uses the midpoint formula again x 100 Percent change in price = New price – Initial price (New Price + Initial Price) ÷ 2

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Percentage Change in Quantity Demanded When the price of a good rises, the quantity demanded of it decreases When the price of a good rises, the quantity demanded of it decreases – A positive change in price bring a negative change in the quantity demanded When the price of a good falls, the quantity demanded of it increases When the price of a good falls, the quantity demanded of it increases – Negative change in price brings a positive change in the quantity demanded

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Elastic and Inelastic Demand Elastic Demand – when the percentage change in the quantity demanded exceeds the percentage change in price Elastic Demand – when the percentage change in the quantity demanded exceeds the percentage change in price Unit Elastic Demand – percentage change in the quantity demanded equals the percentage change in price Unit Elastic Demand – percentage change in the quantity demanded equals the percentage change in price Inelastic Demand – percentage change in the quantity demanded is less than the percentage change in price Inelastic Demand – percentage change in the quantity demanded is less than the percentage change in price

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Elastic Demand Perfectly Elastic Demand – an almost zero percentage change in the price brings a very large percentage change in the quantity demanded Perfectly Elastic Demand – an almost zero percentage change in the price brings a very large percentage change in the quantity demanded Consumers are willing to buy any quantity of the good at a given price but none at a higher price Consumers are willing to buy any quantity of the good at a given price but none at a higher price

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Perfectly Elastic Demand

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Elastic Demand A percentage change in the quantity demanded exceeds the percentage change in price A percentage change in the quantity demanded exceeds the percentage change in price

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Unit Elastic Demand The percentage change in the quantity demanded equals the percentage change in price The percentage change in the quantity demanded equals the percentage change in price

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Inelastic Demand Percentage change in the quantity demanded is less than the percentage change in price Percentage change in the quantity demanded is less than the percentage change in price

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Perfectly Inelastic Demand Percentage change in the quantity demanded is zero for any percentage change in price Percentage change in the quantity demanded is zero for any percentage change in price

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Influences on Price Elasticity of Demand Two influences: Two influences: 1.Availability of substitutes 1.Proportion of income spent

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Influences on Price Elasticity of Demand Demand for good is elastic if a substitute is easy to find Demand for good is elastic if a substitute is easy to find – Soft drink containers Demand for good is inelastic if a substitute is hard to find Demand for good is inelastic if a substitute is hard to find – Oil substitutes?

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Influences on Price Elasticity of Demand Three factors that influence the ability to find a substitute for a good: Three factors that influence the ability to find a substitute for a good: 1.Whether good is a luxury or a necessity 2.How narrowly it is defined 3.Amount of time available to find a substitute for it

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Price Elasticity of Demand The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good Toothpaste? Toothpaste?

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Computing Price Elasticity of Demand If the price elasticity of a demand is greater than 1, the demand is elastic If the price elasticity of a demand is greater than 1, the demand is elastic If the price elasticity of demand equals 1, demand is unit elastic If the price elasticity of demand equals 1, demand is unit elastic If the price elasticity of demand is less than 1, demand is inelastic If the price elasticity of demand is less than 1, demand is inelastic Price elasticity of demand Percentage change in quantity demanded Percentage change in the price =

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Computing Price Elasticity of Demand

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Elasticity Along a Linear Demand Curve Slope measures responsiveness. But slope and elasticity are not the same thing! Slope measures responsiveness. But slope and elasticity are not the same thing! Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies. Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies. Along a linear demand curve, demand is: Along a linear demand curve, demand is: – Unit elastic at the midpoint of the curve. – Elastic above the midpoint of the curve. – Inelastic below the midpoint of the curve.

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Elasticity Along a Linear Demand Curve

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Total Revenue and the Price Elasticity of Demand Total revenue is the amount spent on a good and received by its sellers and equals the price of the good multiplied by the quantity sold Total revenue is the amount spent on a good and received by its sellers and equals the price of the good multiplied by the quantity sold – Starbucks Latte -- $3 – Demand is 15 cups an hour – Total Revenue is $45 an hour Total Revenue Test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change Total Revenue Test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change

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Total Revenue and the Price Elasticity of Demand If demand is elastic: If demand is elastic: A given percentage rise in price brings a larger percentage decrease in the quantity demanded. A given percentage rise in price brings a larger percentage decrease in the quantity demanded. And total revenue decreases. And total revenue decreases. If demand is inelastic: If demand is inelastic: A given percentage rise in price brings a smaller percentage decrease in the quantity demanded. A given percentage rise in price brings a smaller percentage decrease in the quantity demanded. And total revenue increases. And total revenue increases.

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Total Revenue Test Total revenue test: – If price and total revenue change in the opposite directions, demand is elastic. – If a price change leaves total revenue unchanged, demand is unit elastic. – If price and total revenue change in the same direction, demand is inelastic.

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Total Revenue Test At $3 a cup, the quantity demanded is 15 cups an hour. At $3 a cup, the quantity demanded is 15 cups an hour. Total revenue is $45 an hour. Total revenue is $45 an hour. When the price rises to $5 a cup, the quantity demanded decreases to 5 cups an hour. When the price rises to $5 a cup, the quantity demanded decreases to 5 cups an hour. Total revenue decreases to $25 an hour. Total revenue decreases to $25 an hour. Demand is elastic. Demand is elastic.

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Total Revenue Test At $50 a book, the quantity demanded is 5 million books. At $50 a book, the quantity demanded is 5 million books. Total revenue is $250 million. Total revenue is $250 million. When the price rises to $75 a book, the quantity demanded decreases to 4 million books. When the price rises to $75 a book, the quantity demanded decreases to 4 million books. Total revenue increases to $300 million. Total revenue increases to $300 million. Demand is inelastic. Demand is inelastic.

