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EC101 BB & EE / Manove

Lecture 7. Elasticity Lecture 7. Elasticity


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

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