Recall from Chapter 2 that if the price of a computer game falls, then the number of games purchased rises

If the price of the computer game halves, then how does the number of games purchased change? Does it double? Triple? Increase by 20%? We need to understand the Price Elasticity of

Demand to know how much demand will change due to a change in price

CH. 3 – COMPETITIVE DYNAMICS AND GOVERNMENT

3.1 – Price Elasticity of Demand

Consumers can be very responsive or very unresponsive to price changes

Elastic and Inelastic Demand

Selling Ice Cream in Winter Months

Selling Ice Cream in Summer Months

In the winter months, a small change in price caused the demand to halve

In the summer months, a small change in price caused the demand to decrease by 1/6

Elastic and Inelastic Demand

Selling Ice Cream in Winter Months

Selling Ice Cream in Summer Months

Perfectly Elastic Demand Price of a product remains constant whatever

quantities are demanded Perfectly Inelastic Demand Quantity demanded is completely unaffected by

price.

Perfectly Elastic & Inelastic Demand

Perfectly Elastic Demand A single soybean farmer might face the curve on the

right – various quantities at one price Perfectly Inelastic Demand A producer of insulin might face the curve on the left

– quantity demanded is constant.

Perfectly Elastic & Inelastic Demand

Demand elasticity plays a role in determining what effect a price change has on Total Revenue.

Total Revenue is the price of a product multiplied by its quantity demanded.

TR = P X Qd

Total Revenue

Although it might seem that there is a connection between the slope the demand curve and the price elasticity of demand, there is not

Elasticity is expressed in terms of percentage changes in price and quantity demanded, but slope is change in rise over run, which is not always the same thing

Slope of Demand Curve & Elasticity of Demand

Price changes cause large variations in quantity demanded

Total Revenue and Price have an inverse relationship When one increases,

the other decreases and vice versa

Elastic Demand

Price changes cause small variations in quantity demanded

Total Revenue and Price have an direct relationship When one increases,

the other increases; if one decreases, the other decreases

Inelastic Demand

Unit Elastic Demand Demand for which a percentage change in price causes

an equal change in quantity demanded and thus no change in total revenue

Unit Elastic Demand

Portion of Consumer Incomes It’s easier to pay $0.50 more for sugar that $500 more for a

TV, thus, demand for big purchases tends to be more elastic than the demand for small purchases

Access to Substitutes The more specific a product, the more elastic its demand will

be Necessities vs Luxuries

Necessities: inelastic demand; Luxuries: elastic demand Time

Demand becomes elastic over time – just because something you buy every week becomes more expensive, doesn’t mean you suddenly stop buying it. Over a month or two however, you might find a replacement for it.

Factors That Affect Price Elasticity of Demand

Case Study: You can rent 500 DVDs a day at $5 each, and you rent 1500 DVDs when the price drops to $3. What is the price elasticity of demand?

Calculating Price Elasticity of Demand

Although we calculated ed = -2, we take the absolute value and get ed = 2.

Calculating Price Elasticity of Demand

ed Elasticity

>1 Elastic

=1 Unit-Elastic

<1 Inelastic

Income Elasticity (ei) The responsiveness of a product’s quantity demanded

to a change in average consumer income

Income Elasticity

Case Study: Average consumer income increases from $20,000 to $40,000 and causes the quantity demanded of computer tablets to rise from 1000 to 2000. What is the income elasticity of computer tablets?

= 1

Cross-Price Elasticity (exy) The responsiveness of a product’s quantity demanded

to a change in the price of another product

Cross-Price Elasticity

Case Study: If a drop in the price of computer tablets from $1000 to $500 causes the quantity demanded of laptop computers to fall from 5000 to 3000, then what is the cross-price elasticity of these two products?

= 0.75

Cross-Price Elasticity We found exy = 0.75. Cross-price elasticity does have

a sign. If the two products, x and y, are complementary,

then the sign is negative If the two products, x and y, are substitutes, then the

sign is positive