Elasticity is a measure of how responsive the quantity demanded of a good is to a change in its price. Elasticity measures the responsiveness of one variable to another as a ratio of percentages.
Elasticity is a measure of how responsive the quantity demanded of a good is to a change in its price. Elasticity measures the responsiveness of one variable to another as a ratio of percentages.
Elasticity is a measure of how responsive the quantity demanded of a good is to a change in its price. Elasticity measures the responsiveness of one variable to another as a ratio of percentages.
Elasticity of Demand p 1 EC101 BB & EE / Manove So far weve seen that When the price rises, the quantity demanded falls, and quantity supplied iincreases. BUT, by how much will the quantity , y q y demanded fall? AND by how much will the quantity AND by how much will the quantity supplied rise? (And who cares about the answer to this (And who cares about the answer to this question ?) Elasticity of Demand>Who Cares? p 2 EC101 BB & EE / Manove Firms care: Who cares? Governments care: Governments care: Elasticity of Demand>Who Cares? p 3 EC101 BB & EE / Manove Who cares 2 Most important, Elasticity of Demand>Who Cares? p 4 EC101 BB & EE / Manove Who cares 2 To answer these questions, we have to understand the concept of elasticity, which measures the responsiveness of one variable to another as a ratio of percentages. variable to another as a ratio of percentages. We begin with the price elasticity of demand. Elasticity of Demand>Who Cares p 5 EC101 BB & EE / Manove Price Elasticity of Demand A measure of how responsive the quantity demanded of a good is to a change in its price. More precisely, the price elasticity of demand is defined by: c y Percentage Change in Quantity Demanded Percentage Change in Price = c % Q A Percentage Change in Price or equivalently by % % Q P c = A Elasticity of Demand>Definition p 6 [ " ", " ", " "] change Q quantity P price A = = = EC101 BB & EE / Manove Arc Elasticities Th thi th t b tt NOT t There are some things that are better NOT to know, like the arc (midpoint) elasticity formula. ( ) ( ) ( ) ( ) 2 1 2 1 2 1 2 1 / 2 / 2 Q Q Q Q P P P P c +
= +
This is a stupid, confusing and useless formula strongly favored by textbook publishers ( ) ( )
strongly favored by textbook publishers. In fact most formulas are stupid and confusing and should be used only in cookbooks. I want you to understand concepts not I want you to understand concepts, not memorize formulas. Elasticity of Demand>Definition p 7 EC101 BB & EE / Manove Example: Pork Suppose the price of pork falls by pp p p y 2%, and the quantity demanded increases by 6% as a result. Then the price elasticity of demand for pork is Price elasticity of demand is negative (when y g ( price rises, quantity falls, or vice versa) . But we sometimes drop the minus sign Elasticity of Demand>Example Pork p 8 But we sometimes drop the minus sign, because we know it is negative. EC101 BB & EE / Manove Why percentages? Why do we use percentage changes instead of the amount of the change? g Example: Pork again. Elasticity of Demand>Why percentages? p 9 EC101 BB & EE / Manove Why percentages 2 Solution (with percentages): We have so that Also so that so that and Without percentages ??? With prices in dollars: With prices in dollars: With prices in cents: Elasticity of Demand>Why percentages? p 10 EC101 BB & EE / Manove Interpreting Price Elasticity of Demand p g y We see whether Percentage Change in Quantity Demanded Percentage Change in Price c = is larger or smaller than 1. For we say that demand is elastic. 1, c > For we say that demand is elastic. For we say that demand is inelastic. F th t d d i it l ti 1, c > 1, c < 1 For we say that demand is unit-elastic. 1, c = Elasticity of Demand>How Elastic p 11 EC101 BB & EE / Manove Example: Ski Passes What is the elasticity of demand for season ski-passes? Price Quantity Original $400 10 000 Original $400 10,000 New $380 12,000 Elasticity of Demand>How Elastic>Example Ski Passes p 12 So demand for ski passes is _________ . EC101 BB & EE / Manove Factors that Affect Price Elasticity of Demand Price Elasticity of Demand Why is the demand for peas h l ti th th d d f so much more elastic than the demand for coffee? Wh i th d d f l t Why is the demand for luxury sports cars so much more elastic than the demand for coffee? coffee? Elasticity of Demand>What Determines Elasticity? p 13 EC101 BB & EE / Manove Measured Elasticities of Demand * Broiler Chickens 