2. 9/4/20151 ElasticityElasticity Claudia Garcia-Szekely

3. 9/4/20152 2010 120 150 0 62430 D 0 100 50 A movement Along A change in quantity demanded A change in price

4. 9/4/20153 100 110 100130 Big change in Q 100 110 100105 Small change in Q Consumers Overreact Consumers barely notice

5. 9/4/20154 100 110 100130 Big change in Q 100 110 100105 Small change in Q Consumers Overreact Consumers barely notice

6. 9/4/20155 The Price Elasticity of Demand Compares Can you avoid an increase in price of prescription drugs? Can consumers avoid an increase in price of strawberries?

7. 9/4/20156 e p d = e price d =

8. 9/4/20157 Elasticity Between two points Measures the response to a $0.50 change in the price (up or down )

9. Price Elasticity 1.Calculate the difference between the two quantities: 22-19 = 3 2.Calculate the average of the two quantities: (22+19)/2 = 20.5 3.%  Quantity demanded:3/20.5 = 0.146 4.Calculate the difference between the two prices: 1- 0.5= 0.5 5.Calculate the average of the two prices: (1+0.5)/2 = 0.75 6.%  Price: 0.5/0.75 =0.667. Price Elasticity of Demand between B and C. 0.146 /0.667 = - 0.21 Always Negative

10. 9 Elasticity of Demand Between Points A and E Elasticity of Demand Between Points A and E E Midpoint formula gives you the elasticity at the Midpoint 10 A

11. 9/4/201510 Make A the Midpoint Elasticity of Demand at Point A Use a point above A and a point below A 10 7 8 18 12 6 24 A

12. > 1 % Change in Quantity % Change in Price > Consumers Over-react: Demand is Elastic < 1 % Change in Quantity % Change in Price < Consumers Under-react: Demand is Inelastic = 1 % Change in Quantity % Change in Price = Demand is UNIT Elastic The steeper Demand is, the more Inelastic The flatter Demand is, the more Elastic e p d =

13. 9/4/201512 Example It has been observed that a 20% decrease in the price, caused a 5% increase in quantity demanded. Elasticity of Demand is less than one: Inelastic epd epd = 5% / -20% = - 0.25 Elasticity has no units!

14. 9/4/201513 Example It has been observed that a 5% increase in price, caused a 10% reduction in quantity demanded. Elasticity of Demand is greater than one: Elastic e p d = -10% / 5% = - 2

15. The price elasticity of demand is -0.5. What is the change in price necessary to induce a 10% reduction in consumption? 14 e d p = %  Q / %  P -0.5= -10%/ %  P -10 /-0.5 =+%  P 20 =+%  P %  P =%  Q / e d p

16. Calculate price elasticity PRICEQUANTITY 34 112 e = -1 In order to induce a 5% increase in consumption, the price would have to (rise/fall) ________ by _____%

17. 9/4/201516 Price Elasticity of Demand PRICEQUANTITY 54 112 e = - 0.75 If we want to increase quantity demanded by 10% what is the necessary change in price? Price must _________________ by _______% (Increase/decrease) If we want to increase quantity demanded by 10% what is the necessary change in price? Price must _________________ by _______% (Increase/decrease) If we increase the price by 10% how would the quantity demanded change? Quantity demanded_______________ by _______% (Increase/decrease) If we increase the price by 10% how would the quantity demanded change? Quantity demanded_______________ by _______% (Increase/decrease)

18. 9/4/201517 Calculate price elasticity PRICEQUANTITY 33 112 e = -1.2 If we want to increase quantity demanded by 10% what is the necessary change in price? Price must _________________ by _______% (Increase/decrease) If we want to increase quantity demanded by 10% what is the necessary change in price? Price must _________________ by _______% (Increase/decrease) If we increase the price by 10% how would the quantity demanded change? Quantity demanded_______________ by _______% (Increase/decrease) If we increase the price by 10% how would the quantity demanded change? Quantity demanded_______________ by _______% (Increase/decrease)

