1. What is something that you won’t “live without”?
What is something that you could “take or leave”?

2. 18
Extensions of Demand and Supply Analysis

3. Price Elasticity of Demand
Measuring Responsiveness to Price Changes
Relatively Elastic or Inelastic
Price-Elasticity Coefficient and Formula
Percentage Change in Quantity
Demanded of Product X
Ed =
Percentage Change in Price
of Product X

4. Price Elasticity of Demand
Formula Restated
Change in Quantity Demanded of X
Ed =
Original Quantity Demanded of X
Change in Price of X ÷
Original Price of X
Using Averages
Midpoint Formula
W 6.1
Change in Quantity
Ed =
Sum of Quantities/2 ÷
Change in Price
Sum of Prices/2

5. Price Elasticity of Demand
Why Use Percentages?
Elimination of the Minus Sign
Interpretations of Ed
Elastic Demand
Ed =
.04
.02
= 2
Inelastic Demand
Ed =
.01
.02
= .5
Unit Elasticity
Ed =
.02
= 1

6. Price Elasticity of Demand
Extreme Cases
Perfectly Inelastic Demand P Q D1
Perfectly
Inelastic
Demand
(Ed = 0)
Perfectly Elastic Demand P Q D2
Perfectly
Elastic
Demand
(Ed = ∞)

7. The Total Revenue Test Total Revenue (TR) TR = P x Q Elastic Demand P
W 6.2 $3 2 1 Q P a b D1

8. The Total Revenue Test Total Revenue (TR) TR = P x Q Inelastic Demand
W 6.2 $4 3 2 1 Q P c d D2

9. The Total Revenue Test Total Revenue (TR) TR = P x Q Unit-Elastic P e
W 6.2 $3 2 1 Q P e f D3

10. Elasticity on a Linear Demand Curve
G 6.1
Price Elasticity of Demand for Movie
Tickets as Measured by the Elasticity
Coefficient and the Total-Revenue Test
(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
Graphically…

11. Price Elasticity and the Total-Revenue 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
Elastic
Ed > 1
Unit Elastic
Ed = 1 TR
Inelastic
Ed < 1

12. Determinants of Price Elasticity of Demand
Substitutability
Proportion of Income
Luxuries versus Necessities
Time
Applications:
Large Crop Yields
Excise Taxes
Decriminalization of Illegal Drugs

13. Do you supply more labor/day when the price for that labor goes up?
Can you increase that amount just within a day? (or would you have to reshuffle your schedule?)
Can you increase it in a month?
What about over 2 years?
… you become more elastic in your supply over time
See farmer example on page 348

14. Price Elasticity of Supply
Percentage Change in Quantity
Supplied of Product X
Es =
Percentage Change in Price
of Product X
See page 348, example at bottom of page.

15. Price Elasticity of Supply
Unit Elastic Supply
Es = 1
Market Period:
Not Enough Time to Shift Resources P Q Sm
Greatest
Price
Impact Pm P0 D1 D2 Q0

16. Price Elasticity of Supply
Percentage Change in Quantity
Supplied of Product X
Es =
Percentage Change in Price
of Product X
Inelastic Supply
Es < 1
Short Run:
Resources Not Easily Shifted to Alternative Uses P Q Ss
Lower
Price
Impact Ps P0 D1 D2 Q0 Qs

17. Price Elasticity of Supply
Percentage Change in Quantity
Supplied of Product X
Es =
Percentage Change in Price
of Product X
Elastic Supply
Es > 1
Long Run:
Resources Easily Shifted to Alternative Uses P Q Sl
Least
Price
Impact Pl P0 D1 D2 Q0 Ql

18. Price Elasticity of Supply
Applications
Antiques and Reproductions
Volatile Gold Prices

19. Cross elasticity
Will a price decrease on Sprite cannibalize demand from Coke? (Same company)
Depends on the cross elasticity of demand
Coca-Cola Inc. would need to know what the percentage change in quantity demanded of coke versus the percentage change in price of Sprite
Equation looks like …

20. Cross Elasticity of Demand
Percentage Change in Quantity
Demanded of Product X
Exy =
Percentage Change in Price
of Product Y
Substitute Goods – Positive Sign
Complementary Goods- Negative Sign
Independent Goods – Zero or Near-Zero Value

21. Do you buy more Gatorade when your income increases?
It does if Gatorade is a normal good.
But how much more? That’s where Income Elasticity of Demand comes in.

22. Income Elasticity of Demand
Percentage Change in Quantity
Demanded
Ei =
Percentage Change in Income
Normal Goods –
Positive Sign
Inferior Goods- Negative Sign
Insights into the Economy …

23. Income has grown 2 to 3 %
… agriculture has had an Ei = +.2
… housing has had an Ei = +1.4
They’re both normal goods, they both a positive Ei
What might have a negative Ei?

24. On your income, what’s the max that you’d pay for a gallon of gas in any given week?
What do you actually pay?
The difference is your “consumer surplus”
What do you suppose is the lowest price for a gallon that would cause a station to supply a gallon?
The difference between that and the going price is the “producer surplus”

25. Consumer and Producer Surplus
Consumer Surplus
O 6.3
Consumer
Surplus
Equilibrium
Price = $8
Price (Per Bag) P1 D Q1
Quantity (Bags)

26. Consumer and Producer Surplus
Equilibrium
Price = $8
Price (Per Bag) P1
Producer
Surplus Q1
Quantity (Bags)

27. Consumer and Producer Surplus
Efficiency Revisited S
W 6.3
Consumer
Surplus
Equilibrium
Price = $8
Price (Per Bag) P1
Producer
Surplus D Q1
Quantity (Bags)

28. Consumer and Producer Surplus
Efficiency Revisited
Efficiency Losses (Deadweight Losses) S
Efficiency
Losses
Price (Per Bag) P1 D Q2 Q1 Q3
Quantity (Bags)

29. Elasticity and Pricing Power:
Word
Why Different Consumers
Pay Different Prices
All Buyers in a Highly Competitive Market Pay the Same Price Regardless of Their Elasticities
Difficulty in Applying Different Prices
Observe Differences in Group Elasticities
Business Travelers
Leisure Travelers
Discounting for Children
Different Net Prices for College Tuition