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# Ln19 miller950022 17_ln19

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### Ln19 miller950022 17_ln19

1. 1. Chapter 19 Demand and Supply Elasticity
2. 2. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-2 Introduction In recent years, revenues received by musicians have been decreasing, even though prices of music albums and concert tickets have been increasing. This phenomenon can be explained by a key concept known as price elasticity of demand. After reading this chapter, you will understand more about the relationship between prices and revenues.
3. 3. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-3 Learning Objectives • Express and calculate price elasticity of demand • Understand the relationship between the price elasticity of demand and total revenues • Discuss the factors that determine the price elasticity of demand
4. 4. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-4 Learning Objectives (cont'd) • Describe the cross price elasticity of demand and how it may be used to indicate whether two goods are substitutes or complements • Explain the income elasticity of demand • Classify supply elasticities and explain how the length of time for adjustment affects the price elasticity of supply
5. 5. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-5 Chapter Outline • Price Elasticity • Price Elasticity Ranges • Elasticity and Total Revenues • Determinants of the Price Elasticity of Demand • Cross Price Elasticity of Demand • Income Elasticity of Demand • Price Elasticity of Supply
6. 6. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-6 Did You Know That ... • Economists have estimated that when bank debit- card transaction fees increase by 10 percent, the number of debit-card transactions that people wish to utilize declines by nearly 67 percent? • A special name for quantity responsiveness is elasticity, which is one of the topics in this chapter.
7. 7. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-7 Price Elasticity • Price Elasticity of Demand (Ep) – The responsiveness of quantity demanded of a commodity to changes in its price – Defined as the percentage change in quantity demanded divided by the percentage change in price
8. 8. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-8 Price Elasticity (cont'd) • Price Elasticity of Demand (Ep) Ep = Percentage change in quantity demanded Percentage change in price
9. 9. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-9 Ep = –1% +10% = –.1 Price Elasticity (cont'd) • Example – Price of oil increases 10% – Quantity demanded decreases 1%
10. 10. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-10 Price Elasticity (cont'd) • Question – How would you interpret an elasticity of –0.1? • Answer – A 10% increase in the price of oil will lead to a 1% decrease in quantity demanded.
11. 11. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-11 Price Elasticity (cont'd) • Relative quantities only – Elasticity is measuring the change in quantity relative to the change in price • Always negative – An increase in price decreases the quantity demanded, ceteris paribus – By convention, the minus sign is ignored
12. 12. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-12 Price Elasticity (cont’d) • Calculating Elasticity change in Q sum of quantities/2 Ep = change in P sum of prices/2 or ∆ in Q (Q1 + Q2)/2 Ep = ∆ in P (P1 + P2)/2
13. 13. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-13 Example: The Price Elasticity of Demand for a Tablet Device • During a two-month period, the price of Hewlett- Packard’s TouchPad decreased from \$499.99 to \$99.99. • In response, the total quantity demanded rose from 25,000 per month to 425,000 per month. • During this period the total quantity of natural gas consumed in the United States increased from 62.21 billion cubic feet per day to 62.64 billion cubic feet per day. • Assuming other things were equal, what is the price elasticity of demand?
14. 14. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-14 Example: The Price Elasticity of Demand for a Tablet Device (cont'd) • Use the elasticity formula: 425,000 – 25,000 ÷ \$499.99 - \$99.99 (425,000 + 25,000)/2 (\$499.99+\$99.99)/2 = 1.33 ● The price elasticity of 1.33 means that a 1% decrease in price generated a 1.33% increase in the quantity of TouchPads demanded.
15. 15. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-15 Price Elasticity Ranges • Elastic Demand – Percentage change in quantity demanded is larger than the percentage change in price – Total expenditures and price are inversely related in the elastic region of the demand curve – Ep > 1
16. 16. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-16 Price Elasticity Ranges (cont'd) • Unit Elasticity of Demand – Percentage change in quantity demanded is equal to the percentage change in price – Total expenditures are invariant to price changes in the unit-elastic region of the demand curve – Ep = 1
17. 17. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-17 Price Elasticity Ranges (cont'd) • Inelastic Demand – Percentage change in quantity demanded is smaller than the percentage change in price – Total expenditures and price are directly related in the inelastic region of the demand curve – Ep < 1
18. 18. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-18 Price Elasticity Ranges (cont'd) • Elastic demand – % change in Q > % change in P; Ep > 1 • Unit-elastic – % change in Q = % change in P; Ep = 1 • Inelastic demand – % change in Q < % change in P; Ep < 1
19. 19. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-19 Price Elasticity Ranges (cont'd) • Extreme elasticities – Perfectly Inelastic Demand • A demand curve that is a vertical line • It has only one quantity demanded for each price • No matter what the price, quantity demanded does not change • A demand that exhibits zero responsiveness to price changes
21. 21. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-21 Price Elasticity Ranges (cont'd) • Extreme elasticities – Perfectly Elastic Demand • A demand curve that is a horizontal line • It has only one price for every quantity. • The slightest increase in price leads to zero quantity demanded.
