7 - 1 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show AP Microeconomics Total Revenue & Elasticity

7 - 2 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Answers: Find Elasticity from A to B: –E d = 7: Elastic (%ΔP<% ΔQD) Find Elasticity from D to C: –E d = 1: Unitary Elastic (%ΔP=% ΔQD) –Find Elasticity from D to E: –E d = 1: Unitary Elastic (%ΔP=% ΔQD) Find Elasticity from F to G: –E d =.33: Inelastic (%ΔQD<% ΔP)

7 - 3 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D When prices are low, TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE So is total revenue

7 - 4 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D Total revenue rises with price to a point... TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

7 - 5 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

7 - 6 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

7 - 7 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

7 - 8 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D Total revenue rises with price to a point... then declines Inelastic Demand Inelastic Demand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

7 - 9 Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D Total revenue rises with price to a point... then declines Elastic Demand Elastic Demand Inelastic Demand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE Inelastic Demand

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Q P D Total revenue rises with price to a point... then declines Elastic Demand Elastic Demand Inelastic Demand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE Inelastic Demand Unit Elastic

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show RULES: When products are more expensive, say luxuries or normal goods, they tend to be elastic. When products get cheaper, they become smaller in comparison to our total income, therefore price matters less.

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Inelastic from 0 to 1 Typical of necessities one must have Typical of luxuries one wants Elastic from 1 to  Unit elastic when exactly = 1 Price change does not reduce total revenue Price Elasticity is... PRICE ELASTICITY & TOTAL REVENUE

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show DETERMINANTS OF PRICE ELASTICITY OF DEMAND 1. Substitutability 2. Proportion of Income 3. Luxuries versus Necessities 4. Time Applications... Excise Taxes on inelastic products

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Questions to think about: If smoking is so bad, why doesn’t government make it illegal? Rather government imposes high sin and excise taxes on cigarettes. Why would they do this? What does this tell you about the demand elasticity of this product? The same goes for the high excise taxes on the manufacture of gasoline. How would government be hurt by more hybrid cars or vehicles using alternative fuel?

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Excise Taxes We have learned that if a product is inelastic, raising the price will result in more revenue. These are the products that consumers are more likely to buy regardless of price. Example: Gasoline and cigarettes. Result: Government knows that taxing these items will not get consumers to use less, but will raise more revenue.

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show Using Elasticity What is the difference between complements and substitutes? What is the difference between normal and inferior goods? Elasticity can help us to mathematical prove why/how products are related:

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show CROSS ELASTICITY OF DEMAND E xy = Percentage change in quantity demanded of good X Percentage change in the price of good y This type of calculation is used to determine the relationship between two products; the formula will find out if the products are at all related. E xy = %∆QD x %∆P y

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show RULES: Positive Sign Goods are Substitutes Negative Sign Goods are Complementary Zero or near-zero value Goods are Independent TRY THE PROBLEMS (You do not even have to figure out the final answer)

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show INCOME ELASTICITY OF DEMAND E i = Percentage change in quantity demanded Percentage change in income This elasticity shows how income effects consumer’s purchasing power. Normal [sometimes even called superior] goods we buy more when we have extra money; inferior goods we buy more when we have little money. E i = %∆QD %∆income

Copyright McGraw-Hill/Irwin, 2002 Price Elasticity of Demand Price Elasticity and Total Revenue Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity of Demand Income Elasticity of Demand Government-Set Prices Key Terms Previous Slide Next Slide End Show RULES: Positive Sign Goods are Normal or Superior Negative Sign Goods are Inferior TRY THE PROBLEMS (You do not even have to figure out the final answer)