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KRUGMAN'S MICROECONOMICS for AP* The Income Effect, Substitution Effect, and Elasticity Margaret Ray and David Anderson 46 10 Micro: Econ: Module.

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Presentation on theme: "KRUGMAN'S MICROECONOMICS for AP* The Income Effect, Substitution Effect, and Elasticity Margaret Ray and David Anderson 46 10 Micro: Econ: Module."— Presentation transcript:

1 KRUGMAN'S MICROECONOMICS for AP* The Income Effect, Substitution Effect, and Elasticity Margaret Ray and David Anderson Micro: Econ: Module

2 Housekeeping Restroom procedure – ask first. Supply & demand grades in Genesis. Review this week. Read modules 46 and 47 for tomorrow.

3 Today’s Questions : Why the demand curve slopes downwards? How we can measure consumer sensitivity to price?

4 Do Now What is your reaction to price increases?

5 Experiment – Round 1  Assume each team member has $2.00  Assume Starbursts and Lollipops cost $  Have each team member write down how much they would buy of each. Count up the team total.

6 Experiment – Round 2  Assume each team member has $2.00  Assume Starbursts cost $ 0.50, but Lollipops now cost $1.00.  Have each team member write down how much they would buy of each. Count up the team total.

7 Substitution Effect  As price increases for one item, consumers will substitute a lower priced item.

8 Experiment – Round 3  Assume each team member has $2.00  Assume Starbursts prices fall to $0.25, and Lollipops prices return to $0.50.  Have each team member write down how much they would buy of each. Count up the team total.

9 Income Effect  As price decreases, consumers have greater purchasing power. Will increase spending on the item.  Price increases have opposite effect of making people feel poorer, so they consume less of the item.

10 Quick Write  What products would be more impacted by the substitution effect?  By the income effect?

11 Elasticity  Measures responsiveness of one variable (generally quantity) to changes in another.  Price elasticity of demand measures responsiveness in quantity demanded to changes in price.  % ∆ in Q / % ∆ in P

12 Draw Graph with 5 points PointPriceQ A$ B$4.002 C$3.003 D$2.004 E$1.005

13 The Midpoint Formula The solution: Use the Midpoint formula! %ΔQ d = 100*(New Quantity – Old Quantity)/Average Quantity %ΔP = 100*(New Price – Old Price)/Average Price Ed = %ΔQ d /ΔP

14 Desk Partners  Calculate elasticity for three different curves on worksheet #

15 Levels of Elasticity  Elastic > 1  Unit Elastic = 1  Inelastic < 1  What does that mean in English?

16 Summary  Demand curves slope downward because of the income and substitution effects.  Price elasticity of demand measures the responsiveness of quantity demanded to changes in price.  Use mid-point formula  Elastic, unit elastic and inelastic.

17 Exit ticket  Pizza demand in LHS cafeteria  Price change $ 2.00 to $1.00  Quantity demanded increases from 100 to 300  Calculate elasticity using mid-point.  Elastic or inelastic?  Which is greater substitution or income effect?

18 Figure 47.1 Two Extreme Cases of Price Elasticity of Demand Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

19 Figure 47.2 Unit-Elastic Demand, Inelastic Demand, and Elastic Demand Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

20 KRUGMAN'S MICROECONOMICS for AP* Interpreting Price Elasticity of Demand Margaret Ray and David Anderson Micro: Econ: Module

21 Today’s Questions : How does elasticity vary along the demand curve? How can we use elasticity to make money? What factors determine price elasticity of demand?

22 Elasticity Investigation  Desk partners. Graph a demand curve using at least 10 units.  ½ do elastic curves, ½ inelastic curves

23 Elasticity Investigation  Swap your graph with someone across the room.  Calculate three elasticities…..

24 Elasticity Investigation Near Top In Middle Near Bottom

25 Elasticity Investigation Compare your elasticities with two other groups. Is there a common pattern?

26 R ElElasticity along the Demand Curve Why do we get this pattern???

27 Elasticity and Total Revenue Total Revenue and Elasticity TR = P x Q Price effect – direct effect of lower / higher price. Quantity effect – change in quantity due to price change.

28 Activity: Elasticity and Revenue  Switch desk partners with row behind / in front.  Calculate elasticity and revenue for the scenarios in the worksheet.  Is there a predictable relationship between elasticity and revenue?

29 Individual Practice  Help the bookseller in worksheet figure out which customer group should get a discount.

30 Determinants of Price Elasticity of Demand Availability of substitutes Luxury or necessity Share of income spent Time

31 Summary  Price elasticity of demand changes depending upon where you measure it on the demand curve.  Goes from elastic to inelastic.  Understanding elasticity allows us to predict how firm revenue will react to price changes.  Substitutes, Luxury vs. Necessity, Income Share and Time all determine the elasticity of demand for a product.


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