ELASTICITY
ELASTICITY
NEW YORK CITY TRANSIT AUTHORITY <ul><li>May 2003: projected deficit of $1 billion over following two years </li></ul><ul><...
NY MTA  <ul><li>MTA expected to raise an additional $286 million in revenue. </li></ul><ul><li>Management projected that a...
MANAGERIAL ECONOMICS QUESTION <ul><li>Would the MTA forecasts be realized? </li></ul><ul><li>In order to gauge the effects...
OWN-PRICE ELASTICITY: E=Q%/P% <ul><li>Definition: percentage change in quantity demanded resulting from 1% increase in pri...
OWN-PRICE ELASTICITY: CALCULATION
CALCULATING ELASTICITY <ul><li>Arc Approach: </li></ul><ul><li>Elasticity={[Q2-Q1]/avgQ}/{[P2-P1]/avgP </li></ul><ul><li>%...
CALCULATING ELASTICITY <ul><li>Point approach: </li></ul><ul><li>Elasticity={[Q2-Q1]/Q1}/{[P2-P1]/P1} </li></ul><ul><li>% ...
OWN-PRICE ELASTICITY <ul><li>|E|=0, perfectly inelastic  </li></ul><ul><li>0<|E|<1, inelastic </li></ul><ul><li>|E|=1, uni...
OWN-PRICE ELASTICITY: SLOPE <ul><li>Steeper demand curve means demand less elastic  </li></ul><ul><li>But slope not same a...
DEMAND CURVES 0 Quantity Price perfectly elastic demand perfectly inelastic demand
LINEAR DEMAND CURVE <ul><li>Vertical intercept: perfectly elastic </li></ul><ul><li>Upper segment: elastic </li></ul><ul><...
OWN-PRICE ELASTICITIES
OWN-PRICE ELASTICITY: DETERMINANTS <ul><li>availability of direct or indirect substitutes </li></ul><ul><li>cost / benefit...
AMERICAN AIRLINES <ul><li>“ Extensive research and many years of experience have taught us that business travel demand is ...
AADVANTAGE <ul><li>1981: American Airlines pioneered frequent flyer program </li></ul><ul><li>buyer commitment </li></ul><...
FORECASTING: WHEN TO RAISE PRICE <ul><li>CEO: “Profits are low.  We must raise prices.” </li></ul><ul><li>Sales Manager: “...
FORECASTING <ul><li>Forecasting quantity demanded </li></ul><ul><ul><li>Change in quantity demanded = price elasticity of ...
FORECASTING: PRICE INCREASE <ul><li>If demand elastic, price increase leads to </li></ul><ul><ul><li>proportionately great...
INCOME ELASTICITY, I=Q%/Y% <ul><li>Definition: percentage change in quantity demanded resulting from 1% increase in income...
INCOME ELASTICITY <ul><li>I >0, Normal good </li></ul><ul><li>I <0, Inferior good </li></ul><ul><li>Among normal goods: </...
INCOME ELASTICITY
CROSS-PRICE ELASTICITY: C=Q%/PO% <ul><li>Definition: percentage change in quantity demanded for one item resulting from 1%...
CROSS-PRICE ELASTICITY <ul><li>C>0, Substitutes </li></ul><ul><li>C<0, complements </li></ul><ul><li>C=0, independent </li...
CROSS-PRICE ELASTICITIES
ADVERTISING ELASTICITY: A=Q%/A% <ul><li>Definition: percentage change in quantity demanded resulting from 1% increase in a...
ADVERTISING ELASTICITY: ESTIMATES If advertising elasticities are so low, why do manufacturers of beer, wine, cigarettes a...
ADVERTISING <ul><li>direct effect: raises demand </li></ul><ul><li>indirect effect: makes demand less sensitive to price <...