19. QPe 10010.25 1209.90-5.23 1409.55-4.27 1609.20-3.57 1808.85-3.03 2008.50-2.61 2208.15-2.27 2407.80-1.98 2607.45-1.74 2807.10-1.54 3006.75-1.36 3206.40-1.21 3406.05-1.08 3436.00-1.01 3605.70-0.96 3805.35-0.85 4005.00-0.76 4204.65-0.67 4404.30-0.59 4603.95-0.52 4803.60-0.46 5003.25-0.40 5202.90-0.34 5402.55-0.29 5602.20-0.25 5801.85-0.20 6001.50-0.16 6201.15-0.12 6400.80-0.09 6600.45-0.05 6800.10-0.02 6860.00 The Elasticity Changes Along the Demand Curve For low prices (at the bottom of the demand curve) demand is relatively inelastic For high prices (at the top of the demand curve) demand is relatively elastic As Price Increases Elasticity Increases At the midpoint, |e| = 1 At the midpoint, |e| = 1 |e| < 1 |e| > 1 |e| = 1

20. 9/4/201519 The Elasticity Changes Along the Demand Curve |e| < 1 |e| > 1 |e| = 1 Midpoint 0100 100/2 = 50 01000 1000/2 = 500

21. Po At P o : Both Elastic Demand A is (elastic/inelastic)_____ Midpoint Demand A Elasticity is NOT the same as slope P1 At P 1 : Both Inelastic Demand B is (elastic/inelastic)_____ Demand B Elasticity changes along Demand line Slope Remains the same along Demand line

22. 50 45 40 3530 25 20 15 10 5 0 2 4 6 8 12 14 16 18 20 17.5

23. 50 45 20 15 10 25 40 35 30 5 0 2 12 6 16 10 4 14 8 18 20

24. 50 45 20 15 10 25 40 35 30 5 0 2 12 6 16 10 4 14 8 18 20 17.5

25. D1 is more elastic than D2 a.For prices below P 2 b.For prices above P 2 c.For prices above P 3 d.For all prices

26. % Change in Quantity % Change in Price e = > 1 % Change in Quantity % Change in Price > Demand is Elastic 0.60 10,000 Units 0.61 0 Units |e| = 8 Demand is Perfectly Elastic Almost no change in P Very large change in Q

27. % Change in Quantity % Change in Price e = < 1 % Change in Quantity % Change in Price < Demand is Inelastic Demand is Perfectly Inelastic 0.60 3.61 |e| =0 Large change in P No change in Q

28. % Change in Quantity % Change in Price e = = 1 % Change in Quantity % Change in Price = Demand is UNIT Elastic Demand is UNIT Elastic Everywhere |e| =1

29. The demand curve with the smallest elasticity at point M is___ The demand curve with the largest elasticity at point M is ___ Demand curve _______ is perfectly elastic Demand curve _______ is perfectly inelastic M

30. 90 = 18 x5 50 45 40 35 30 25 20 15 10 5 0 2 4 6 8 12 14 16 18 20 160 =16x10 210 =14x15 240 =12x20 250 =10x25 240 =8x30 210 =6x35 160 =4x40 2x45= 90 250 =10x25 Maximum Total Revenue

31. 90 160 210 240 250 240 210 160 90

32. 160 210 240 250 240 210 160 90

33. 32 If after an increase price… Total Revenues Decrease Total Revenues Increase Total Revenues Remain the Same Demand is unit elastic Demand is Elastic Demand is Inelastic

35. 9/4/201534 3. Is this demand elastic or inelastic? PRICETOTAL REVENUE ELASTICITY 11,950,000 1.252,062,500 Demand is Inelastic

36. 9/4/201535

37. What Determines the Elasticity? 9/4/201536

38. 9/4/201537 The number of Substitutes Available. The more substitutes, the easier it is for consumers to switch. The more sensitive (elastic) demand would be to price changes

39. Definition of the market. If price increases, consumers have many alternatives: Other flavors Other brands Other desserts Narrowly defined markets have more elastic demands.

40. 39 The Definition of the market. ALL NO If ALL food prices increase, consumers have NO alternatives: Broadly defined markets have less elastic demands

41. 9/4/201540 a)All cars b)Imported cars c)German cars d)German Red Cars e)BMW red convertibles Which product has a more elastic demand? Which product has more substitutes?

42. 9/4/201541 The Amount of Time to React The longer the time to react, the easier it is to find a substitute or modify behavior.

