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Lecture 5 handout
This document discusses concepts of elasticity in microeconomics including: - Price elasticity of demand which measures the responsiveness of quantity demanded to changes in price. It uses the midpoint formula and compares values to benchmarks to determine if demand is elastic or inelastic. - Cross-price elasticity of demand which measures the responsiveness of quantity demanded of one good to price changes in another good, identifying if goods are substitutes or complements. - Income elasticity of demand which measures the responsiveness of quantity demanded to changes in income, identifying if goods are inferior, normal, or luxury goods. - Price elasticity of supply which measures the responsiveness of quantity supplied to changes in price, identifying if
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Lecture 5 handout
- 1. Microeconomics Chapter 5 ! Elasticity 100 90 80 70 60 50 40 30 20 10 0 Movement along the ! Demand Curve 0 1 2 3 4 5 6 7 8 9 10 Price Quantity Price changes! ! demand curve does not change! ! quantity demanded! changes Shift in the Demand Curve 100 90 80 70 60 50 40 30 20 10 0 0 1 2 3 4 5 6 7 8 9 10 Price Quantity Price does not change! ! demand curve shifts! ! quantity demanded! changes Movement or Shift? Variable Change Movement Shift Price Income Related Goods Tastes Population and Demographics Expectations Key Terms ELASTICITY EQUATION BENCHMARK elasticity! price elasticity of demand! total revenue! total expenditure! income elasticity of demand! cross-price elasticity of demand! price elasticity of supply! Price! Demand MPF Cross-! Price Income Price! Supply Inelastic | Elastic ! 1 Compliments | Substitutes! 0 Inferior | Normal | Luxury! 0 1 Inelastic | Elastic ! 1 %ΔQD %ΔP ΔQ x P Q ΔP %ΔQD1 %ΔP2 %ΔQD %ΔI %ΔQS %ΔP Elasticity If I change one thing does another thing also change?
- 2. Elasticity A measureof how much one economic variable responds to changes in another economic variable Price Elasticity of Demand % % QD P Percentage Change in Quantity Demanded! Percentage Change in Price Demand Schedule Price Quantity Total Revenue 90 1 90 80 2 160 70 3 210 60 4 240 50 5 250 40 6 240 30 7 210 20 8 160 10 9 90 Total Revenue! Curve 260 208 156 104 52 0 10 20 30 40 50 60 70 80 90 Total! Revenue Price Per Pizza Percentage Change % New - Old Old Ignore units in the scale Price Elasticity of Demand 1. Calculate Elasticity! 2. Take Absolute Value! 3. Compare to benchmark of 1 Inelastic Elastic <1 >1 1 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1 2 3 4 5 6 7 8 9 10 Gallons - Gasoline Price %rQD %rP (4-5)÷5 (6-3)÷3 -.2 1 .2 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1 2 3 4 5 6 7 8 9 10 Gallons - Ice Cream Price %rQD %rP (3-5)÷5 (4-3)÷3 -.4 .33 1.2 Price Increase $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1 2 3 4 5 6 7 8 9 10 Gallons - Ice Cream Price %rQD %rP (5-3)÷3 (3-4)÷4 .66 -.25 2.67 Price Decrease ! Midpoint Formula
- 3. $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1 2 3 4 5 6 7 8 9 10 Gallons - Ice Cream Price %rQD %rP (3-5)÷5 (4-3)÷3 -.4 .33 1.2 Price Increase $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1 2 3 4 5 6 7 8 9 10 Gallons - Ice Cream Price %rQD %rP (5-3)÷3 (3-4)÷4 +66% -25% 2.67 Price Decrease Midpoint Formula Trick: Flip denominator and multiply Delta Q! over! Q Bar Delta P! over ! P Bar Q Q P P X = $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1 2 3 4 5 6 7 8 9 10 Gallons - Ice Cream Price 7 4 1.75 Midpoint Formula rQ Q rP x P 2 4 1 x 3.5 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1 2 3 4 5 6 7 8 9 10 Gallons - Gasoline Price $100.00 $90.00 $80.00 $70.00 $60.00 $50.00 $40.00 $30.00 $20.00 $10.00 $0.00 3 4.5 6 Gallons - Gasoline Price Scales can be deceptive ! What determines Price Elasticity of Demand?
