1. Chapter 6 Elasticity, Consumer Surplus, and Producer Surplus
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives Price elasticity of demand The total revenue test
Price elasticity of supply
Cross elasticity of demand
Income elasticity of demand
Consumer & producer surplus
Efficiency losses
6-2

3. Price Elasticity of Demand
Measuring responsiveness to price changes
Elastic demand
Large change in quantity purchased for given price change
Inelastic demand
Small change in quantity purchased for given price change
6-3

4. Price Elasticity of Demand
Price-elasticity coefficient and formula
Percentage Change in Quantity
Demanded of Product X
Ed =
Percentage Change in Price
of Product X
6-4

5. Price Elasticity of Demand
Calculate percentage change
Restate formula
Change in Quantity Demanded of X
Ed =
Original Quantity Demanded of X
Change in Price of X ÷
Original Price of X
6-5

6. Price Elasticity of Demand
Calculation problem
Starting point matters
Midpoint formula
Change in Quantity
Ed =
Sum of Quantities/2 ÷
Change in Price
Sum of Prices/2
6-6

7. Interpretations of Elasticity
Elastic Demand
Ed =
.04
.02
= 2
Inelastic Demand
Ed =
.01
.02
= .5
Unit Elasticity
Ed =
.02
= 1
6-7

8. Price Elasticity of Demand
Why use percentages?
Unit free measure
Compare responsiveness across products
Elimination of the (-) sign
Extreme cases
Perfectly inelastic demand
Perfectly elastic demand
6-8

9. The Total Revenue Test Total Revenue = TR = PxQ Inelastic demand
P and TR change in same direction
Elastic demand
P and TR change in opposite direction
6-9

10. The Total Revenue Test Lower price and elastic demand
Blue gain exceeds gold loss $3 2 1 Q P a b D1
6-10

11. The Total Revenue Test Lower price and inelastic demand
Gold loss exceeds blue gain $4 3 2 1 Q P c d D2
6-11

12. The Total Revenue Test Lower price and unit-elastic demand
Blue gain equals yellow loss $3 2 1 Q P e f D3
6-12

13. Elasticity on a Linear Demand Curve
(1)
Total Quantity of
Tickets Demanded
Per Week, Thousands
(3)
Elasticity
Coefficient (Ed)
(4)
Total Revenue
(1) X (2)
(5)
Total-Revenue
Test
(2)
Price Per Ticket 1 2 3 4 5 6 7 8 $8 7 6 5 4 3 2 1
$8,000
14,000
18,000
20,000
8,000 ]
5.00
2.60
1.57
1.00
0.64
0.38
0.20 ]
Elastic
Unit Elastic
Inelastic
6-13

14. Elasticity and the TR Curve1 2 3 4 5 6 7 8
Quantity Demanded
Price
(Thousands of Dollars)
Total Revenue
$20 18 16 14 12 10 $8
Elastic
Ed > 1 a b c d e f g h
Unit Elastic
Ed = 1
Inelastic
Ed < 1 D TR
6-14

15. Determinants of Elasticity
Substitutability
More substitutes, more elastic demand
Proportion of income
Price relative to income
Luxuries versus necessities
Luxuries are more elastic
Time
More elastic in the long run
6-15

16. Applications of Elasticity
Large crop yields
Inelastic demand
Excise taxes
Decriminalization of illegal drugs
Elastic or inelastic demand?
6-16

17. Price Elasticity of Supply
Responsiveness to price changes by producers
Percentage Change in Quantity
Supplied of Product X
Es =
Percentage Change in Price
of Product X
6-17

18. Price Elasticity of Supply
Market period
Perfectly inelastic supply
Short run
Fixed plant size
Long run
Adjustable plant size
Supply more elastic
6-18

19. Price Elasticity of Supply
The Market Period
Perfectly inelastic supply P Q Sm
Greatest
Price
Impact Pm P0 D1 D2 Q0
6-19

20. Price Elasticity of Supply
The Short Run
Inelastic supply P Q Ss
Lower
Price
Impact Ps P0 D1 D2 Q0 Qs
6-20

21. Price Elasticity of Supply
The Long Run
Elastic supply P Q Sl
Least
Price
Impact Pl P0 D1 D2 Q0 Ql
6-21

22. Price Elasticity of Supply
Applications
Antiques and reproductions
Limited, inelastic supply
Strong demand
Resulting high price
Volatile gold prices
Inelastic supply
Shifting demand
6-22

23. Cross Elasticity of Demand
Responsiveness of sales to change in price of another good
Percentage Change in Quantity
Demanded of Product X
Exy =
Percentage Change in Price
of Product Y
6-23

24. Cross Elasticity of Demand
Substitute goods
Positive sign
Complementary goods
Negative sign
Independent goods
Zero
6-24

25. Income Elasticity of Demand
Percentage Change in Quantity
Demanded
Ei =
Percentage Change in Income
Responsiveness of sales to change in income
Normal goods – positive sign
Inferior goods– negative sign
6-25

26. Consumer Surplus Benefit surplus
Maximum willingness to pay (WTP) less than actual price paid
Person Max WTP Actual Price CS
Bob $13 $8 $5
Barb $12 $8 $4
Bill $11 $8 $3
Bart $10 $8 $2
Brent $9 $8 $1
Betty $8 $8 $0
6-26

27. Consumer Surplus Consumer Surplus Price (Per Bag) Quantity (Bags)
Equilibrium
Price = $8
Price (Per Bag) P1 D Q1
Quantity (Bags)
6-27

28. Producer Surplus Benefit surplus
Actual price received more than minimum acceptable price (AP)
Person Min AP Actual Price PS
Carlos $3 $8 $5
Courtney $4 $8 $4
Chuck $5 $8 $3
Cindy $6 $8 $2
Craig $7 $8 $1
Chad $8 $8 $0
6-28

29. Producer Surplus Producer Surplus Price (Per Bag) Quantity (Bags) S
Equilibrium
Price = $8
Price (Per Bag) P1 Q1
Quantity (Bags)
6-29

30. Efficiency Revisited Productive and allocative efficiency Consumer
Surplus
Equilibrium
Price = $8
Price (Per Bag) P1
Producer
Surplus D Q1
Quantity (Bags)
6-30

31. Efficiency Loss Deadweight loss Efficiency Losses Price (Per Bag)Q2 Q1 Q3
Quantity (Bags)
6-31

32. Elasticity and Pricing Power
Competitive markets
No pricing power
Firms with market power
Charge different prices
Differences in group elasticities
Business vs. leisure travelers
Discounting for children
College tuition
6-32

33. Key Terms price elasticity of demand midpoint formula elastic demand
inelastic demand
unit elasticity
perfectly inelastic demand
perfectly elastic demand
total revenue (TR)
total-revenue test
price elasticity of supply
market period
short run
long run
cross elasticity of demand
income elasticity of demand
consumer surplus
producer surplus
efficiency losses (deadweight losses)
6-33

34. Next Chapter Preview…
Consumer Behavior
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