Price Elasticity Coefficient Formula E d = % change in quantity demanded of product X % change in price of product X Calculating % change % Change in quantity = nqd – iqd initial quantity demanded Example: % Change in quantity 100,000 nqd - 110,000 iqd = - 10, ,000 =.10 or 10% 100,000 1

Price Elasticity Coefficient Formula E d = % change in quantity demanded of product X % change in price of product X Change in price = New Price – Initial Price Initial price New Price = $4 Initial Price = $3 $4 np - $3 ip = $1 =.33 or 33% $3 ip $3

Price Elasticity Coefficient Formula E d = % change in quantity demanded of product X % change in price of product X 10% =.30 or 30% 33%

Chapter 6: Extensions of Supply, Demand, and Supply Analysis

Elasticity It is all about how things respond to changes in prices –Responsive or not responsive 5

Supply and Demand Review 1.Define the Law of Demand 2.Define the Law of Supply 3.What is the difference between a change in demand and a change in quantity demanded? 4.What happens if price is above equilibrium? 5.What happens if price is below equilibrium? 6.Define Consumer’s and Producer’s Surplus 7.Identify the rule for double shifts in S&D 8.Explain the results of an excise tax

HOW MUCH MORE OR LESS? DOES IT MATTER? THE LAW OF DEMAND SAYS... Consumers will buy more when prices go down and less when prices go up 7

Elasticity Elasticity shows how sensitive quantity is to a change in price.

Summary of the Chapter Paul Salmon Video - Elasticity 9

Goals Of This Chapter By the end of this chapter you should be able to do the –Elasticity SlideElasticity Slide 10

4 Types of Elasticity 1.Elasticity of Demand 2.Elasticity of Supply 3.Cross-Price Elasticity (Subs or Comp) 4.Income Elasticity (Norm or Inferior)

Total Revenue Total revenue = total amount the seller receives from the sale of a product or service –In a particular time period Formula TR = P * Q TR = total revenue P = Price Q = quantity 12

Total Revenue Formula TR = P X Q TR = total revenue P = Price Q = quantity Example –Price is $3.50 per gallon –Quantity = 10 gallons –$3.5 * 10 = $35 Total Revenue 13

What Happens If--- What happens to total revenue if –Prices go up? –Prices go down? We know about the Supply and Demand Curve –Does not tell us what happens if--- Brings us to elasticity 14

Elasticity Measure of the responsiveness of the quantity demanded to a good or service –To change in price –When all other factors remain the same

1. Elasticity of Demand Elasticity of Demand- Measurement of consumers responsiveness to a change in price. What will happen if price increase? How much will it affect Quantity Demanded Who cares? Used by firms to help determine prices and sales Used by the government to decide how to tax

Elasticity of Demand In the previous section, supply and demand curves were drawn as straight lines. This is a simplification, –we assume rate of change of demand or supply is the same for all prices in the market. At some prices, a small change in price may – cause a large change in the quantity demanded.

Name--- In the short run, name Products whose price change will not change demand much Products whose price change will change demand significantly 18

This shown in the diagram as the movement from Pe to Pe1; a small change in price which causes an even larger percentage decrease in quantity demanded (from Qe to Qe1. At other prices, a large increase in price may see a much smaller decrease in demand. This shown in the diagram as the movement from Pe2 to Pe3; a large change in price which causes a smaller percentage decrease in quantity demanded (from Qe2 to Qe3.

