1. Elasticity

2. Elasticity What do you think?
Could reducing the supply of illegal drugs cause an increase in drug-related burglaries?
Chapter 4: Elasticity

3. The Effect of Extra Border Patrols on the Market for Illicit Drugs80 40 S’
Total Expenditure = P x Q
S $ = $50 x 50
S’ $ = $80 x 40 50 S D
P($/ounce)
Q(1,000s of ounces/day)
Chapter 4: Elasticity

4. Price Elasticity of Demand
A measure of the extent to which quantity demanded and quantity supplied respond to variations in price, income, and other factors.
Chapter 4: Elasticity

5. Price Elasticity of Demand
Defined
Generally
A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good
Formally
The percentage change in the quantity demanded that results from a 1 percent change in its price
Chapter 4: Elasticity

6. Price Elasticity of Demand
Measuring Price Elasticity of Demand
Chapter 4: Elasticity

7. Price Elasticity of Demand
Assume
The price of pork falls by 2% and the quantity demanded increases by 6%
Then the price elasticity of demand for pork is
Chapter 4: Elasticity

8. Price Elasticity of Demand
Measuring Price Elasticity of Demand
Observations
Price elasticity of demand will always be negative (i.e., an inverse relationship between price and quantity)
For convenience we drop the negative sign
Chapter 4: Elasticity

9. Price Elasticity of Demand
Measuring Price Elasticity of Demand
When is
> 1: elastic
< 1: inelastic
= 1: unit elastic
Chapter 4: Elasticity

10. Elastic and Inelastic Demand
Unit elastic
Elastic
Price elasticity
of demand 1 2 3
Chapter 4: Elasticity

11. Price Elasticity of Demand
What is the elasticity of demand for pizza?
Originally
Price = $1/slice
Quantity demanded = 400 slices/day
New
Price = $0.97/slice
Quantity demanded = 404 slices/day, then
Chapter 4: Elasticity

12. Price Elasticity of Demand
What is the elasticity of season ski passes?
Originally
Price = $400
Quantity demanded = 10,000 passes/year
New
Price = $380
Quantity demanded = 12,000 passes/year, then
Chapter 4: Elasticity

13. Price Elasticity of Demand
Determinants of Price Elasticity of Demand
Substitution possibilities
Budget share
Time
Chapter 4: Elasticity

14. Price Elasticity Estimates for Selected Products
Good or service Price elasticity
Green peas 2.80
Restaurant meals 1.63
Automobiles 1.35
Electricity 1.20
Beer 1.19
Movies 0.87
Air travel (foreign) 0.77
Shoes 0.70
Coffee 0.25
Theater, opera 0.18
Chapter 4: Elasticity

15. Price Elasticity of Demand
What do you think?
Why is the price elasticity of demand more than 14 times larger for green peas than for theater and opera performances?
Chapter 4: Elasticity

16. Price Elasticity of Demand
Economic Naturalist
Will higher taxes on cigarettes curb teenage smoking?
Why was the luxury tax on yachts such a disaster?
Chapter 4: Elasticity

17. A Graphical Interpretation of Price Elasticity
For small changes in price
Where Q is the original quantity and P is the original price
Chapter 4: Elasticity

18. A Graphical Interpretation of Price Elasticity of DemandQ P
Price
P P Q
Q Q
Quantity
Chapter 4: Elasticity

19. A Graphical Interpretation of Price Elasticity
Example
Originally
Price (P) = $100
Quantity (Q) = 20
New
Price (P) = $105
Quantity (Q) = 15
Chapter 4: Elasticity

20. Calculating Price Elasticity of Demand20 D A 16 12
Price 8 4 1 2 3 4 5
Quantity
Chapter 4: Elasticity

21. Calculating Price Elasticity of Demand20 D A
Question
What is the price elasticity
of demand when P = $4? 16 12
Price 8 4 1 2 3 4 5
Quantity
Chapter 4: Elasticity

22. Price Elasticity and the Steepness of the Demand Curve
What is the price elasticity of
Demand for D1 & D2 when P = $4? D1 D2 12 4 6
Price
Quantity
Chapter 4: Elasticity

23. Price Elasticity and the Steepness of the Demand Curve12 D1 D2 4 6 10 1
For D2 when P = $1
Price
Quantity
Chapter 4: Elasticity

24. Price Elasticity and the Steepness of the Demand Curve12
Quantity
Price D1 D2 4 6 10 1
Observation
If two demand curves have a point in common, the steeper curve must be less elastic with respect to price at that point
Chapter 4: Elasticity

25. Price Elasticity Regions along a Straight-Line Demand Curve
Observation
Price elasticity varies at every point along a straight-line demand curve
b/2
a/2 a b
Price
Quantity
Chapter 4: Elasticity

26. Perfectly Elastic Demand Curve
Quantity
Price
Chapter 4: Elasticity

27. Perfectly Inelastic Demand Curve
Quantity
Price
Chapter 4: Elasticity

28. Elasticity and Total Expenditure
Total Expenditure = P x Q
Market demand measures the quantity (Q) at each price (P)
Total Expenditure = Total Revenue
Chapter 4: Elasticity

29. The Demand Curve for Movie Tickets12 D 10 A
Total Expenditure
= $1,000/day 8 6
Price ($/ticket) 4 2 1 2 3 4 5 6
Quantity (100s of tickets/day)
Chapter 4: Elasticity

30. The Demand Curve for Movie Tickets12 D 10 B
Total Expenditure
= $1,600/day 8 6
Price ($/ticket) 4 2 1 2 3 4 5 6
Quantity (100s of tickets/day)
Chapter 4: Elasticity

31. Elasticity and Total Expenditure
What do you think?
Will increasing the market price always increase total revenue?
Chapter 4: Elasticity

