Presentation on theme: "Mr. Barnett University High AP Economics"— Presentation transcript:
1 Mr. Barnett University High AP Economics 2012-2013 Elasticity
2 ElasticityWe already know that if the price of a good rises, consumers will buy lessBut….how much less?Economists measure the change through elasticityElasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinantsBasically, a measure of how much buyers and sellers respond to change in market conditions
3 Price Elasticity Remember the Law of demand…. A fall in the price of a good will raise the quantity demandedPrice Elasticity – measures how much the quantity demanded responds to a change in priceDemand is:Elastic – if quantity demanded responds substantially to a change in priceInelastic – if quantity demanded responds only slightly to a change in price
4 Influences on Price Elasticity of Demand Availability of close substitutesGoods with close substitutes tend to have more elastic demand because it is easier for consumer to switch from that good to anotherExampleButter goes up $0.15 in pricePrice of margarine stays the sameResult: large drop in quantity of butter sold
5 Influences on Price Elasticity of Demand Necessities versus luxuriesNecessities have _________ demandsLuxuries have ___________demandsExample:When the price of a dentist visit increases, people will not drastically reduce the # of visitsWhen the price of video games rise, the quantity demanded of video games falls substantiallyNote: Whether a good is a necessity or a luxury depends on personal preference
6 Influences on Price Elasticity of Demand Definition of the marketElasticity of demand in a market depends on its definition (how we qualify it)Narrowly defined markets tend to have more elastic demand than broadly defined marketsBecause easier to find substitutes if more narrowly definedFood -> inelasticIce Cream -> elasticVanilla Ice Cream -> very elastic
7 Influences on Price Elasticity of Demand Time HorizonGoods have more elastic demand in the long termExampleWhen the price of gasoline increases, the quantity of gasoline only falls slightly in the short termLong term, people will set up carpools, buy more fuel efficient cars, electric cars, ride buses, move closer to work
8 Influences on Price Elasticity of Demand Inexpensive vs expensiveExpensive items tend to have elastic demand curveInexpensive items tend to have inelastic demand curveA screw doubles in price from $0.05 to $0.10A civic doubles in price from $20,000 to $40,000
9 Total Revenue = Price x Quantity TR = P x Q Price (P)Quantity (Q)TRPrice (P)Quantity (Q)TRPrice INC, Total Revenue INCPrice INC, Total Revenue DECPrice DEC, Total Revenue DECPrice DEC, Total Revenue INC
10 Elasticity Coefficient Test The Elasticity Coefficient equals the percentage change in quantity demanded divided by the percentage change in priceButter goes from $1.00 to $1.20Causes 40% drop in amount bought40 percent/20 percent = 2.0Elasticity coefficient = 2Note: Use absolute values so all elasticities are positive numbersA larger price elasticity implies a greater responsiveness of quantity demanded to change in price
11 Computing the elasticity coefficient of demand Make sure to use positive numbersMake sure to start with original numbers
12 Figure out the elasticity of demand of both graphs above using the TR test Figure out the elasticity of demand of both graphs above by figuring out the of elasticity coefficientInelasticElasticElasticity Coefficient TestEd < 1Ed > 1
13 Influences on Price Elasticity of Demand So 5 tests of ElasticityTestsInelasticElasticSubstitutesFew SubstitutesMany SubstitutesNecessity v LuxuryNecessityLuxuryCostInexpensiveExpensiveTotal RevenueP Inc, TR IncP Dec, TR DecP Inc, TR DecP Dec, TR IncElasticity Coefficient TestEd < 1Ed > 1
14 Classification of Elasticity When the price elasticity of demand is greater than one, demand is defined to be elasticPercentage change in quantity demanded will be greater than the percentage change in priceWhen the price elasticity of demand is less than one, demand is defined to be inelasticPercentage change in price will be greater than the percentage change in quantity demandedWhen the price elasticity of demand is equal to one , the demand is said to have unit elasticityPercentage change in price will be equal to the percentage change in quantity demanded
15 Elasticity of Demand Curves Most demand curves that have a downward slope have an elastic, inelastic and unit elastic portion
16 Drawbacks to Coefficient Test There are some drawbacks to using the coefficient of price elasticity of demand testAs we have seen, the PED can vary at different points along a demand curve, due to its percentage natureAlso, percentage changes are not symmetric; rather, the percentage change between any two values depends on which one is chosen as the starting value and which one as the ending valueWhat if a company just wants to compare the results of two different possible pricings, instead of “starting” at one price and moving to another?If quantity demanded increases from 10 to 15 units, the percentage change is 50% (15-10)/10If quantity demanded decreases from 15 to 10 units, the percentage change is 33.3%....(10-15)/10
17 Midpoint MethodThus, we can use the midpoint method to avoid those problems. Also known as Arc ElasticityInvolves calculating the percentage change in either P or Qd by dividing the change in the variable by the midpoint between the initial and final levels rather than by the initial value itselfFormula:Note: Use averages for quantities and prices. Avoids having to deal with beg and ending valuesExample:Price of hamburgers rise from $4 to $6Quantity demanded falls from 120 to 80% change in quantity demanded = (120-80)/100 = 40%% change in price = (6-4)/5 x 100% = 40%Price elasticity of demand = 40/40 = 1
21 Figure 1 The Price Elasticity of Demand (d) Elastic Demand: Elasticity Is Greater Than 1PriceDemand$5501. A 22%increasein price . . .4100Quantityleads to a 67% decrease in quantity demanded.