FORECASTING DEMAND <ul><li>Q%=E*P%+I*Y%+C*Po%+a*A% </li></ul>
FORECASTING DEMAND  <ul><li>Effect on cigarette demand of </li></ul><ul><li>10% higher income </li></ul><ul><li>5% less ad...
ADJUSTMENT TIME <ul><li>short run: time horizon within which a buyer cannot adjust at least one item of consumption/usage ...
ADJUSTMENT TIME <ul><li>For non-durable items, the longer the time that buyers have to adjust, the bigger will be the resp...
NON-DURABLE:  SHORT/LONG-RUN DEMAND 0 <ul><ul><li>4.5 </li></ul></ul>5 1.5 1.6 1.75 long-run demand short-run demand Quant...
SHORT/LONG-RUN ELASTICITIES
STATISTICAL ESTIMATION: DATA <ul><li>time series  –  record of changes over time in one market  </li></ul><ul><li>cross se...
MULTIPLE REGRESSION <ul><li>Statistical technique to estimate the separate effect of each independent variable on the depe...
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Elasticity ppt @ bec doms

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  • 1
  • 2 Elasticity of demand: the responsiveness of demand to changes in an underlying factor; there is an elasticity corresponding to every factor that effects demand
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  • 7 Arc approach to deriving the own-price elasticity of demand: calculate the percentage change in the quantity demanded divided by the percentage change in price; Example: suppose that, when cigarette price rises from $1.0/pack to $1.1, quantity demanded changes from 1.5 to 1.44 billion packs; then, elasticity = -4.1/9.5 = -0.432. Contrast with the point approach to deriving the own-price elasticity of demand calculates the coefficient from a mathematical equation, in which the quantity demanded is a function of the price and other variables.
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  • 11 Distinguish between the own-price elasticity of demand and the slope of a demand curve; example -- straight-line demand curve: same slope throughout, but different elasticity at every point; steeper is the demand curve, the less elastic is demand, and vice versa. Own-price elasticity can also vary with changes in any of the other factors that affect demand.
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  • 18 Price increase would always reduce sales; real question: how would it affect profit ? answer depends, in part, on price elasticity of demand
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  • 20 Buyer’s expenditure = seller’s revenue; if demand is elastic, reduction in purchases will be proportionately greater than price increase, hence expenditure will fall if demand is inelastic, reduction in purchases will be proportionately less than price increase, hence expenditure will increase;
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  • 28 Answer: the Table shows advertising elasticities for market demand brand owners advertise to draw customers from each other – brand-level demand is more sensitive to advertising
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  • Elasticity ppt @ bec doms

    1. 1. ELASTICITY
    2. 2. ELASTICITY
    3. 3. NEW YORK CITY TRANSIT AUTHORITY <ul><li>May 2003: projected deficit of $1 billion over following two years </li></ul><ul><ul><li>Raised single-ride fares from $1.50 to $2 </li></ul></ul><ul><ul><li>Raised discount fares </li></ul></ul><ul><ul><ul><li>One-day unlimited pass from $4 to $7 </li></ul></ul></ul><ul><ul><ul><li>30-day unlimited pass from $63 to $70 </li></ul></ul></ul><ul><ul><li>Increased pay-per-ride MetroCard discount from 10% bonus for purchase of $15 or more to 20% for purchase of $10 or more. </li></ul></ul>
