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# Lecture Ten - Twelve Slides

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### Lecture Ten - Twelve Slides

1. 1. Chapter 5 Elasticity You are responsible for reading Chapter 4!!!
2. 2. What have we done? <ul><li>Chapter 3 gave us downward sloping demand curves </li></ul><ul><ul><li>Law of demand </li></ul></ul><ul><li>Now want to see how Q d changes when price changes </li></ul>
3. 3. Elasticity <ul><li>Response of one variable to a change in another variable </li></ul><ul><li>Price elasticity of demand </li></ul><ul><ul><li>Measure of the responsiveness of Q d of a product to a change in the price of that product </li></ul></ul>
4. 4. or rewrite as
5. 5. So… <ul><li>What if E d = 3? </li></ul><ul><ul><li>If price was increased from the prevailing point the % change in Q d would be 3 times the change in price </li></ul></ul><ul><li>Shouldn’t it be negative? </li></ul><ul><ul><li>So price increases and Q d decreases? </li></ul></ul><ul><li>Yes!! </li></ul><ul><ul><li>For ease we look at the absolute value, but know that the law of demand holds </li></ul></ul>
6. 6. Point elasticity <ul><li>Measures the change between two observed points. </li></ul>
7. 7. example <ul><li>P 1 = 10 </li></ul><ul><li>P 2 = 12 </li></ul><ul><li>Q 1 = 100 </li></ul><ul><li>Q 2 = 50 </li></ul><ul><li>Elasticity?? </li></ul><ul><li>Which is Point A??? </li></ul><ul><li>Big Problem!!! </li></ul>
8. 8. Problem <ul><li>Answers vary depending on where you start </li></ul><ul><li>Becomes more important the larger the change </li></ul>
9. 9. Arc Elasticity <ul><li>To avoid the endpoint problem take elasticity at the midpoint (average) of the two points </li></ul>
10. 10. Differences <ul><li>With arc elasticity it is clear which points are used </li></ul><ul><li>P 1 is the first price </li></ul><ul><li>P 2 is the second price </li></ul><ul><li>Q d 1 and Q d 2 are the first and second quantity demanded respectively </li></ul>
11. 11. Price elasticity of demand can yield 5 basic results <ul><li>Numerator > Denominator </li></ul><ul><li>Numerator < Denominator </li></ul><ul><li>Numerator = Denominator </li></ul><ul><li>Numerator = 0 </li></ul><ul><li>Denominator = 0 </li></ul><ul><li>Each has a specific name and result </li></ul>
12. 12. Elastic Demand <ul><li>Ed > 1 </li></ul><ul><li>% change in quantity demanded > % change in price </li></ul><ul><li>FLATTER CURVE </li></ul><ul><li>What are some examples of an elastic good??? </li></ul>
13. 13. Inelastic Demand <ul><li>E d <1 </li></ul><ul><li>% change in the price > percent change in quantity demanded </li></ul><ul><li>STEEPER CURVE </li></ul><ul><li>What are some examples of an inelastic good? </li></ul>
14. 14. Price Elasticity of Demand
15. 15. Unit Elastic Demand <ul><li>E d =1 </li></ul><ul><li>% change in price = % change in quantity demanded </li></ul><ul><li>Change in price brings a proportionate change in quantity demanded </li></ul><ul><li>CURVE </li></ul>
16. 16. Price Elasticity of Demand
17. 17. Perfectly Elastic Demand <ul><li>Ed = (denominator = 0) </li></ul><ul><li>% change in quantity demanded is A LOT in response to a change in price </li></ul><ul><li>Price increases and quantity demanded goes to 0 </li></ul><ul><li>Totally flat --- horizontal </li></ul><ul><li>Extreme </li></ul><ul><li>Examples??? </li></ul>
18. 18. Perfectly inelastic demand <ul><li>E d = 0 </li></ul><ul><li>% change in quantity demanded DOESN’T CHANGE in response to a change in price </li></ul><ul><li>Totally steep --- vertical </li></ul><ul><li>Extreme </li></ul><ul><li>Examples??? </li></ul>
19. 19. Price Elasticity of Demand