23. 23. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-23 Elasticity and Total Revenues • When demand is elastic, a negative relationship exists between changes in price and changes in total revenues • When demand is unit-elastic, changes in price do not change total revenues • When demand is inelastic, a positive relationship exists between changes in price and total revenues
24. 24. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-24 Example: Price and Revenue Changes and Price Elasticity of Demand for Air Travel • During a recent period, the per-mile price that passengers paid to fly on U.S. airlines rose by 14 percent. • Associated with this price increase was a 17 percent rise in total revenues received by airlines. • Thus, within this time interval, demand was inelastic.
25. 25. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-25 Figure 19-2 The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service, Panel (a)
26. 26. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-26 Figure 19-2 The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service, Panel (b)
27. 27. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-27 Figure 19-2 The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service, Panel (c)
28. 28. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-28 Elasticity and Total Revenues (cont'd) • Elasticity-revenue relationship – Total revenues are the product of price times units sold. – The law of demand states along a given curve, price is inverse to quantity.
29. 29. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-29 Elasticity and Total Revenues (cont'd) • What happens to the product of price times quantity depends on which of the opposing forces exerts a greater force on total revenues • This is what price elasticity of demand is designed to measure: responsiveness of quantity demanded to a change in price
31. 31. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-31 What If . . . The government offers to pay for higher-priced health care to try to reduce society’s overall health care expenditures? • Estimates of the price elasticity of demand for most health care services vary between 0.2 and 0.6, indicating that the demand for health care is inelastic. • So, when health care prices increase, consumers spend more on these services. • Suppose the government were to step into the market to pay for health care in response to an observed increase in prices.
32. 32. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-32 What If . . . The government offers to pay for higher-priced health care to try to reduce society’s overall health care expenditures? (cont’d) • Government expenditures on health care would increase. • Taken together, the private and public sectors constitute society. • Therefore, the intervention would serve to increase total expenditures on health care.
33. 33. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-33 Determinants of the Price Elasticity of Demand • Existence of substitutes – The closer the substitutes and the more substitutes there are, the more elastic is demand • Share of the budget – The greater the share of the consumer’s total budget spent on a good, the greater is the price elasticity
34. 34. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-34 Determinants of the Price Elasticity of Demand (cont'd) • The length of time allowed for adjustment – The longer any price change persists, the greater is the elasticity of demand – Price elasticity is greater in the long run than in the short run
36. 36. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-36 Determinants of the Price Elasticity of Demand (cont'd) • How to define the short run and the long run – The short run is a time period too short for consumers to fully adjust to a price change – The long run is a time period long enough for consumers to fully adjust to a change in price, other things constant
37. 37. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-37 Example: What Do Real-World Price Elasticities of Demand Look Like? • Economists have found that estimated elasticities of demand are greater in the long run than in the short run. • Remember that even though we are leaving off the negative sign, there is an inverse relationship between price and quantity demanded.
39. 39. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-39 Cross Price Elasticity of Demand • Cross Price Elasticity of Demand (Exy) – The percentage change in the demand for one good (holding its price constant) divided by the percentage change in the price of a related good
40. 40. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-40 Cross Price Elasticity of Demand (cont'd) • Formula for computing cross price elasticity of demand between good X and good Y % change in amount of good X demanded % change in price of good Y Exy =
41. 41. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-41 Cross Price Elasticity of Demand (cont'd) • Substitutes – Exy would be positive • An increase in the price of X would increase the quantity of Y demanded at each price. • Complements – Exy would be negative • An increase in the price of X would decrease the quantity of Y demanded at each price.
42. 42. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-42 Income Elasticity of Demand • Income Elasticity of Demand (Ei) – The percentage change in demand for any good, holding its price constant, divided by the percentage change in income – The responsiveness of demand to changes in income, holding the good’s relative price constant
44. 44. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-44 Income Elasticity of Demand (cont'd) • Calculating the income elasticity of demand Ei = Change in quantity ÷ Change in income Average quantity Average income – The income elasticity of demand can be either negative or positive – Remember that in calculating the income elasticity of demand, the price of the good is assumed to be constant
46. 46. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-46 Income Elasticity of Demand (cont'd) • From Table 19-3, income elasticity of demand for digital apps: Ei = 2/[(6+8)/2] = 2/7 \$2000/[(\$4000+\$60000)/2] 2/5 = 0.71
47. 47. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-47 Example: Are Wal-Mart’s Products Inferior Goods? • Since the economic downturn of 2008 – 2009, WalMart’s sales have outpaced those of other retailers. • Economic research shows that the income elasticity of demand for products sold by Wal-Mart is -0.7. • This inverse relationship between income and purchases at Wal-Mart demonstrates that Wal- Mart’s product line constitutes an inferior good.
48. 48. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-48 Price Elasticity of Supply • Price Elasticity of Supply (Es) – The responsiveness of the quantity supplied of a commodity to a change in its price – The percentage change in quantity supplied divided by the percentage change in price
49. 49. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-49 Percentage change in quantity supplied Percentage change in price ES = Price Elasticity of Supply (cont'd) • Formula for computing price elasticity of supply
50. 50. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-50 Price Elasticity of Supply (cont'd) • Classifying supply elasticities – Perfectly Elastic Supply • Quantity supplied falls to zero when there is the slightest decrease in price • The supply curve is horizontal at a given price
51. 51. Copyright ©2014 Pearson Education, Inc. All rights reserved. 19-51 Price Elasticity of Supply (cont'd) • Classifying supply elasticities – Perfectly Inelastic Supply • Quantity supplied is constant no matter what happens to price • The supply curve is vertical at a given price