    4. 4. NY MTA <ul><li>MTA expected to raise an additional $286 million in revenue. </li></ul><ul><li>Management projected that average fares would increase from $1.04 to $1.30, and that total subway ridership would decrease by 2.9%. </li></ul>
    5. 5. MANAGERIAL ECONOMICS QUESTION <ul><li>Would the MTA forecasts be realized? </li></ul><ul><li>In order to gauge the effects of the price increases, the MTA needed to predict how the new fares would impact total subway use, as well as how it would affect subway riders’ use of discount fares. </li></ul><ul><li><Note> We can use the concept of elasticity to address these questions. </li></ul>
    6. 6. OWN-PRICE ELASTICITY: E=Q%/P% <ul><li>Definition: percentage change in quantity demanded resulting from 1% increase in price of the item. </li></ul><ul><li>Alternatively, </li></ul>
    7. 7. OWN-PRICE ELASTICITY: CALCULATION
    8. 8. CALCULATING ELASTICITY <ul><li>Arc Approach: </li></ul><ul><li>Elasticity={[Q2-Q1]/avgQ}/{[P2-P1]/avgP </li></ul><ul><li>% change in qty = (1.44-1.5)/1.47 = -4.1% </li></ul><ul><li>% change in price = (1.10-1)/1.05 = 9.5% </li></ul><ul><li>Elasticity=-4.1%/9.5% </li></ul><ul><li>=-0.432 </li></ul>
    9. 9. CALCULATING ELASTICITY <ul><li>Point approach: </li></ul><ul><li>Elasticity={[Q2-Q1]/Q1}/{[P2-P1]/P1} </li></ul><ul><li>% change in qty = (1.44-1.5)/1.5= -4% </li></ul><ul><li>% change in price = (1.10-1)/1= 10% </li></ul><ul><li>Elasticity=-4%/10%=-0.4 </li></ul>
    10. 10. OWN-PRICE ELASTICITY <ul><li>|E|=0, perfectly inelastic </li></ul><ul><li>0<|E|<1, inelastic </li></ul><ul><li>|E|=1, unit elastic </li></ul><ul><li>|E|>1, elastic </li></ul><ul><li>|E|=infinity, perfectly elastic </li></ul>
    11. 11. OWN-PRICE ELASTICITY: SLOPE <ul><li>Steeper demand curve means demand less elastic </li></ul><ul><li>But slope not same as elasticity </li></ul>
    12. 12. DEMAND CURVES 0 Quantity Price perfectly elastic demand perfectly inelastic demand
    13. 13. LINEAR DEMAND CURVE <ul><li>Vertical intercept: perfectly elastic </li></ul><ul><li>Upper segment: elastic </li></ul><ul><li>Middle: Unit elastic </li></ul><ul><li>Lower segment: inelastic </li></ul><ul><li>Horizontal intercept: perfectly inelastic </li></ul>
    14. 14. OWN-PRICE ELASTICITIES
    15. 15. OWN-PRICE ELASTICITY: DETERMINANTS <ul><li>availability of direct or indirect substitutes </li></ul><ul><li>cost / benefit of economizing (searching for better price) </li></ul><ul><li>buyer ’ s prior commitments </li></ul><ul><li>separation of buyer and payee </li></ul>
    16. 16. AMERICAN AIRLINES <ul><li>“ Extensive research and many years of experience have taught us that business travel demand is quite inelastic … On the other hand, pleasure travel has substantial elasticity. ” </li></ul><ul><li>Robert L. Crandall, CEO, 1989 </li></ul>
    17. 17. AADVANTAGE <ul><li>1981: American Airlines pioneered frequent flyer program </li></ul><ul><li>buyer commitment </li></ul><ul><li>business executives fly at the expense of others </li></ul>
    18. 18. FORECASTING: WHEN TO RAISE PRICE <ul><li>CEO: “Profits are low. We must raise prices.” </li></ul><ul><li>Sales Manager: “But my sales would fall!” </li></ul><ul><li>Real issue: How sensitive are buyers to price changes? </li></ul>
    19. 19. FORECASTING <ul><li>Forecasting quantity demanded </li></ul><ul><ul><li>Change in quantity demanded = price elasticity of demand x change in price </li></ul></ul>
