2. Price Elasticity of Demand Measurement of a good’s responsiveness to a change in price The price effect is greater for some goods than for others Examples:

4. Price Elasticity of Demand Large Price Effect → Elastic Ex: Small Price Effect → Inelastic Ex: Other Examples?

5. Factors Affecting Elasticity of Demand Wants = more elastic, needs = more inelastic Time: Can purchase be delayed? Time to adjust… Longer price change persists = more elastic (long run) Immediately after price change = more inelastic (short run) Availability, Suitability, Price of Substitutes More/better/cheaper substitutes = more elastic Ex: Ibuprofen vs. Insulin Percentage of Budget Larger % = more elastic Ex: New Car for me vs. LeBron James

6. Testing for Elasticity of Demand Graphical Comparison The flatter the curve, the more Elastic the good. The steeper the curve, the more Inelastic the good. ***ONLY APPLICABLE WHEN COMPARING 2 CURVES Inelastic Elastic

7. Testing for Elasticity of Demand Total Revenue Test --- TR = P x Q Example: If P and TR move in the same direction, demand is inelastic If P and TR move in opposite directions, demand is elastic Gas? Grade upgrade certificates?

8. $3 2 1 0 10 20 30 40 Q P Lower price and elastic demand Blue gain exceeds gold loss a b D1D1 The Total Revenue Test 6-7

9. $4 3 2 1 0 10 20 Q P Lower price and inelastic demand Gold loss exceeds blue gain c d D2D2 The Total Revenue Test 6-8

10. $3 2 1 0 10 20 30 Q P Lower price and unit-elastic demand Blue gain equals yellow loss e f D3D3 The Total Revenue Test 6-9

11. As long as Total Revenue is increasing with every decrease in price, Demand is elastic **Marginal Revenue is positive When Total Revenue begins to decrease with every decrease in price, Demand becomes inelastic **Marginal Revenue is negative

12. Price Elasticity of Demand Price-elasticity coefficient and formula Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product X E d = 6-11

13. Price Elasticity of Demand Calculate percentage change Restate formula Change in Quantity Demanded of X Original Price of X E d = Change in Price of X Original Quantity Demanded of X ÷ 6-12

14. Price Elasticity of Demand Calculation problem $4-$5 is 25% increase $5-$4 is 20% decrease Starting point matters Midpoint formula Change in Quantity E d = Sum of Quantities/2 ÷ Change in Price Sum of Prices/2 6-13

15. Elasticity and the TR Curve 012345678 012345678 Quantity Demanded Price Total Revenue (Thousands of Dollars) $20 18 16 14 12 10 8 6 4 2 $8 7 6 5 4 3 2 1 a b c d e f g h Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 D TR 6-14

16. Price Elasticity of Demand Why use percentages? Unit free measure Dollars vs. pennies Compare responsiveness across products JBCs vs. Porsches Elimination of the (-) sign Extreme cases Perfectly inelastic demand Perfectly elastic demand 6-15

17. Interpretations of Elasticity Elastic Demand Inelastic Demand Unit Elasticity E d =.04.02 = 2E d =.01.02 =.5E d =.02 = 1 6-16

18. Extending Elasticity of Demand How does elasticity of demand affect us? What do these have in common? Government taxes inelastic goods… Why? Why doesn’t govt. tend to tax elastic goods?

19. “Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” -Ronald Reagan

20. Homework: Read pgs. 143-149 and complete Review question #6 and Problems #5 and 7

21. 20 Copyright ACDC Leadership 2015

22. Elasticity of Supply Elastic – easy/quick to produce – lower marginal cost for each additional unit produced Inelastic – harder/slower to produce – higher marginal cost for each additional unit produced Elasticity of supply increases as producers have more time to adjust to a price change Ex: 1979 Today

23. Factors Affecting Elasticity of Supply 1.Ease of Production easier = more elastic 2.Responsiveness to price change quicker adjustment = more elastic 3.Time more time to adjust = more elastic

24. Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X E s = Responsiveness to price changes by producers 6-23

25. Elasticity of Supply changes over time Market Period – immediately after a change in price Perfectly inelastic supply Short Run – up to a few months after a change in price Inelastic or somewhat elastic supply Fixed plant size Long Run – many months/years after a price change Perfectly Elastic supply Adjustable plant size

26. P Q Price Elasticity of Supply The Market Period Perfectly inelastic supply D1D1 D2D2 SmSm Q0Q0 PmPm P0P0 Greatest Price Impact 6-25

27. Price Elasticity of Supply The Short Run Inelastic supply P Q D1D1 D2D2 SsSs Q0Q0 PsPs P0P0 QsQs Lower Price Impact 6-26 Fixed land. Some fixed capital. More labor? More fertilizer?

28. Price Elasticity of Supply The Long Run Elastic supply P Q D1D1 D2D2 SlSl Q0Q0 PlPl P0P0 QlQl Least Price Impact 6-27

29. Price Elasticity of Supply Applications Antiques and reproductions Limited, inelastic supply Strong demand Resulting high price Volatile gold prices Inelastic supply Shifting demand Kidneys 6-28

30. Cross Elasticity of Demand Responsiveness of sales to change in price of another good Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product Y E xy = 6-29

31. Cross Elasticity of Demand Substitute goods Positive sign Complementary goods Negative sign Independent goods Zero or near zero Coke and Sprite Example Mergers 6-30

32. Practice Problem Let’s look at 2 goods, Widgets and Wadgets. Given the following information: 1. Calculate the price elasticity of demand for widgets. Is demand for widgets elastic, inelastic, or unit elastic? 2. Calculate the cross elasticity of demand for wadgets as they relate to widgets. Would wadgets be considered complements, substitutes, or independent of widgets? P₁P₂Q₁Q₂ Widgets$3$54721 Wadgets$2 123

33. Income Elasticity of Demand Responsiveness of sales to change in income Income increases 20%, and quantity decreases 15% then the good is a(n)… INFERIOR GOOD Normal goods – positive sign Inferior goods– negative sign How can this help you profit from a recession? Percentage Change in Quantity Demanded Percentage Change in Income E i = 6-32

34. 33 2010 Question 6 Copyright ACDC Leadership 2015

35. 2008 Audit Question 34