Inelastic Demand

If price increases, quantity demanded will fall a little If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 20% 5% INelastic = Quantity is INsensitive to a change in price. Examples: Gasoline Milk Diapers A INELASTIC demand curve is steep! (looks like an “I”) Chewing Gum Medical Care Toilet paper

Inelastic Demand If percentage change in price produces a smaller percentage change in quantity demanded 22

Inelastic Demand 20% 5% General Characteristics of INelastic Goods: Few Substitutes Necessities Small portion of income Required now, rather than later Elasticity coefficient less than 1

Example: Calculate 24

Elastic Demand

If price increases, quantity demanded will fall a lot If price decreases, quantity demanded increases a lot. In other words, the amount people buy is sensitive to price. Elastic = Quantity is sensitive to a change in price. An ELASTIC demand curve is flat! Examples: Soda Boats Beef Real Estate Pizza Gold

Elastic Demand General Characteristics of Elastic Goods: Many Substitutes Luxuries Large portion of income Plenty of time to decide Elasticity coefficient greater than 1

Price Elasticity Coefficient Formula E d = % change in quantity demanded of product X % change in price of product X Calculating % change % Change in quantity = nqd – iqd initial quantity demanded Example: % Change in quantity 100,000 nqd - 110,000 iqd = - 10, ,000 =.10 or 10% 100,000 28

Price Elasticity Coefficient Formula E d = % change in quantity demanded of product X % change in price of product X Change in price = New Price – Initial Price Initial price New Price = $4 Initial Price = $3 $4 np - $3 ip = $1 =.33 or 33% $3 ip $3

Price Elasticity Coefficient Formula E d = % change in quantity demanded of product X % change in price of product X 10% =.30 or 30% 33%

Graph Graph the previous example Is it elastic or inelastic? WHY? –Inelastic because change in % change in quantity demanded is less than % change in price Or a 33% change in price created a 10% drop in quantity demanded Calculated price elastic is < 1 therefore price is inelastic

You Solve Decide the price elasticity of demand for a slice of pizza at $2.00 by examining a price decrease from $2.00 to $1.50 per slice. In this case, the demand pizza would increase from 7 million slices to 10 million slices. You can use these figures to calculate the price elasticity of demand

E d = % change in quantity demanded of product X % change in price of product X E d = (10M – 7M) ÷ 7M (DN-O÷O) ($ $2.00) ÷ $2.00 (PN-O÷O) E d =.43 = Drop the negative: E d is > 1 therefore the demand for pizza slices is elastic

Negative Numbers If price increases by 10% and consumers respond by decreasing purchases by 20% the equation computes the elasticity coefficient as -2. The result is negative because an increase in price (a positive number) leads to a decrease in purchases (a negative number). Because the law of demand says it will always be negative, many economists ignore the negative sign

Elastic or Inelastic? Beef Gasoline-.20 Real Estate- 1.6 Medical Care-.31 Electricity-.13 Gold- 2.6 Elastic INelastic Elastic INelastic Elastic What about the demand for insulin for diabetics? Perfectly INELASTIC (Coefficient = 0) What if % change in quantity demanded equals % change in price? Unit Elastic (Coefficient =1)

2. Price Elasticity of Supply Elasticity of Supply- Elasticity of supply shows how sensitive producers are to a change in price. Elasticity of supply is based on time limitations. Producers need time to produce more. INelastic = Insensitive to a change in price (Steep curve) Most goods have INelastic supply in the short-run Elastic = Sensitive to a change in price (Flat curve) Most goods have elastic supply in the long-run Perfectly Inelastic = Q doesn’t change (Vertical line) Set quantity supplied

Elasticity of supply is influenced by a number of factors. These include : the length of the production period. In the late 1990's, demand for Australia wines overseas has reached all time records. Vines take three years to grow to a point where they yield adequate amounts of fruit. Increases in demand for Australian wine has seen prices rise (from Po to P1), and returns to existing grape growers are excellent. Those who wish to buy grapes face a market where supply can only increase marginally (from Qo to Q1), in the short term. However, many new stands of vines are being planted, and in a few years, returns to growers may stabilise, as supply increases. Prices will fall from P1 to P2 as the supply of grapes increases from Q1 to Q2.