    20. 20. FORECASTING: PRICE INCREASE <ul><li>If demand elastic, price increase leads to </li></ul><ul><ul><li>proportionately greater reduction in purchases </li></ul></ul><ul><ul><li>lower expenditure </li></ul></ul><ul><li>If demand inelastic, price increase leads to </li></ul><ul><ul><li>proportionately smaller reduction in purchases </li></ul></ul><ul><ul><li>higher expenditure </li></ul></ul>
    21. 21. INCOME ELASTICITY, I=Q%/Y% <ul><li>Definition: percentage change in quantity demanded resulting from 1% increase in income. </li></ul><ul><li>Alternatively, </li></ul>
    22. 22. INCOME ELASTICITY <ul><li>I >0, Normal good </li></ul><ul><li>I <0, Inferior good </li></ul><ul><li>Among normal goods: </li></ul><ul><li>0<I<1, necessity </li></ul><ul><li>I>1, luxury </li></ul>
    23. 23. INCOME ELASTICITY
    24. 24. CROSS-PRICE ELASTICITY: C=Q%/PO% <ul><li>Definition: percentage change in quantity demanded for one item resulting from 1% increase in the price of another item. </li></ul><ul><li>(%change in quantity demanded for one item) / (% change in price of another item) </li></ul>
    25. 25. CROSS-PRICE ELASTICITY <ul><li>C>0, Substitutes </li></ul><ul><li>C<0, complements </li></ul><ul><li>C=0, independent </li></ul>
    26. 26. CROSS-PRICE ELASTICITIES
    27. 27. ADVERTISING ELASTICITY: A=Q%/A% <ul><li>Definition: percentage change in quantity demanded resulting from 1% increase in advertising expenditure. </li></ul>
    28. 28. ADVERTISING ELASTICITY: ESTIMATES If advertising elasticities are so low, why do manufacturers of beer, wine, cigarettes advertise so heavily? Item Market Elasticity Beer U.S. 0 Wine U.S. 0.08 Cigarettes U.S. 0.04
    29. 29. ADVERTISING <ul><li>direct effect: raises demand </li></ul><ul><li>indirect effect: makes demand less sensitive to price </li></ul><ul><li>Own price elasticity for antihypertensive drugs </li></ul><ul><li>Without advertising: -2.05 </li></ul><ul><li>With advertising: -1.6 </li></ul>
    30. 30. FORECASTING DEMAND <ul><li>Q%=E*P%+I*Y%+C*Po%+a*A% </li></ul>
    31. 31. FORECASTING DEMAND <ul><li>Effect on cigarette demand of </li></ul><ul><li>10% higher income </li></ul><ul><li>5% less advertising </li></ul>change elas. effect income 10% 0.1 1% advert. -5% 0.04 -0.2% net +0.8%
    32. 32. ADJUSTMENT TIME <ul><li>short run: time horizon within which a buyer cannot adjust at least one item of consumption/usage </li></ul><ul><li>long run: time horizon long enough to adjust all items of consumption/usage </li></ul>
    33. 33. ADJUSTMENT TIME <ul><li>For non-durable items, the longer the time that buyers have to adjust, the bigger will be the response to a price change. </li></ul><ul><li>For durable items, a countervailing effect (that is, the replacement frequency effect) leads demand to be relatively more elastic in the short run. </li></ul>
    34. 34. NON-DURABLE: SHORT/LONG-RUN DEMAND 0 <ul><ul><li>4.5 </li></ul></ul>5 1.5 1.6 1.75 long-run demand short-run demand Quantity (Million units a month) Price ($ per unit)
    35. 35. SHORT/LONG-RUN ELASTICITIES
    36. 36. STATISTICAL ESTIMATION: DATA <ul><li>time series – record of changes over time in one market </li></ul><ul><li>cross section -- record of data at one time over several markets </li></ul><ul><li>Panel data: cross section over time </li></ul>
    37. 37. MULTIPLE REGRESSION <ul><li>Statistical technique to estimate the separate effect of each independent variable on the dependent variable </li></ul><ul><li>dependent variable = variable whose changes are to be explained </li></ul><ul><li>independent variable = factor affecting the dependent variable </li></ul>

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