Copyright © 2004 South-Western Warm Up: Let’s have on final practice problem… Spring Break gets extended by one week this year!!! At the same time, United Airlines’ pilots go on strike. What impact will these events have on the equilibrium price and equilibrium quantity for airline tickets to Cancun? 1. Equilibrium Price 2. Equilibrium Quantity Hint: Draw two graphs
Copyright © 2004 South-Western Question: You own a thriving sandwich shop in downtown Crystal Lake. You want to increase your revenue (make more $) Should you raise the prices or lower them? That depends on the market’s price elasticity of demand for your product.
Copyright © 2004 South-Western 5 Elasticity and Its Application
Copyright © 2004 South-Western Price Elasticity of Demand Where would you buy gas at the “old 5-Way”? SHELL or MOBILE? Shell - $2.39Mobil - $2.61
Copyright © 2004 South-Western Price Elasticity of Demand Remember the LAW OF DEMAND?? Price Elasticity of Demand : Describes the sensitivity of quantity demanded to movements in price. Price elasticity of demand describes the SLOPE of the demand curve
Copyright © 2004 South-Western Figure 1b The Price Elasticity of Demand
Copyright © 2004 South-Western Figure 1c The Price Elasticity of Demand
Copyright © 2004 South-Western Figure 1d The Price Elasticity of Demand
Copyright © 2004 South-Western Figure 1a The Price Elasticity of Demand Can you name any products that would have a demand curve that looks like this? Perhaps … Chemotherapy drugs
Copyright © 2004 South-Western Figure 1e The Price Elasticity of Demand
Copyright © 2004 South-Western Price Elasticity of Demand Price Elasticity of Demand : Describes the sensitivity of quantity demanded to movements in price. **Or, how likely will consumers buy something else if you raise price. What determines the sensitivity (elasticity)? 1.Availability of Substitutes Many substitutes More Elastic (more sensitive to movements in price) Few substitutes More Inelastic (less sensitive) 2.Luxury vs. Necessity Luxury goods Elastic Necessity goods Inelastic
Copyright © 2004 South-Western 3. Definition of the Market (ie. Gas vs. Thornton’s Gas) Gas (Broad Definition of the Market) Inelastic Thornton’s Gas (Specific Definition of the Market) Elastic 4. Time Horizon (Short Time Horizon vs. Long ) Short Time horizon More Inelastic Long Time horizon More Elastic Determinants of Elasticity of Demand Cont’d….
Copyright © 2004 South-Western 5 Elasticity and Its Application Practice Problems- wkst Elasticity and Its Application Practice Problems- wkst
Copyright © 2004 South-Western How sensitive is the demand for these products to changes in price? Elastic Demand or Inelastic Demand 1. Salt Inelasticnecessity 2. New Cars Elasticluxury, has substitutes 3. Pork Chops Elastichas substitutes 4. European vacation trip Elasticluxury, has substitutes 5. Insulin Inelastic-necessity 6. Insulin at one of four drugstores in a shopping mall Elastic -narrow market
Copyright © 2004 South-Western Question: You own a thriving sandwich shop in downtown Crystal Lake. You want to increase your revenue (make more $) Should you raise the prices or lower them? That depends on the market’s price elasticity of demand for your product.
Copyright © 2004 South-Western Figure 2 Total Revenue- The total revenue is the price of the product times the quantity sold.
Copyright © 2004 South-Western Figure 3 How Total Revenue Changes When Price Changes: Inelastic Demand The two graphs show the difference in total revenue for the same product priced at $1 and 3$. Notice the slope of the demand curve!! Because the price elasticity of demand is inelastic, raising the price results in greater total revenues, since the quantity sold only goes down by a small percentage, relative to the price change.
Copyright © 2004 South-Western Figure 4 How Total Revenue Changes when Price Changes: Elastic Demand Look what happens to total revenue if price is raised and price elasticity of demand is elastic. Price is raised from $4 to $5 and total revenue goes down by $100.
Copyright © 2004 South-Western Figure 10a Policies to Reduce the Use of Illegal Drugs
Copyright © 2004 South-Western Figure 10b Policies to Reduce the Use of Illegal Drugs
Copyright © 2004 South-Western Figure 5 Elasticity of a Linear Demand Curve
Copyright © 2004 South-Western Figure 5 Elasticity of a Linear Demand Curve Question: How does Wallmart see the Price Elasticity of Demand for their products? Elastic or Inelastic
Copyright © 2004 South-Western Figure 6b The Price Elasticity of Supply
Copyright © 2004 South-Western Figure 6c The Price Elasticity of Supply Suppliers also have a price elasticity to supply. Suppliers respond to price changes by supplying more or less, but how much more or less varies according which product.
Copyright © 2004 South-Western Figure 6d The Price Elasticity of Supply The production of some products respond easier to price changes, than others. Suppliers can supply much more if price increases. Think: Cell Phone shops, or Cash for Gold stores.
Copyright © 2004 South-Western Figure 7 How the Price Elasticity of Supply Can Vary For many products it’s easier to expand production at first, but gets more difficult after initial efficiencies are exhausted.
Copyright © 2004 South-Western Figure 8 An Increase in Supply in the Market for Wheat
Copyright © 2004 South-Western Figure 9a A Reduction in Supply in the World Market for Oil
Copyright © 2004 South-Western Figure 9b A Reduction in Supply in the World Market for Oil