20. 20. Aren’t demand curve downward sloping? <ul><li>Because the extremes (perfectly inelastic and perfectly elastic) are not. </li></ul><ul><li>Use as points of reference only </li></ul>
21. 21. How does a change in price affect Total Revenue of a Firm? <ul><li>Revenue depends on elasticity </li></ul><ul><li>Michael Jordan and Nike shoes </li></ul><ul><ul><li>No substitutes -- inelastic demand </li></ul></ul><ul><ul><ul><li>What happens to Qd if price increases? </li></ul></ul></ul><ul><ul><li>Substitutes – elastic demand </li></ul></ul><ul><ul><ul><li>What happens to Qd if price increases? </li></ul></ul></ul>
22. 22. What is total revenue?? <ul><li>Total revenue = price*quantity </li></ul><ul><li>Firm uses to decide if to produce more or less </li></ul>
23. 23. examples <ul><li>Elastic demand </li></ul><ul><ul><li>Price increase </li></ul></ul><ul><ul><li>Price decrease </li></ul></ul><ul><li>Inelastic demand </li></ul><ul><ul><li>Price increase </li></ul></ul><ul><ul><li>Price decrease </li></ul></ul><ul><li>Unit elastic demand </li></ul><ul><ul><li>Price increase </li></ul></ul><ul><ul><li>Price decrease </li></ul></ul>
24. 24. Elasticities, Price Changes, and Total Revenue
25. 25. Important to look at because… <ul><li>Elasticity of the demand determines if with a price increase… </li></ul><ul><ul><li>Total revenue increases </li></ul></ul><ul><ul><li>Total revenue decreases </li></ul></ul><ul><ul><li>Total revenue remains the same </li></ul></ul>
26. 26. Price elasticity of demand and a straight line <ul><li>Demand is downward sloping </li></ul><ul><li>Along the line elasticity varies from highly elastic to highly inelastic </li></ul><ul><li>But…remember SLOPE is constant </li></ul>
27. 27. P Q G F E D C B A Find Total Revenue and Elasticity of Demand 9 2 G 8 3 F 7 4 E 6 5 D 5 6 C 4 7 B 3 8 A Q d P Point
28. 28. Price Elasticity of Demand along a Demand Curve
29. 29. Summary <ul><li>Upper end of Demand Curve </li></ul><ul><ul><li>Q d is low and price is high </li></ul></ul><ul><ul><li>Freak out more when price is high </li></ul></ul><ul><li>Lower end of Demand Curve </li></ul><ul><ul><li>Q d is high and price is low </li></ul></ul><ul><ul><li>Freak out less when price is low </li></ul></ul>
30. 30. So… <ul><li>As move down the demand curve from higher prices to lower the price elasticity of demand goes from elastic to inelastic </li></ul>
31. 31. Determinates of price elasticity of demand <ul><li>Number of substitutes available </li></ul><ul><ul><li>Increase substitutes increases elasticity </li></ul></ul><ul><ul><li>More narrowly defined goods have more substitutes (compared to broadly defined) </li></ul></ul><ul><ul><ul><li>Example: Fords vs all cars </li></ul></ul></ul>
32. 32. More determinates <ul><li>Percentage of one’s budget that is spent on the good </li></ul><ul><ul><li>More expensive??? More elastic </li></ul></ul><ul><ul><li>More affected by price (even small changes) </li></ul></ul>
33. 33. Final determinate <ul><li>Amount of time that passed since price change </li></ul><ul><ul><li>Increase time passed gives more opportunity to change behavior or react to price change </li></ul></ul><ul><ul><li>Overtime can look for substitutes </li></ul></ul><ul><ul><li>Increase time increases elasticity </li></ul></ul><ul><ul><li>More elastic in long term than short </li></ul></ul>
34. 34. Cross Elasticity of Demand <ul><li>Measures the responsiveness of quantity demanded to a change in price of ANOTHER good </li></ul>
35. 35. When would you use Cross Price Elasticity? <ul><li>To determine if goods are substitutes or compliments </li></ul><ul><li>Ec>0 – substitutes </li></ul><ul><ul><li>% change in quantity demanded and price move in same direction </li></ul></ul><ul><li>Ec<0 – compliments </li></ul><ul><ul><li>% change in quantity demanded and price move in opposite directions </li></ul></ul><ul><li>Ec=0 – goods unrelated </li></ul>
