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# Elasticity

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Discussion of elasticity (price-elasticity of demand and supply, income elasticity of demand, and cross-price elasticity of demand) for my Principles of Microeconomics students.

Discussion of elasticity (price-elasticity of demand and supply, income elasticity of demand, and cross-price elasticity of demand) for my Principles of Microeconomics students.

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• 1. Elasticityjuliohuato@gmail.com
• 2. Price Elasticity of Demand • Measures buyers’ responsiveness to price changes • Elastic demand • Sensitive to price changes • Large change in quantity when price changes • Inelastic demand • Insensitive to price changes • Small change in quantity when price changesLO1
• 3. Price Elasticity of Demand Formula Percent change in QuantityEd = Demanded of Product X Percent change in Price of Product X
• 4. Price Elasticity of Demand Formula
• 5. Price Elasticity of Demand Formula • It is in percentages • Unit free measure • Compares responsiveness across products • Eliminates the minus sign • Easier to compare elasticitiesLO1 4-5
• 6. Interpretation of Elasticity of Demand • Ed > 1 demand is elastic • Ed = 1 demand is unit elastic • Ed < 1 demand is inelastic • Extreme cases • Perfectly inelastic • Perfectly elastic
• 7. Extreme Cases P D1 Perfectly inelastic demand (Ed = 0) 0 Perfectly inelastic demand
• 8. Extreme Cases P D2 Perfectly elastic demand (Ed = ∞) 0 Perfectly elastic demand
• 9. Total Revenue Test
• 10. Total Revenue Test • Increase price with elastic demand: orange gain is less than blue loss •Decrease price with elastic demand: orange loss is less than blue gain •Elastic demand forces sellers to lower prices P \$3 a 2 b 1 D1 0 10 20 30 40 Q
• 11. Total Revenue Test • Increase price with inelastic demand: orange gain is more than blue loss • Decrease price with inelastic demand: orange loss exceeds blue gain • With inelastic demand, sellers can increase prices and gain P \$4 c 3 2 d 1 D2 0 10 20 Q
• 12. Total Revenue Test • With unit elastic demand: increasing or decreasing price leaves R unchanged P \$3 e 2 f 1 D3 0 10 20 30 Q
• 13. Total Revenue TestPrice Elasticity of Demand for Movie Tickets as Measured by the ElasticityCoefficient and the Total-Revenue Test (1) (3) (4) (5) Total Quantity of Elasticity Total TotalTickets Demanded per (2) Coefficient Revenue Revenue Week, Thousands Price per Ticket (Ed) (1) X (2) Test 1 \$8 \$8,000 2 7 5.00 14,000 Elastic 3 6 2.60 18,000 Elastic 4 5 1.57 20,000 Elastic 5 4 1.00 20,000 Unit Elastic 6 3 0.64 18,000 Inelastic 7 2 0.38 14,000 Inelastic 8 1 0.20 8,000 Inelastic
• 14. Elasticity and Total Revenue \$8 Elastic 7 a Ed > 1 6 b 5 c Unit Elastic Price 4 d Ed = 1 3 e Inelastic 2 f Ed < 1 1 g h D 0 1 2 3 4 5 6 7 8 Quantity Demanded (Thousands of Dollars) \$20 18 Total Revenue 16 14 12 10 8 6 TR 4 2 0 1 2 3 4Demanded Quantity 5 6 7 8
• 15. Summary of Price Elasticity of DemandPrice Elasticity of Demand: A SummaryAbsolute Value Impact on Total Revenue of a:of ElasticityCoefficient Demand Is: Description Price Increase Price DecreaseGreater than 1 Elastic or Qd changes by a Total Revenue Total Revenue(Ed > 1) relatively larger decreases increases elastic percentage than does priceEqual to 1 Unit or unitary Qd changes by Total revenue Total revenue(Ed = 1) elastic the same is unchanged is unchanged percentage as does priceLess than 1 Inelastic or Qd changes by a Total revenue Total revenue(Ed < 1) relatively smaller increases decreases inelastic percentage than does price
• 16. Determinants of Elasticity of Demand • Substitutability • More substitutes, demand is more elastic • Proportion of Income • Higher proportion of income, demand is more elastic • Luxuries vs. Necessities • Luxury goods, demand is more elastic • Time • More time available, demand is more elastic
• 17. Price Elasticity of DemandSelected Price Elasticities of Demand Price Elasticity Price ElasticityProduct or Service of Demand (Ed) Product or Service of Demand (Ed)Newspapers .10 Milk .63Electricity (household) .13 Household appliances .63Bread .15 Liquor .70MLB Tickets .23 Movies .87Telephone Service .26 Beer .90Cigarettes .25 Shoes .91Sugar .30 Motor vehicles 1.14Medical Care .31 Beef 1.27Eggs .32 China, glassware 1.54Legal Services .37 Residential land 1.60Automobile repair .40 Restaurant meals 2.27Clothing .49 Lamb and mutton 2.65Gasoline .60 Fresh peas 2.83
• 18. Applications of Ed• Large Crop Yields • Inelastic demand, lower total revenue• Excise Taxes • Inelastic demand, more total revenue• Decriminalization of Illegal Drugs • Inelastic demand, more total revenue
• 19. Price Elasticity of SupplyMeasures sellers’ responsiveness to price changes • Elastic supply, producers are responsive to price changes • Inelastic supply, producers are not responsive to price changes
• 20. Price Elasticity of Supply• Formula to compute elasticity• Es > 1 supply is elastic• Es < 1 supply is inelastic Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X
• 21. Price Elasticity of Supply• Time is primary determinant of elasticity of supply• Time periods considered • Market period • Short Run • Long Run
• 22. Elasticity of Supply: The Market Period • Perfectly inelastic supply P Sm Pm P0 D2 D1 Q0 Q
• 23. Elasticity of Supply: The Short Run• Supply is more elastic than in marketperiod P Ss Ps P0 D2 D1 Q0 Qs Q
• 24. Elasticity of Supply: The Long Run• Supply is even more elastic than inthe short run P Sl Pl P0 D2 D1 Q0 Ql Q
• 25. Applications of Elasticity of Supply Antiques • Inelastic supply Reproductions • More elastic supply Volatile gold prices • Inelastic supply
• 26. Cross Elasticity of Demand • Measures responsiveness of sales to change in the price of another good • Substitutes – positive sign • Complements – negative sign • Independent goods - zero Percentage change in quantity demanded of product XEx,y = Percentage change in price of product Y
• 27. Cross Elasticity of Demand• Application • Change the price? • Allow a merger?
• 28. Income Elasticity of Demand• Measures responsiveness of buyers to changes in income• Normal goods – positive sign• Inferior goods – negative sign Percentage change in quantity demanded Ei = Percentage change in income
• 29. Income Elasticity Insights• High income elasticities • Most affected by a recession• Low or negative income • Least affected by a recession
• 30. Ex,y and EiCross and Income Elasticities of DemandValue ofCoefficient Description Type of Good(s)Cross elasticity: Quantity demanded of W changes in same Substitutes Positive (Ewz > 0) direction as change in price of Z Negative (Exy < 0) Quantity demanded of X changes in Complements opposite direction from change in price of YIncome elasticity: Quantity demanded of the product changes Normal or superior Positive (Ei >0) in same direction as change in income Negative (Ei<0) Quantity demanded of the product changes Inferior in opposite direction from change in income
• 31. Elasticity and Pricing Power• Charge different prices based on price elasticities• Examples: • Business air travelers • Adult vs. child
• 32. Summary• Price elasticity of demand• Income elasticity of demand• Cross-price elasticity of demand• Price elasticity of supply