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Addiction and Elasticity Nonusers demand for addictive substances is elastic. Nonusers demand for addictive substances is elastic. So a moderately higher price leads to a substantially smaller number of people trying a drug. So a moderately higher price leads to a substantially smaller number of people trying a drug. Existing users demand for addictive substances is inelastic. Existing users demand for addictive substances is inelastic. So even a substantial price rise brings only a modest decrease in the quantity demanded. So even a substantial price rise brings only a modest decrease in the quantity demanded.

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Price Elasticities of Demand Notes

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Definition: Price elasticity of demand is Price elasticity of demand is To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price

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Percentage Price in Change Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price? Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price? = – x

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Percentage Change in Price Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price? Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price? = – x

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Percentage Change in Price Elasticity compares the percentage change in the quantity demanded with the percentage change in price Elasticity compares the percentage change in the quantity demanded with the percentage change in price Midpoint Method -- Midpoint Method --

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Percentage Price in Change Midpoint Method Calculation Midpoint Method Calculation Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price. Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price. x= – ( + ) ÷ 2

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Percentage Change in Price

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Percentage Change in Quantity Demanded Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. Uses the midpoint formula again Uses the midpoint formula again x 100 Percent change in price = New price – Initial price (New Price + Initial Price) ÷ 2

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Percentage Change in Quantity Demanded When the price of a good rises, the quantity demanded of it decreases When the price of a good rises, the quantity demanded of it decreases When the price of a good falls, the quantity demanded of it increases When the price of a good falls, the quantity demanded of it increases

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Elastic and Inelastic Demand Elastic Demand – Elastic Demand – Unit Elastic Demand – Unit Elastic Demand – Inelastic Demand – Inelastic Demand –

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Elastic Demand Perfectly Elastic Demand – Perfectly Elastic Demand – Consumers are willing to buy any quantity of the good at a given price but none at a higher price Consumers are willing to buy any quantity of the good at a given price but none at a higher price

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Perfectly Elastic Demand

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Elastic Demand

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Unit Elastic Demand

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Inelastic Demand

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Perfectly Inelastic Demand

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Influences on Price Elasticity of Demand Two influences: Two influences: 1.Availability of ________________ 1.Proportion of ___________spent

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Influences on Price Elasticity of Demand Demand for good is elastic if a substitute is easy to find Demand for good is elastic if a substitute is easy to find Demand for good is inelastic if a substitute is hard to find Demand for good is inelastic if a substitute is hard to find

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Influences on Price Elasticity of Demand Three factors that influence the ability to find a substitute for a good: Three factors that influence the ability to find a substitute for a good:

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Price Elasticity of Demand The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good

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Computing Price Elasticity of Demand If the price elasticity of a demand is greater than 1, the demand is ____________ If the price elasticity of a demand is greater than 1, the demand is ____________ If the price elasticity of demand equals 1, demand is ____________ If the price elasticity of demand equals 1, demand is ____________ If the price elasticity of demand is less than 1, demand is ____________ If the price elasticity of demand is less than 1, demand is ____________ Price elasticity of demand Percentage change in quantity demanded Percentage change in the price =

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Computing Price Elasticity of Demand

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Elasticity Along a Linear Demand Curve Slope measures responsiveness. But slope and elasticity are not the same thing! Slope measures responsiveness. But slope and elasticity are not the same thing! Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies. Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies. Along a linear demand curve, demand is: Along a linear demand curve, demand is: – ____________ at the midpoint of the curve. – ____________ above the midpoint of the curve. – ____________ below the midpoint of the curve.

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Elasticity Along a Linear Demand Curve

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Total Revenue and the Price Elasticity of Demand Total revenue is the amount spent on a good and received by its sellers and equals the price of the good multiplied by the quantity sold Total revenue is the amount spent on a good and received by its sellers and equals the price of the good multiplied by the quantity sold – Starbucks Latte -- $3 – Demand is 15 cups an hour – Total Revenue is $45 an hour Total Revenue Test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change Total Revenue Test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change

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Total Revenue and the Price Elasticity of Demand If demand is elastic: If demand is elastic: If demand is inelastic: If demand is inelastic:

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Total Revenue Test Total revenue test: – If price and total revenue change in the opposite directions, demand is ________ – If a price change leaves total revenue unchanged, demand is ____________. – If price and total revenue change in the same direction, demand is ____________.

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Total Revenue Test At $3 a cup, the quantity demanded is 15 cups an hour. At $3 a cup, the quantity demanded is 15 cups an hour. Total revenue is ____________ Total revenue is ____________ When the price rises to $5 a cup, the quantity demanded decreases to 5 cups an hour. When the price rises to $5 a cup, the quantity demanded decreases to 5 cups an hour. Total revenue decreases to ____________. Total revenue decreases to ____________. Demand is ____________. Demand is ____________.

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Total Revenue Test At $50 a book, the quantity demanded is 5 million books. At $50 a book, the quantity demanded is 5 million books. Total revenue is ____________ Total revenue is ____________ When the price rises to $75 a book, the quantity demanded decreases to 4 million books. When the price rises to $75 a book, the quantity demanded decreases to 4 million books. Total revenue increases to ____________. Total revenue increases to ____________. Demand is ____________. Demand is ____________.

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Addiction and Elasticity Nonusers demand for addictive substances is ____________. Nonusers demand for addictive substances is ____________. Existing users demand for addictive substances is ____________. Existing users demand for addictive substances is ____________.

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