Elasticity Over Time - Supply 38

Elasticity Over Time - Supply 39

Elasticity Over Time - Supply 40

2.Price Elasticity of Supply Over Time

Price Elasticity of Supply Over Time How would you graph the supply elasticity of Gas over time? Lets see 42

3. Cross-Price Elasticity of Demand Cross-Price elasticity shows how sensitive a product is to a change in price of another good It shows if two goods are substitutes or complements % change in price of product “a” % change in quantity of product “b” (test) If coefficient is negative (shows inverse relationship) then the goods are complements If coefficient is positive (shows direct relationship) then the goods are substitutes P increases 20%Q decreases 15%

Think Pizza and Burgers are elastic and substitutes of each other If the price of pizza declines 1. What happens to the sale of pizza? 2. What happens to the sale of burgers? 2. Soda is a compliment to pizza. What happens to the sale of soda? Lets Graph

Income elasticity shows how sensitive a product is to a change in INCOME It shows if goods are normal or inferior % change in income % change in quantity (test) If coefficient is negative (shows inverse relationship) then the good is inferior If coefficient is positive (shows direct relationship) then the good is normal Ex: If income falls 10% and quantity falls 20%… Income increases 20%, and quantity decreases 15% then the good is a… 4. Income-Elasticity of Demand INFERIOR GOOD

Total Revenue Test Uses elasticity to show how changes in price will affect total revenue (TR). (TR = Price x Quantity) Elastic Demand- Price increase causes TR to decrease Price decrease causes TR to increase Inelastic Demand- Price increase causes TR to increase Price decrease causes TR to decrease Unit Elastic- Price changes and TR remains unchanged Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases?

Is the range between A and B, elastic, inelastic, or unit elastic? A B 10 x 100 =$1000 Total Revenue 5 x 225 =$1125 Total Revenue Price decreased and TR increased, so… Demand is ELASTIC 125% 50%

You Should Now Get This Elastic and Inelastic Demand Baby –Winner 2013 Econ video contest 48

Total Revenue Test

} inelastic } unit elastic } elastic

Password 1.Demand 2.Substitute 3.Inferior Good 4.Elastic 5.Total Revenue Test

Terms 1.Subsidy 2.Supply 3.Excise Tax 4.Inelastic 5.Elasticity Coefficient

Elasticity Practice 53

Graph the following chart Calculate the E d using the top set of numbers and prices rising

Answers -Graph This is what your graph should look like

Answers - E d Ed = % change in quantity demanded of product X % change in price of product X % Change in quantity = nqd – iqd initial quantity demanded % Change in price = New Price – Initial Price Initial price Ed = (90 – 100) ÷ 100 ($2 - $1.00) ÷ $1.00 Ed = -.10 = Drop the negative: E d is < 1 therefore the demand for is INelastic

Calculate the TR and determine if Total Revenue increased or decreased with a price increase What is gain or loss on price move?

Answers $3 * 70 = $210 $2 * 90 = $180 Total Revenue increased $30

What Happens If --- Graph the following chart Calculate the E d using the bottom two numbers and prices rising

Answers - E d Ed = % change in quantity demanded of product X % change in price of product X % Change in quantity = nqd – iqd initial quantity demanded % Change in price = New Price – Initial Price Initial price Ed = (40 – 70) ÷ 70 ($4 - $3.00) ÷ $3.00 Ed = or 42.85% = or 33.33% Drop the negative: E d is > 1 therefore the demand for is elastic

E d & TR Test “quiz”

Practice Problem See handout

Consumer and Producer Surplus Consumer Surplus –Difference between maximum price willing to pay and the actual price producers charge –Think of it as a “willing to pay” curve 63

Marginal Benefit & Surplusses Marginal Benefit –What you gain when you get one more unit –Measured by what you are willing to give up –Everyday life we say “getting value for our money” –There is a difference between value and price

Value vs. Price Value is what we get Price is what we pay Everyday idea of value is marginal benefit OR The measure of the maximum price what consumers are willing to pay for another unit of a good or service

Pizza Sales Per Slice P D $ Consumer Surplus Amount Paid Market Price Consumer surplus from 10 th slice of pizza Willing to pay

