1. Econ 201 Chpt. 5 Demand Elasticity Own & Cross-price

2. What Does Elasticity Measure Price sensitivity of demand –Own price: measures how much qty demanded changes as (own) good’s price changes –Cross price: measures how much qty demanded changes as another good’s price (substitute or complement) changes For “close” substitutes -> larger change in quantity demanded (larger shift in own good’s demand curve)

3. Demand Curves

4. Key Points About Demand Curves How much is demanded at what price? –Signals to firms how much customers are willing to pay for a good or service How responsive is demand to price? –For the short term: what is the slope of the demand curve

5. Calculating the Slope

6. A Hypothetical Demand Curve PriceQty Demanded $101 $92 $83 $74 $65 $56 $47 $38 $29 $110

7. Calculating the Slope

8. Price Sensitivity of Demand Economist use the price elasticity of demand to summarize how responsive quantity demanded is to price Demand curves are not always linear; and responsiveness can change with price

9. Calculating Elasticity Elasticity is calculated at a point on the demand curve –Several choices: Initial point, final point, average (arc) elasticity –At $5 -> Qd = 6; At $6 ->Qd = 7 –Elasticity of demand (intital point):

10. Own-Price Elasticity

11. Demand and Own-price Elasticity

12. Demand Elasticity Own Price Always negative –First law of demand Talk about it in absolute terms –Less than |1| -> inelastic –Equal to |1| -> unit elastic –More than |1| -> (highly) elastic

13. Demand Elasticity Cross-price Substitutes –Demand (schedule) shifts right if price of substitute increases Quantity demanded will increase cross-price elasticity is always (+) positive Complements –Demand shifts left with increase in price of a substitute Cross-price elasticity is always (-) negative

14. What Does the Magnitude of the Elasticity Tell Us? Own-price –Larger absolute value (|e| > 1) Large changes in Qd with small changes in price –Close substitutes exist (pepsi/coke) –Or much consumption is discretionary (micro-brews) –Cross-price Large value (e >1) –Close (or good) substitute for good exists –Complements Large absolute value (|e| > 1) Consumption in fixed proportions