1. Elasticity: Measuring Responsiveness Dr. D. Foster - Microeconomics Inelastic Elastic

2. Elasticity A measure of responsiveness... A measure of responsiveness... Price elasticity of demand. Price elasticity of demand. Income elasticity of demand. Income elasticity of demand. Cross price elasticity of demand. Cross price elasticity of demand. Price elasticity of supply. Price elasticity of supply.

3. Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP if |  D | > 1 and demand is. Responsive if |  D | > 1 and demand is elastic. if |  D | < 1 and demand is. Unresponsive if |  D | < 1 and demand is inelastic. Note: Technically, calculated  D is always <0. %Δ = percentage change in

4. Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP Perfectly elastic  D =   D =  Perfectly inelastic  D = 0

5. Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP Along a straight line, changing elasticity!! Elastic Inelastic

6. Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP We talk about demand curves that are relatively elastic vs. relatively inelastic... Inelastic Elastic

7. Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP Elasticity tells us how TR will change with a change in the price... If elastic, ↑P will ↓TR (output effect dominates) (conversely, a ↓P will ↑TR) If elastic, ↑P will ↓TR (output effect dominates) (conversely, a ↓P will ↑TR) If inelastic, ↑P will ↑TR (price effect dominates) (conversely, a ↓P will ↓TR)

8. Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP How to calculate this... Easy if the %Δ is given for both. Easy if the %Δ is given for both. Find the %Δ from the base. Find the %Δ from the base. Find the %Δ from the average. Find the %Δ from the average. What is elasticity if price rises by 10% and quantity demanded falls by 5%? What is elasticity if price rises from $1 to $1.10 and quantity demanded falls from 100 to 95?  D = 5/97.5.10/1.05 =.538

9. Price Elasticity of Demand Determinants of elasticity... The degree of substitutes available more substitutes = more elastic Amount of budget spent on this good higher proportion spent = more elastic Relative importance of this good more of a luxury = more elastic Time to respond to price change more time = more elastic

10. Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP What happens when electricity prices rise? $.05 Over next month $.50 10 11 1 Over 5 years Over next year 6

11. Elasticity Questions 1. If the price of butter goes up 50% and the quantity demanded falls by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? 1. If the price of butter goes up 50% and the quantity demanded falls by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? 2. If the price of the Rolling Stones’ CD, Semi-Serious, is reduced from $20 to $18, and the quantity demanded (say, on a per month basis) rises by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? 2. If the price of the Rolling Stones’ CD, Semi-Serious, is reduced from $20 to $18, and the quantity demanded (say, on a per month basis) rises by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why?

12. Elasticity Questions 3. If the price of gas goes up by 30% and the quantity demanded falls from 1,000,000 gallons/day to 900,000 gallons/day, what is the price elasticity of demand? Is this elastic or inelastic? Why? If the price, then, falls back by 30%, would you predict the response by consumers will be elastic or inelastic? Why? 3. If the price of gas goes up by 30% and the quantity demanded falls from 1,000,000 gallons/day to 900,000 gallons/day, what is the price elasticity of demand? Is this elastic or inelastic? Why? If the price, then, falls back by 30%, would you predict the response by consumers will be elastic or inelastic? Why? 4. A popular pair of Nike shoes, the Paris Hilton Liteweights, is reduced in price from $80 to $40, while the quantity demanded rises from 10,000 pairs/week to 20,000 pairs/week. What is the price elasticity of demand? Is this elastic or inelastic? Why? 4. A popular pair of Nike shoes, the Paris Hilton Liteweights, is reduced in price from $80 to $40, while the quantity demanded rises from 10,000 pairs/week to 20,000 pairs/week. What is the price elasticity of demand? Is this elastic or inelastic? Why?

13. Elasticity Questions 5. What do execs at Pepsi expect TR to do when they have a sale on their soft drink? Why? 6. You manage a concert hall that seats 500. Consider the following demand information: What do you charge? What do you charge? At a price of: Amount sold is: $10500 $15400 $20200

14. Elasticity Questions 7. Consider Demand (D A ) with equilibrium at point A. A $.50 per unit tax is placed on this good... a) Does S’ show the new supply? Yes. Do you know why? b) What is the change in total revenue as you move to the new equilibrium at A’? c) What is the price elasticity of demand? d) What is the value of the taxes collected?

15. Elasticity Questions 8. Consider Demand (D B ) with equilibrium at point B. A $.50 per unit tax is placed on this good... a) Does S’ show the new supply? Yes. Do you know why? b) What is the change in total revenue as you move to the new equilibrium at B’? c) What is the price elasticity of demand? d) What is the value of the taxes collected?

16. Elasticity A measure of responsiveness... Price elasticity of demand: P and Q D Income elasticity of demand Cross price elasticity of demand Price elasticity of supply

17. Income Elasticity of Demand How responsive is the Q D to a Δ in Income? May be a Normal good (>0) or an inferior good ( 0) or an inferior good (<0) Cross Price Elasticity of Demand How responsive is the Q D for one good if there is a ΔP of some related good? If substitutes then >0; If complements then 0; If complements then <0 Price Elasticity of Supply How responsive is the Q S to a ΔP? Positive

18. Elasticity: Measuring Responsiveness Dr. D. Foster - Microeconomics Inelastic Elastic