- 4. Close Substitutes Passageof Time Luxuries vs. Necessities Definition of Market Share of Budget Close Substitutes Elastic >1 Inelastic <1 Passage of Time More Time! More Elastic Luxuries vs. Necessities Elastic Inelastic Definition of Market Demand for Gasoline in General Demand for Gasoline in Rexburg Elastic Inelastic Share of the Budget Small Large Inelastic Elastic ! Price Elasticity and Total Revenue $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 $3.00 x 5 = $15 Net Gain = $9 1 2 3 4 5 6 7 8 9 10 Gallons - Gasoline Price $6.00 x 4 = $24 Inelastic (<1)! Raising prices will increase total revenue Lose Gain Total Revenue TR = P x Q $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 $3.00 x 5 = $15 Net Gain = -$3 1 2 3 4 5 6 7 8 9 10 Gallons - Ice Cream Price $4.00 x 3 = $12 Elastic (>1)! Raising prices will decrease total revenue Lose Gain Total Revenue TR = P x Q
- 5. ! Cross-Price Elasticityof Demand Cross-Price Elasticity of Demand % % QD P Percentage Change in Quantity Demanded of one good! Percentage Change in Price! of another good 1 2 Cross-Price Elasticity of Demand 1. Calculate Elasticity! 2. Compare to benchmark of 0 Compliments Substitutes <0 >0 0 % % QD1 P2 35% 50% =.7 >0 Substitutes % % QD1 P2 -40% 50% =-.8 <0 Compliments Cross-Price Elasticity of Demand Compliments Substitutes <0 >0 0 % % QD P 1 2 ! Income Elasticity of Demand ! Income Elasticity of Demand % % QD I Normal, Inferior, or Luxury? Percentage Change in ! Quantity Demanded ! Percentage Change in Income Income Elasticity of Demand 1. Calculate Elasticity! 2. Compare to benchmark of 0 and 1 Inferior Normal Luxury <0 0 1 >1
- 6. % % QD I 10% 20% =.5 >0! <1 Normal % % QD I -50% 20% =-2.5 <0 Inferior % % QD I 100% 20% = 5 >1 Luxury Income Elasticity of Demand % % Inferior Normal Luxury <0 0 1 >1 QD I ! Price Elasticity of Supply ! Price Elasticity of Supply % % QS P Percentage Change in ! Quantity Supplied! Percentage Change in Price Price Elasticity of Supply 1. Calculate Elasticity! 2. Compare to benchmark of 1 % Inelastic Elastic <1 >1 1 % QS P 10% 20% =.5 <1 Inelastic % % QS P 40% 20% = 2 >1 Elastic
- 7. Price Elasticity ofSupply Inelastic Elastic <1 1 >1 % % QS P ! What determines Price Elasticity of Demand? Close Substitutes Passage of Time Luxuries vs. Necessities Definition of Market Share of Budget Cross-Price Elasticity of Demand 1. Calculate Elasticity! ! %ΔQD1 %ΔP2 ! 2. Compare to benchmark of 0 Compliments Substitutes <0 >0 0 Income Elasticity of Demand 1. Calculate Elasticity! ! ! 2. Compare to benchmark of 0 and 1 Inferior Normal Luxury <0 0 1 >1 %ΔQD %ΔI ELASTICITY EQUATION BENCHMARK Price Elasticity ! of Demand Midpoint! Formula Cross-Price! Elasticity Income! Elasticity Price Elasticity! of Supply Inelastic | Elastic ! 1 Compliments | Substitutes! 0 Inferior | Normal | Luxury! 0 1 Inelastic | Elastic ! 1 %ΔQD %ΔP ΔQ x P Q ΔP %ΔQD1 %ΔP2 %ΔQD %ΔI %ΔQS %ΔP Elasticity Quiz 1. Prices increase from $5.00 to $6.00. Quantity 1. Prices increase from $5.00 to $6.00. Quantity demanded decreases from 100 units to 80 units.! ! What is the price elasticity of demand?! What is the total revenue at $5.00 per unit?! What is the total revenue at $6.00 per unit?! ! 2. If I increase prices from $20 to $25, quantity demanded decreases from 1,000 units to 900 units. Should I raise prices? Why?! ! 3. Prices increase from $10 to $15 for product A. Quantity demanded for product B increases from 500 units to 600 units! ! What is the cross-price elasticity of demand? Are these products compliments or substitutes?! ! 4. Prices increase from $10 to $15 for product C. Quantity demanded for product B decreases from 40 units to 30 units! ! What is the cross-price elasticity of demand? Are these products compliments or substitutes?! ! 5. Your income increase from $10 to $15 per hour. Quantity demanded for product E decreases from 20 units to 15 units! ! What is the income elasticity of demand? Is this product an inferior, normal, or luxury good?! ! 6. Your income decreases from $12 to $10 per hour. Quantity demanded for product F increases from 10 units to 12 units! ! What is the income elasticity of demand? Is this product an inferior, normal, or luxury good?! demanded decreases from 100 units to 80 units.! ! What is the price elasticity of demand?! Midpoint Formula ! ! ΔQ ! x P 20 Q ΔP ! What is the total revenue at $5.00 per unit?! ! $5 x 100 = $500! ! What is the total revenue at $6.00 per unit?! ! $6 x 80 = $480 x 5.50 110 1.22 = = = 90 1 90