22 Figure 1 The Price Elasticity of Demand (e) Perfectly Elastic Demand: Elasticity Equals InfinityPrice1. At any priceabove $4, quantitydemanded is zero.$4Demand2. At exactly $4,consumers willbuy any quantity.3. At a price below $4,quantity demanded is infinite.Quantity
23 Total Revenue = Amount paid by buyers and received by sellers of a good = price of the good times the quantity sold
24 Review Even though slope is constant, elasticity is not Slope is the ratio of changes in the 2 variablesElasticity is the ratio of percentage changes in the two variablesAt points with a high price and low quantity, the demand curve is ____At points with a low price and high quantity, the demand curve is ____
25 Elasticity When the price is $1, demand is inelastic An increase in price to $2 will increase total revenueWhen the price is $5, demand is elastic,A price increase to $6 will reduce total revenueAt $3.50, demand is unit elastic, and consumers will buy any quantity
26 Figure 3 How Total Revenue Changes When Price Changes: Inelastic Demand An Increase in price from $1to $3 …… leads to an Increase in total revenue from $100 to $240DemandDemand$380Revenue = $240$1100Revenue = $100QuantityQuantity
27 Figure 4 How Total Revenue Changes When Price Changes: Elastic Demand An Increase in price from $4to $5 …… leads to an decrease in total revenue from $200 to $100$520DemandDemandRevenue = $100$450Revenue = $200QuantityQuantity
29 Midpoint exampleExample: If the price of Hello Kitty pencil toppers increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 toppers, then your elasticity of demand, using the midpoint formula, would be calculated as…
30 Income Elasticity Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income
31 Income Elasticity Normal goods have ______income elasticities Inferior goods have ______income elasticitiesHigher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goodsNecessities tend to have _____income elasticities, whereas luxuries tend to have ______income elasticities
32 Important Side NoteWe use the absolute value when figuring out price elasticity of demand because the value is always negative (because when price changes in one direction, quantity demanded always changes in the other).But this isn't true for income. When income changes, people might want to buy more or less of the good.
34 Income ElasticityAfter irrevocably destroying symbols borrowed from the American West, PSY’s income rises from $100,000 to 1,000,000. The quantity of hamburger he buys each week rises from two pounds to four pounds.What is PSY’s income elasticity?What kind of good is hamburger for PSY?
35 Cross-Price Elasticity Cross-Price Elasticity of demand: A measure of how much the quantity demanded of one good responds to a change in the price of another goodCross-Price Elasticity = % change in quantity demanded of good 1___________________________________% change in price of good 2Substitutes have ______ cross price elasticities, whereas complements have ________cross-price elasticities
36 The sign matters for cross-price elasticity. When the price of one good changes, people might want to buy more of the other good, or less.
37 Cross Price Elasticities The price of Kris-Kross cassette tapes rise from $8 to $10. As a result, the quantity of Kris-Kross trading cards demanded falls from 8,000 per week to 9,500.What is the cross-price elasticity?What is the relationship between the two goods?
38 Elasticity of SupplyPrice elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good.Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price
44 Determinants of Price Elasticity of Supply Flexibility of SellersGoods that are somewhat fixed in supply have inelastic suppliesGoods that are not (books, cars, tamagotchi pets) have elastic supplies
46 Determinants of Price Elasticity of Supply Time PeriodSupply is usually more inelastic in the short runSupply is usually more elastic in the long run
47 The price of chocolate milk increases from $2. 85 per gallon to $3 The price of chocolate milk increases from $2.85 per gallon to $3.15 per gallon and the quantity supplied rises from 9,000 to 11,000 gallons per monthPrice elasticity of supply is ?
48 APPLICATION of ELASTICITY Can good news for farming be bad news for farmers?What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?
49 THE APPLICATION OF SUPPLY, DEMAND, AND ELASTICITY Examine whether the supply or demand curve shifts.Determine the direction of the shift of the curve.Use the supply-and-demand diagram to see how the market equilibrium changes.
51 Compute the Price Elasticity of Supply Supply is inelastic
52 Supply Supply _____, price _____, quantity demanded ______ If demand is ineastic, the fall in price is greater than the increase in quantity demanded and total revenue ______Demand for basic foodstuffs is usually inelasticLess revenue for farmersBecause farmers are price takers they still have incentive to adopt new hybrid so they can produce and sell more wheatExplains why number of farms has declined so much over the past 200 yearsAlso explains why some gov policies encourage farmers to decrease the amuont of crops planted
53 In the 1970s and 1980s, OPEC reduced the amount of oil it was willing to supply to world markets. The decrease in supply led to an increase in the price of oil and a decrease in quantity demanded. The increase in price was much larger in the short run than the long run. Why?