0.5 to 0.6 * Soft drinks 0.8 to 1.0 (general) 3.8 (Coca Cola) * Petroleum (World) 0.4 ( ) 4.4 (Mountain Dew) * Steel * Car fuel 0.25 (Short run) 0 64 (L ) Steel 0.2 to 0.3 0.64 (Long run) * Medicine (US) * Eggs 0.1 (US) 0.35 (Canada) ( ) 0.31 (Insurance) .03 to .06 (Pediatric Visits) ( ) 0.55 (South Africa) http://en wikipedia org/wiki/ Elasticity of Demand>Estimates p 14 Visits) http://en.wikipedia.org/wiki/ Price_elasticity_of_demand EC101 BB & EE / Manove Measured Elasticities of Demand * Cigarettes (US) 0 3 t 0 6 (G l) * Rice 0 47 (A i ) 0.3 to 0.6 (General) 0.6 to 0.7 (Youth) 0.47 (Austria) 0.80 (Bangladesh) 0.80 (China) * Alcoholic beverages (US) 0.3 (Beer) 1 0 (Wine) ( ) 0.25 (Japan) 0.55 (US) 1.0 (Wine) 1.5 (Spirits) * Ai li t l (US) * Cinema visits (US) 0.87 * Airline travel (US) 0.3 (First Class) 0.9 (Discount) * Transport 0.20 (Bus travel US) ( ) 1.5 (for Pleasure) ( ) 2.80 (Ford) http://en wikipedia org/wiki/ Elasticity of Demand>Estimates p 15 http://en.wikipedia.org/wiki/ Price_elasticity_of_demand EC101 BB & EE / Manove Price Elasticity and the Slope of the Demand Curve Slope of the Demand Curve What is the price elasticity of Demand for D 1 & D 2 when P = $4? 1 2 $ Elastic Demand: Quantity Demanded changes a lot in response to a price change (D ) Price D change. (D 2 ) Inelastic Demand: Quantity D d d h l littl i D 1 D 2 2 Demanded changes only a little in response to a price change. (D 1 ) 4 16 10 Quantity 8 Elasticity of Demand>Slopes of Demand Curve p 16 EC101 BB & EE / Manove Perfectly Inelastic and P f tl El ti Perfectlyinelastic d d t Price Perfectly Elastic Demand demandcurvescannot goupforever,because consumerseventually runoutofmoney. Perfectly Inelastic Demand: No Ch i Q i D d d Change in Quantity Demanded in response to a Price Change Perfectlyelastic demandcurvescannot go on forever, because 4 PerfectlyElasticDemand:Jump in Quantity Demanded in response to goonforever,because consumerseventually runoutofmoney. Quantity 8 QuantityDemandedinresponseto evenasmallPriceChange Elasticity of Demand>Perfectly Elastic and Inelastic p 17 EC101 BB & EE / Manove Price Elasticity Changes along St i ht Li D d C a StraightLine Demand Curve NOTE! Price elasticity varies at Price elasticity varies at every point along a straightline demand curve. a P r i c e a/2 b/2 b Elasticity of Demand>Linear Demand Curve p 18 Quantity EC101 BB & EE / Manove Changes in Total Expenditure Will an increase in price always result in an increase in buyers total expenditure? Price Quantity Total Revenue (P x Q) 2 5 2 5 UP 4 4 UP 6 3 UP 8 2 UP 10 1 Elasticity of Demand>Expenditures p 19 EC101 BB & EE / Manove Total Expenditure F ti f P i as a Function of Price Total revenue is at a maximum at the 1,800 1,600 12 10 midpoint on a straightline demand curve A B i t u r e
( $ / d a y ) 1,600 1,000 $ / t i c k e t ) 10 8 6 C B A T o t a l
e x p e n d i P r i c e
( $ 6 4 2 C Price ($/ticket) 2 6 8 10 12 0 4 Quantity (100s of tickets/day) 1 3 4 5 6 0 2 Elasticity of Demand>Expenditures p 20 EC101 BB & EE / Manove Elasticity and the Effect of a Price Change on Total Expenditure Price Change on Total Expenditure Elasticity of Demand>Expenditures p 21 EC101 BB & EE / Manove Cross-Price Elasticity A cross price elasticity is the ratio of E l A cross-price elasticity is the ratio of the percentage change in the quantity demanded of one good to the % % Chicken Q P c A = A Example percentage change in price of another good. T d b tit t if % Beef P A Two goods are substitutes if you can use one of them instead of the other. Two goods are complements if you normally use both of them together normally use both of them together. Elasticity of Demand>cross-Price p 22 EC101 BB & EE / Manove Examples of Cross Price Elasticity When the price of meat goes up by 10% the quantity of chicken demanded rises by 5%. Then the cross-price l ti it f hi k ith t t b f i ? elasticity of chicken with respect to beef is ____ ? Elasticity of Demand>cross-Price p 23 EC101 BB & EE / Manove Income Elasticity The income elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in the persons income. Normal goods: g Inferior goods: Elasticity of Demand>Income p 24 EC101 BB & EE / Manove Examples of Income Elasticity Wh it i i f $25 000 t When per capita income increases from $25,000 to $30,000, the quantity of air travel demanded (by consumers) increases by 30%. Then the income elasticity co su e s) c eases by 30% e e co e e as c y of demand for air travel is _____ ? Elasticity of Demand>Income p 25