36. 36. Income elasticity of demand <ul><li>Measures the responsiveness of quantity demanded to the change in income </li></ul>
37. 37. Why use income elasticity of demand? <ul><li>Use to determine if a good is normal or inferior </li></ul><ul><li>E y >0 – normal good </li></ul><ul><ul><li>As income increases Q d increases </li></ul></ul><ul><li>E y <0 – inferior good </li></ul><ul><ul><li>As income increases Q d decreases </li></ul></ul>
38. 38. Can also say… <ul><li>If |E y | > 1 </li></ul><ul><ul><li>% change in Q d > % change in Y </li></ul></ul><ul><ul><li>Income elastic </li></ul></ul><ul><li>If |E y | < 1 </li></ul><ul><ul><li>% change in Q d < % change in Y </li></ul></ul><ul><ul><li>Income inelastic </li></ul></ul><ul><li>If |E y | = 1 </li></ul><ul><ul><li>% change in Q d = % change in Y </li></ul></ul><ul><ul><li>Income unit elastic </li></ul></ul>
39. 39. Can we use income elasticity in the real world?? <ul><li>If invest in the stock market do you want to invest in a normal or inferior good? </li></ul><ul><li>Normal </li></ul><ul><li>Why </li></ul><ul><li>Increase income would increase quantity bought and increase stock prices </li></ul>
40. 40. Price Elasticity of Supply <ul><li>Measures the responsiveness of quantity supplied of a good to the change in the price of that good </li></ul>
41. 41. Classification is like demand <ul><li>Es > 1 </li></ul><ul><ul><li>Elastic </li></ul></ul><ul><li>Es < 1 </li></ul><ul><ul><li>Inelastic </li></ul></ul><ul><li>Es = 1 </li></ul><ul><ul><li>Unit elastic </li></ul></ul><ul><li>Each of these will result in a “normal” upward sloped supply curve </li></ul>
42. 42. Any extreme elasticities??? <ul><li>Yes!! </li></ul><ul><li>Es = </li></ul><ul><ul><li>Perfectly elastic or horizontal </li></ul></ul><ul><li>Es = 0 </li></ul><ul><ul><li>Perfectly inelastic or vertical </li></ul></ul>
43. 43. Price Elasticity of Supply
44. 44. Price Elasticity of Supply
45. 45. Price Elasticity of Supply
46. 46. Does time play a role in elasticity of supply? <ul><li>Yes!! </li></ul><ul><li>Overtime producers are able to adjust their behavior and production patterns </li></ul><ul><li>Supply becomes more elastic as time passes </li></ul>
47. 47. Elasticity and taxes <ul><li>If government levies a tax on a product who pays the tax?? </li></ul><ul><li>Producers?? Consumers?? Share?? </li></ul><ul><li>Depends on the elasticity of demand and supply </li></ul>
48. 48. How find?? <ul><li>Find equilibrium price </li></ul><ul><li>Supply shifts left in the amount of the tax </li></ul><ul><li>Find new equilibrium </li></ul><ul><li>Find point of second equilibrium on ORGINAL supply curve </li></ul><ul><ul><li>Shows the actual price realized by firm or equilibrium price – tax = point in question </li></ul></ul><ul><li>Difference between points determines how much of tax you pay </li></ul>
49. 49. Who Pays the Tax?
50. 50. Who pays more of the tax?? <ul><li>Perfectly inelastic demand </li></ul><ul><li>Perfectly elastic demand </li></ul><ul><li>Demand more elastic than supply </li></ul><ul><li>Supply more elastic than demand </li></ul>
51. 51. Different Elasticities and Who Pays the Tax
52. 52. Different Elasticities and Who Pays the Tax
53. 53. Summary <ul><li>E d > E s producer bears most of the tax burden </li></ul><ul><li>E d < E s consumer bears most of the tax burden </li></ul><ul><li>E d = E s equally share the tax burden </li></ul>
54. 54. Homework Numbers 5, 6, and 8 Working with Graphs and Numbers 1, 2, and 4
55. 55. Do we understand Chapter 5??