32. The Demand Curve for Movie Tickets
Total Expenditure
= $1,600/day 12 D 10 8 6
Price ($/ticket) 4 2 1 2 3 4 5 6
Quantity (100s of tickets/day)
Chapter 4: Elasticity

33. The Demand Curve for Movie Tickets12
Total Expenditure
= $1,000/day D 10 8 6
Price ($/ticket) 4 2 1 2 3 4 5 6
Quantity (100s of tickets/day)
Chapter 4: Elasticity

34. Elasticity and Total Expenditure
General Rule
A price increase will increase total revenue when the % change in P is greater than the % change in Q.
Chapter 4: Elasticity

35. The Demand Curve for Movie Tickets12
Quantity (100s of tickets/day)
Price ($/ticket) 1 3 4 5 6 10 8 2
Chapter 4: Elasticity

36. Total Expenditure as a Function of Price
Price ($/ticket) Total expenditure ($/day)
12 0
10 1,000
8 1,600
6 1,800
4 1,600
2 1,000
0 0
Chapter 4: Elasticity

37. Total Expenditure as a Function of Price
Total revenue is at a maximum at the
midpoint on a straight-line demand curve 12
Quantity (100s of tickets/day)
Price ($/ticket) 1 3 4 5 6 10 8 2
1,800
Price ($/ticket)
Total expenditure ($/day) 2 6 8 10 12
1,600
1,000 4
Chapter 4: Elasticity

38. Elasticity and Total Expenditure
What do you think?
Should a rock band raise or lower its price to increase total revenue?
Assume
Chapter 4: Elasticity

39. Elasticity and Total Expenditure
What do you think?
Should a rock band raise or lower its price to increase total revenue?
Then
Total revenue = $20 x 5,000 = $100,000/week
If P is increased 10%, Q will decrease 30%
Total revenue = $22 x 3,500 = $77,000/week
If P is lowered 10%, Q will increase 30%
Total revenue = $18 x 6,500 = $177,000/week 7
Chapter 4: Elasticity

40. Elasticity and Total Expenditure
Rule
When price elasticity is greater than 1, changes in price and changes in total expenditures always move in opposite directions.
When price elasticity is less than 1, changes in price and changes in total expenditures always move in the same direction. 7
Chapter 4: Elasticity

41. Elasticity and the Effect of a Price Change on Total Expenditure7
Chapter 4: Elasticity

42. Elasticity and Total Expenditure
Cross-Price Elasticity of Demand
The percentage by which quantity demanded of the first good changes in response to a 1 percent change in the price of the second good 7
Chapter 4: Elasticity

43. Elasticity and Total Expenditure
Cross-Price Elasticity of Demand
Substitute Goods
When the cross-price elasticity of demand is positive
Complement Goods
When the cross-price elasticity of demand is negative 7
Chapter 4: Elasticity

44. Elasticity and Total Expenditure
Income Elasticity of Demand
The percentage by which quantity demanded changes in response to a 1 percent change in income 7
Chapter 4: Elasticity

45. Elasticity and Total Expenditure
Income Elasticity of Demand
Normal Goods
Income elasticity is positive
Inferior Goods
Income elasticity is negative 7
Chapter 4: Elasticity

46. The Price Elasticity of Supply
The percentage change in the quantity supplied that occurs in response to a 1 percent change in price
Chapter 4: Elasticity

47. A Supply Curve for Which Price Elasticity Declines as Quantity Rises2 8 A 4 S 3 10 B
Price
Quantity
Chapter 4: Elasticity

48. Calculating the Price Elasticity of Supply Graphically12 4 A S 15 5 B P Q
Price
Quantity
Chapter 4: Elasticity

49. The Price Elasticity of Supply
Observation
The price elasticity of supply will always equal 1 at any point along a straight-line supply curve that passes through the origin.
Chapter 4: Elasticity

50. A Perfectly Inelastic Supply Curve
What is the price elasticity of supply of land
within the borough limits of Manhattan? S
Elasticity = 0 at every
point along a vertical
supply curve
Price ($/acre)
Quantity of land in Manhattan
(1,000s of acres)
Chapter 4: Elasticity

51. A Perfectly Elastic Supply Curve
What is the price elasticity of supply of lemonade? S
If MC is constant, then the
price elasticity of supply at every point
along a horizontal supply curve is infinite
Price (cents/cup) 14
Quantity of lemonade
(cups/day)
Chapter 4: Elasticity

52. The Price Elasticity of Supply
Determinants of Supply Elasticity
Flexibility of inputs
Mobility of inputs
Ability to produce substitute inputs
Time
Chapter 4: Elasticity

53. The Price Elasticity of Supply
Economic Naturalist
Why are gasoline prices so much more volatile than car prices?
Differences in markets
Demand for gasoline is more inelastic
Gasoline market has larger and more frequent supply shifts
Chapter 4: Elasticity

54. Greater Volatility in Gasoline Prices than in Car Prices6
1.69 S’ D
Gasoline
1.02
7.2 S
Price ($/gallon)
Quantity
(millions of gallons/day)
Chapter 4: Elasticity

55. Greater Volatility in Gasoline Prices than in Car Prices
Cars D 17 S’ 11
16.4 12 S
Price ($1,000s/car)
Quantity
(1,000s of cars/day)
Cars
Chapter 4: Elasticity

56. The Price Elasticity of Supply
What do you think?
How would elasticity of supply and fluctuating demand impact price volatility?
Chapter 4: Elasticity

57. The Price Elasticity of Supply
Unique and Essential Inputs: The Ultimate Supply Bottleneck
Why does Shaquille O’Neal get paid over $120 million over a seven-year contract?
Chapter 4: Elasticity

58. End of
Chapter