43. 9/4/201542 When Demand is Inelastic LossLoss Gain Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 S1S1 LossLoss > TR increase Midpoint InelasticInelastic Restricting Supply increase revenue for producers

44. 9/4/201543 When Demand is Elastic Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 S1S1 TR Decrease > Gain Loss Gain Midpoint ElasticElastic Restricting Supply decrease revenue for producers

45. 9/4/201544 When Demand is Elastic Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 S1S1 TR Increase > Gain Loss Gain Loss ElasticElastic Midpoint Increasing Supply Increase revenue for producers

46. Loss Gain Loss 9/4/201545 When Demand is Inelastic Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 S1S1 TR decrease > Gain Midpoint InelasticInelastic Increasing Supply decrease revenue for producers

47. 9/4/201546 The Elasticity Changes Along the Demand Curve |e| < 1 |e| > 1 |e| = 1 Midpoint Decrease Price to Increase TR Increase Price to Increase TR An increase/decrease in price would leave TR unchanged

48. Table 5. Estimated Price Elasticities of Demand for Various Goods and Services GoodsEstimated Elasticity of Demand Inelastic Salt0.1 Matches0.1 Toothpicks0.1 Airline travel, short-run0.1 Gasoline, short-run0.2 Gasoline, long-run0.7 Residential natural gas, short-run0.1 Residential natural gas, long-run0.5 Coffee0.25 Fish (cod) consumed at home0.5 Tobacco products, short-run0.45 Legal services, short-run0.4 Physician services0.6 Taxi, short-run0.6 Automobiles, long-run0.2

49. 9/4/201548 Approximately Unitary Elasticity Movies0.9 Housing, owner occupied, long-run1.2 Shellfish, consumed at home0.9 Oysters, consumed at home1.1 Private education1.1 Tires, short-run0.9 Tires, long-run1.2 Radio and television receivers1.2

50. 9/4/201549 Elastic Restaurant meals2.3 Foreign travel, long-run4 Airline travel, long-run2.4 Fresh green peas2.8 Automobiles, short-run1.2 - 1.5 Chevrolet automobiles4 Fresh tomatoes4.6

51. 9/4/201550 Types of Elasticity Price elasticity of demand. Price elasticity of supply. Income elasticity of demand. Cross Price elasticity of demand.

52. 9/4/201551 The Price Elasticity of Supply Measures how easy or difficult it is for producers to react to price changes. Since there is a direct relationship between the price and the quantity supplied The price elasticity of supply is always positive.

53. 9/4/201552 Price Elasticity of Supply e p s e p d = % Change Quantity Supplied % Change in price e p d = Change in Q s Average QsQs Change in Price Average Price

54. 9/4/201553 Extreme Cases S Po Constant Costs: Production can not increase P Fixed Quantity Q1Q1 Q0Q0 D1D1 D0D0 D1 S D0 P e p s = 0 Demand increase e p s = 8 Perfectly Elastic Supply Production increase w/o increase in prices Perfectly Inelastic Supply

55. 9/4/201554 Perfectly Inelastic Supply Rembrandts Seats in a theater or stadium

56. Elasticity changes along a Supply Curve e p s = infinity e p s = 0 e decreases e = 1 S S S e increases P e > 1 elastic e < 1 inelastic Note these three supply curves have the same SLOPE yet Elasticity is different! Cut Vertical Axis: elastic Cut Horizontal Axis: inelastic Perfectly Elastic e p s = 8 Perfectly Inelastic e p s = 0

57. Calculate the Elasticity at point B. Without calculating the elasticity, you know the elasticity at point B is: 1; = 1? How do you know?

58. When price rises by 20%, quantity supplied rises by 20%. Which curve best demonstrates the elasticity of supply in this example? 30% When price rises by 20%, quantity supplied remains the same. Which curve best demonstrates the elasticity of supply in this example? E Po P1 P2 P3 P4

59. 9/4/201558 Without calculating the elasticity: a.Is the elasticity at A>B? A<B? A=B? b.Is the demand elasticity at F>1? F<1? F=1? c.Is the demand elasticity at B >0? <0? =0? d.Is the supply elasticity at F>1? F<1? F=1? e.Is the supply elasticity at C >0? <0? =0? f.Is the elasticity at C>D? C<D? C=D? g.Is the elasticity at E>1? E<1? E=1? h.Is the elasticity at C>1? C<1? C =1? E F

60. Calculating the resulting change in price 9/4/201559 %  Price = %  Demand/(Ed + Es) P0P0 Q0Q0 P1P1 Q1Q1

61. 9/4/201560 %  Price = %  Demand/(Ed + Es) P0P0 Q0Q0 P1P1 Q1Q1 Suppose demand shifts out to the right by 10 percent, the elasticity of demand is 1.5 and the elasticity of supply is 0.5. By how much will price change? %  Price = 10%/(1.5 + 0.5) %  Price = 10/2 %  Price = 5 Price increase by 5%