Voluntary Exchange In the free-market, buyers and sellers voluntarily come together to seek mutual benefits. 67

Voluntary Exchange In the free-market, buyers and sellers voluntarily come together to seek mutual benefits. 68

Voluntary Exchange In the free-market, buyers and sellers voluntarily come together to seek mutual benefits. 69

Voluntary Exchange In the free-market, buyers and sellers voluntarily come together to seek mutual benefits. 70

Example of Voluntary Exchange Ex: You want to buy a truck so you go to the local dealership. You are willing to spend up to $20,000 for a new 4x4. The seller is willing to sell this truck for no less than $15,000. After some negotiation you buy the truck for $18,000. Analysis: Buyer’ Maximum- Sellers Minimum- Price- Consumer’s Surplus- Producer’s Surplus- $20,000 $15,000 $18,000 $2,000 $3,000 71

Consumer Surplus is the difference between what you are willing to pay and what you actually pay. CS = Buyer’s Maximum – Price Producer’s Surplus is the difference between the price the seller received and how much they were willing to sell it for. PS = Price – Seller’s Minimum Voluntary Exchange Terms 72

Pearl Exchange Activity 73

Voluntary Exchange Activity 74

S P Q D Consumer and Producer’s Surplus $ $ CS PS 75 Calculate the : 1.Consumer Surplus 2.Producer Surplus 3.Total Surplus

Calculating Consumer Surplus In Dollars Max Willing to pay Actual price (E) CalculateCS $9$59 – 5 =$4 $8$58 – 5 =$3 $7$57 – 5 =$2 $6$56 – 5 =$1 $5 5 – 5 =$0 76 Sum = CS = $10

Calculating Producer Surplus In Dollars Min Price charged Actual price (E) CalculatePS $2$5 5 – 2 =$3 $ =$2 $4$ =$1 $5 5 – 5 =$0 77 Sum = PS = $6

Surpluses Could be calculated in Quantity 78

Summary Consumption Inefficiency Production Inefficiency

Practice Problem Name of ConsumerPrice willing to pay Matt$20 Don$15 Sarah$8 George$12 Ann$7 Q. If dinner sells for $10, what is the value of Dons’ consumer surplus?

Practice Problem Name of ConsumerPrice willing to pay Matt$20 Don$15 Sarah$8 George$12 Ann$7 Q. If dinner sells for $10, what is the value of Dons’ consumer surplus? A. Willing to pay is $15. Market price is $10. Willing to pay ($15) – Actual Price ($10) = $5

Practice Problem Name of ConsumerPrice willing to pay Matt$20 Don$15 Sarah$8 George$12 Ann$7 Q. If dinner sells for $11, what is the TOTAL value of consumer surplus?

Practice Problem Name of ConsumerPrice willing to pay Matt$20 Don$15 Sarah$8 George$12 Ann$7 Q. If dinner sells for $11, what is the TOTAL value of consumer surplus? A.20 – 11 = 9, 15 – 11 = 4, 12 – 11 = = $14 consumer surplus

For a given linier demand curve, the value of consumer surplus does what as market price increases?

Decreases as market price increases

(1) Price (2) Q A (3) (4) Q B (5) (6) Q C (7) $10100$_____100$_____100$_____ 9111_____130_____110_____ 8125_____170_____120_____ 7143_____220_____130_____ 6167_____280_____140_____ 5200_____350_____150_____ A marketing firm has done a study of market demand for DVDs of three different movies. Calculate the total revenue for each movie in columns 3, 5, and 7. Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue?

(1) Price (2) Q A (3) (4) Q B (5) (6) Q C (7) $10100$ $ $ Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue? Applying the total revenue test, we see that total revenues remain approximately constant for movie A, meaning that demand is unit-elastic. Total revenues for movie B are increasing as price decreases, meaning that demand for movie B is elastic. Total revenues for movie C are decreasing as price decreases, meaning the demand for movie C is inelastic. [text: E pp ; MA pp ; MI pp ]