1. Price Elasticity of Demand  Elasticity of Demand describes the percentage change in quantity demanded that follows a price change.

2. Elasticity of Demand  Demand is Elastic  Demand is Inelastic Change in PriceLarge Change in Q d Change in PriceSmall/No Change in Q d

3. Example: Dentist Visits  If the price increases, how much change will there be in the Quantity Demanded? Elastic or Inelastic?

4. Example: Sailboats Elastic or Inelastic?

5. Key Factor - Preferences  Decides whether something is a necessity or a luxury. ************************************************  Make a list of goods and services and divide them up into the two categories of Elastic and Inelastic demand. …Can you come up with any more broader categories…such as Necessities (vs) Luxuries?

6. Determinants of Elasticity  Necessities (vs) Luxuries  Necessities tend to have inelastic demand and luxuries tend to have elastic demand  Substitution possibilities  Price elasticity of demand will be relatively high if it is easy to substitute between products  Budget Share  Items that take up a larger share of the budget tend to have higher price elasticities of demand  Time  Because substitution often takes time, price elasticity will usually be higher in the long run than in the short run  Durability of Goods  Computers, cars, washers, and dryers will be in greater demand if the price drops.  Drugs  Legal (heart medicine antibiotics) or illegal (heroin, cocaine)

7. Calculating Elasticity of Demand  Price elasticity of demand is defined as:  the percentage change in the quantity of a good demanded resulting from a one-percent change in its price  = % change in quantity demanded / % change in price  = (ΔQ/Q)/(ΔP/P)  Price Elasticity = (P/Q)*(1/slope)

8. Principles of Microeconomics, 2nd Canadian EditionSlide 1-8Copyright © 2005 McGraw-Hill Ryerson Limited Equation for a Straight Line Demand Curve  P is for the price of the good  Q is for the quantity demanded  b is the vertical intercept  m represents the slope

9. Principles of Microeconomics, 2nd Canadian EditionSlide 1-9Copyright © 2005 McGraw-Hill Ryerson Limited FIGURE 4.6 The Market Demand Curve for Canned Tuna

10. Principles of Microeconomics, 2nd Canadian EditionSlide 1-10Copyright © 2005 McGraw-Hill Ryerson Limited FIGURE 4.12 Graphical Interpretation of Price Elasticity of Demand Price elasticity of demand at any point along a straight-line demand curve is the ratio of price to quantity at that point times the reciprocal of the slope of the demand curve.

11. Principles of Microeconomics, 2nd Canadian EditionSlide 1-11Copyright © 2005 McGraw-Hill Ryerson Limited FIGURE 4.11 Elastic and Inelastic Demand Three Cases!

12. Examples.  1) Find slope given price, quantity and y-intercept.  Then calculate price elasticity of demand.  Determine unit elastic, elastic, inelastic? 2) Using a graph, be able to do the same thing.

13. Special Cases.  Perfectly Elastic demand  Price elasticity of demand is infinite  (ΔQ/Q)/(ΔP/P) = ∞  Slightest change in price leads consumers to find substitutes.  Horizontal demand curve  Ex: - Foreign currency market  Perfectly Inelastic demand  Price elasticity of demand is zero  (ΔQ/Q)/(ΔP/P) = 0  Consumers do not switch to substitutes even when price increases dramatically  Vertical demand curve  Ex: - Diabetic (insulin) - Addict (heroin)

14. Principles of Microeconomics, 2nd Canadian EditionSlide 1-14Copyright © 2005 McGraw-Hill Ryerson Limited FIGURE 4.14 Perfectly Elastic, Perfectly Inelastic, and Unit Elastic Demand Curves Demand Curves The horizontal demand curve in panel (a) is perfectly elastic, or infinitely elastic, at every point. Even the slightest increase in price leads consumers to desert the product in favour of substitutes. The vertical demand curve in panel (b) is perfectly inelastic at every point. Consumers do not, or cannot, switch to substitutes even in the face of large increases in price. The demand curve in panel (c) represents a case of unit elastic demand. Regardless of the price selected, total expenditure is unchanged. In this example, total expenditure is $28 no matter what price is selected.

15. Elasticity of Supply  Can be elastic or inelastic depending on the product and circumstances.  “responsiveness of producers to price changes in their products”  Key Factors  Time  Inelastic – short run, elastic – long run  Perishability  Goods stored easily – More elastic Ex: Raspberries (Perish very quickly)…no matter what the price, suppliers will not want to carry large amounts.

16. Practice!!!  1) Determining whether things will have an inelastic or elastic demand.  2) Calculating price elasticity of demand. ...assignment!

17. Expenditure & Revenue  Total Expenditure = Total Revenue (Consumers) (Producers) Total Expenditure = (Number of Units bought) (Price) = TR

18. Principles of Microeconomics, 2nd Canadian EditionSlide 1-18Copyright © 2005 McGraw-Hill Ryerson Limited FIGURE 4.10 Total Expenditure as a Function of Price For a good whose demand curve is a straight line, total expenditure reaches a maximum at the price corresponding to the midpoint of the demand curve.

19. Principles of Microeconomics, 2nd Canadian EditionSlide 1-19Copyright © 2005 McGraw-Hill Ryerson Limited FIGURE 4.7 The Demand Curve for Movie Tickets An increase in price from $2 to $4 per ticket increases total expenditure on tickets. 0123456 2 4 6 8 10 12 D Quantity (100s of tickets/day) Price ($/ticket) An increase in price from $2 to $4 per ticket increases total expenditure on tickets

20. Law of Demand & Total Expenditures  Many firms would like to know:  “ Will consumers spend more on my product (will I get more revenue, in total) if I sell more units at a lower price or fewer units at a higher price? ”  Answer depends on the price elasticity of demand  When price rises, total expenditure may  Increase  Decrease  Or stay the same

21. Price Elasticity and Expenditures  For a product whose demand is “ price elastic ”  Quantity demanded is highly responsive to price changes  Percentage change in quantity dominates  An increase in price will reduce total expenditure  A decrease in price will increase total expenditure  For a product whose demand is “ price inelastic ”  Quantity demanded is not responsive to price changes  Percentage change in price dominates  An increase in price will increase total expenditure  A decrease in price will decrease total expenditure

22. Example Tickets at a Blue Jays game. P X Q = TR Old Price $ 40 X 33,781 = $1,354,840 New Price $ 50 X 25,000 = $ 1,250,000 Demand is Elastic. Price results in TR …The price resulted in a big change of attendance at the game. (Obviously, there could be other factors as well…different teams in town)

23. Principles of Microeconomics, 2nd Canadian EditionSlide 1-23Copyright © 2005 McGraw-Hill Ryerson Limited FIGURE 4.10 Total Expenditure as a Function of Price For a good whose demand curve is a straight line, total expenditure reaches a maximum at the price corresponding to the midpoint of the demand curve. Elastic side Inelastic side

24. Elasticity of Demand – Important for businesses to consider…  What happens if a florist increases the price of roses 400 % in October ? Will sales go up or down ?  A. Probably, down  What happens if a florist increases the price of roses on February 14 th ? Will sales go down or up?  A. Probably up - Why? Frantic husbands and boyfriends will pay exorbitant prices for a dozen roses on Valentine’s Day – if they know what’s good for them ! !

25. Practice!!!  1) Calculating Total Revenue/Total Expenditures using a graph.  2) Given a change in price, calculate the change in TR/TE, then determine whether the price elasticity of demand is Elastic, Inelastic, or Unit Elastic.