62. Calculating the resulting change in price 9/4/201561 %  Price = %  Supply/(Ed + Es) P0P0 Q0Q0 P1P1 Q1Q1

63. 9/4/201562 %  Price = %  Supply/(Ed + Es) P0P0 Q0Q0 P1P1 Q1Q1 If supply increases by 4 percent, the elasticity of demand is 0.5, and elasticity of supply is 1.5, then the price will: %  Price = 4/(0.5+ 1.5) %  Price = 4/(2) %  Price = 2% Price decrease by 2%

64. 63 A significant price decline with virtually no change in quantity would most likely be caused by : a. a highly elastic demand and a shift in supply to the right. b. a highly inelastic supply and a shift in demand to the right. c. a highly inelastic demand and a shift in supply to the right. d. a highly elastic supply and a shift in demand to the left. Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 S1S1 Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 D1D1 Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 S1S1 Q1Q1 P1P1 Q0Q0 P0P0 D0D0 S0S0 D1D1 a b c d

65. |e| < 1 |e| > 1 |e| = 1 Income increase Measures the SIZE of the shift Normal Inferior Income Increase

66. 9/4/201565 Income Elasticity e p d = Change in Quantity / Average Quantity Change in Income / Average Income e p d = Percentage Change in Demand Percentage Change in Income

67. 9/4/201566 Income Elasticity 1.Find the Percentage change in quantity demanded = 100 / 350 = 0.286 2.Find the percentage change in income = 1000/1500 = 0.667 3.The Income Elasticity = 0.286/0.667 = 0.429 + e y d = Change in Quantity / Average Quantity Change in Income / Average Income

68. 9/4/201567 Normal Goods The Demand for normal goods INCREASES when income INCREASES. There is a positive relationship between income and demand for normal goods. The sign of the income elasticity for normal goods is positive.

69. Normal Goods: Luxuries Goods which you can consume less when your income drops. Goods which you would consume more when your income increase. 9/4/201568 e p d = Percentage Change in Demand larger than change in income Percentage Change in Income 1

70. Normal Goods: Necessities Goods which you can NOT consume less when your income drops. Goods which you would NOT consume more when your income increase. 9/4/201569 e p d = Percentage Change in Demand SMALLER than change in income Percentage Change in Income 1

71. 9/4/201570 Inferior Goods Demand for inferior goods DECREASES when income INCRESES. There is a negative relationship between income and demand for inferior goods. The sign of the income elasticity for inferior goods is negative.

72. 9/4/201571 Inferior Good Income Elasticity

73. |e| < 1 |e| > 1 |e| = 1 Price of substitute increase Price of Complement Increase

74. 9/4/201573 Cross Price Elasticity Formula % Change in Quantity demanded of X %Change in price of Y. e p d = Coke Pepsi

75. 9/4/201574 Cross Price Elasticity for Complements Demand drops when the price of a complement increases. If price of PRINTERS increases, the Demand for INK drops. Price and Demand move in opposite directions. The cross price elasticity for complements is NEGATIVE.

76. 9/4/201575 Cross Price Elasticity Complements ( Negative) All Negative!

77. 9/4/201576 Cross Price Elasticity for Substitutes When price INCREASES, Demand for the substitute INCREASES too. If the price of Texaco gasoline rises, the Demand for Chevron gasoline rises too. Price and Demand for substitutes move in the SAME direction. The cross price elasticity between substitutes is POSITIVE.

78. 9/4/201577 Cross Price Elasticity Substitutes (Positive) All Positive!

79. 9/4/201578 IncomeDemand X 1000 2000900 3000800 4000700 5000600 IncomeDemand Y 1000300 2000400 3000500 4000600 5000700 6000800 Calculate the Income Elasticity for an increase in income from $3,000 to $4,000. Is the good Normal or Inferior? Is the elasticity positive or negative?

80. Use the information in table 1 above to calculate: 1.Price elasticity of demand for good X between points B and D. 2.Price elasticity of demand for good X at C. 3.Price elasticity of supply between A and B. 4.Cross Price elasticity between X and N between points E and F. Are X and N substitutes? Or complements? 5.Cross Price elasticity between X and R between points E and F. Are X and R substitutes? Or complements? Your answer must have a value AND A SIGN!

81. Solutions 9/4/201580

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