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Full powerpoint over elasticity
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5/24/2018 Chapter 4 Elasticity
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Chapter 4A
Elasticity
Gary Payne, MBA
Sam Houston State University
5/24/2018 Chapter 4 Elasticity
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Elasticity
04
McGraw-Hill/IrwinCopyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/
http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/http://highered.mcgraw-hill.com/sites/0077337735/information_center_view0/5/24/2018 Chapter 4 Elasticity
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Student Learning Outcomes (SLO)
Calculate supply and demand elasticities, identify the
determinants of price elasticity of demand and supply, and
demonstrate the relationship between elasticity and total
revenue.
SLO 4
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4 Terms and Concepts
Price elasticity of demand
Midpoint formula
Elastic demand
Inelastic demand
Unit elasticity
Perfectly inelastic demand
Perfectly elastic demand
Total revenue (TR)
Total-revenue test
Price elasticity of supply
Market period
Short run
Long run
Cross elasticity of demand
Income elasticity of demand
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Elasticity
Why do buyers of some products respond to price increases by
substantially reducing their purchases while buyers of other
products respond by only slightly cutting back their purchases?
Why does the demand for some products rise a great deal when
household income increases while the demand for other productsrises just a little?
Elasticity lets us know the degree to which changes in prices and
incomes affect supply and demand.
5/24/2018 Chapter 4 Elasticity
6/74Dr. Fidel Gonzalez (SHSU) 6
Elasticity
Examples:
In 1997, the Texas Department of Transportation (TDOT)
increased the price of vanity plates with the intention of
increasing the amount of money they received from the
sale of vanity plates.
According to the Law of Demand when the price goes up
the quantity demanded goes down. Hence, the TDOT was
expecting the quantity demanded to go down but less
than the increase in the price so that at the end the totalmoney they receive increases.
5/24/2018 Chapter 4 Elasticity
7/74Dr. Fidel Gonzalez (SHSU) 7
Elasticity
So what happened?
When the price of vanity plates increased the money received
by the TDOT decreased. In other words, the percentage
change in the price of vanity plates was less that the
percentage decrease in the quantity of vanity plates.
They could have benefited from a better understanding of the
elasticity concept!
5/24/2018 Chapter 4 Elasticity
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Price Elasticity of Demand
The law of demand tells us that, other things equal, consumers will
buy more of a product when its price declines and less when its
price increases. But how much more or less will they buy?
Price elasticity of demandmeasures the responsiveness
(sensitivity) of consumers to a price change. For some productsfor example, restaurant mealsconsumers are
highly responsive to price changes. Demand is relatively elasticor
elastic.
For other productsfor example toothpasteconsumers pay muchless attention to price changes. Substantial price changes cause only
small changes in the amount purchased. Demand is relatively
inelasticor simply inelastic.
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Price Elasticity (cont'd)
Price Elasticity of Demand (Ep)
Ep=Percentage change in quantity demanded
Percentage change in price
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Ep=1%
+10% =.1
Price Elasticity (cont'd)
Example
Price of oil increases 10%
Quantity demanded decreases 1%
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The Price Elasticity of Demand
Heads Up!
Do not confuse elasticity with slope
When computing elasticity at different points on a linear
demand curve, the slope is constant, but the value forelasticity will change
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Price Elasticity of Demand
The Price-Elasticity Coefficient and Formula
Economists measure the degree to which demand is price elastic or
inelastic with the coefficient Ed
__________________________
Percentage change in quantity
Demanded of product XEd =
Percentage change in price
Of product X
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Calculating Elasticity
To calculate the Ep, we compare percentage changes in
quantity demanded and price.
Change in QD / original QD
Change in P / original P
Arithmetic problemthe percentage change from 2 to 3 (50
percent) is not the same as the percentage change from 3 to 2
(33.3 percent).
So, we use average values
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ELASTICITY AND ITSAPPLICATION
14
Calculating Percentage Changes
P
Q
D
$250
8
B
$200
12
A
Demand for
your websites
Problem:
The standard method givesdifferent answers depending on
where you start.
From A to B,Prises 25%, Qfalls 33%,
elasticity = 33/25 = 1.33
From B to A,
Pfalls 20%, Qrises 50%,elasticity = 50/20 = 2.50
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Price Elasticity of Demand
Using Averages
An annoying problem arises in computing the price-elasticity
coefficient. A price change from, say, $4 to $5 along a demand
curve is a 25 percent increase, but the opposite price change from
$5 to $4 along the same curve is a 20 percent decrease. Elasticity should be the same whether price rises or falls.
Simplest solution to the problem is to use the midpoint formula
which averages the two prices and the two quantities.
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Price Elasticity Mid-Point Formula
Calculating Elasticity
Elasticity formula:
Change in QSum of quantities/2
Ep= Change inP
Sum of prices/2
or
in Q
(Q1+ Q2)/2Ep=
in P
(P1+ P2)/2
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17
Calculating Percentage Changes
Using the midpoint method, the % change
in Pequals
$250$200
$225x 100% = 22.2%
The % change in Qequals
128
10x 100% = 40.0%
The price elasticity of demand equals
40/22.2 = 1.8
.40 / .22 = 1.81 %
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Price Elasticity of Demand
Midpoint Formula
This class will use the midpoint formula for all future calculations
Ed = Change in quantity
Sum of quantities/2
Change in price
Sum of prices/2
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Price Elasticity of Demand
Elimination of Minus Sign
We know from the downsloping demand curve that price and
quantity demanded are inversely related. Thus, the price-elasticity
coefficient of demand Edwill always be a negative number.
Economists usually ignore the minus sign and simply present theabsolute value to avoid any ambiguity.
Interpretations of Ed
We can interpret the coefficient of price elasticity of demand asfollows
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Price Elasticity of Demand
Elastic Demand
Demand is elasticif a specific percentage change in price results in
a larger percentage change in quantity demanded. Edwill be
greater than 1
Ed =.04
.02
= 2
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21
D
Elastic demand
P
QQ1
P1
Q2
P2
Q rises more
than 10%
> 10%
10%> 1
Price elasticity
of demand
=% change in Q
% change in P=
P fallsby 10%
Consumers
price sensitivity:
Dcurve:
Elasticity:
relatively flat
relatively high
> 1
The more responsive buyers are to a change in price, theflatter the demand curve will be
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Price Elasticity of Demand
Inelastic Demand
If a specific percentage change in price produces a smaller
percentage change in quantity demanded, demand is inelastic.Ed
will be less than 1
Ed =.01
.02
= .5
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23
D
Inelastic demand
P
QQ1
P1
Q2
P2
Q rises less
than 10%
< 10%
10%< 1
Price elasticity
of demand
=% change in Q
% change in P=
P fallsby 10%
Consumers
price sensitivity:
Dcurve:
Elasticity:
relatively steep
relatively low
< 1
The less responsive buyers are to a change in price, the
steeper the demand curve will be
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Price Elasticity of Demand
Unit Elasticity
The case separating elastic and inelastic demands occurs where a
percentage change in price and the resulting percentage change in
quantity demanded are the same. Ed= 1
Ed =
.02
.02= 1
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25
D
Unit elastic demand
P
QQ1
P1
Q2
P2
Qrises by 10%
10%
10%
= 1Price elasticity
of demand
=% change in Q
% change in P=
P fallsby 10%
Consumers
price sensitivity:
Elasticity:
intermediate
1
Dcurve:
intermediate slope
Demand is unit elastic if quantity demanded changes by the same
percent as the price
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Summary of Price Elasticities of Demand
Polar Cases of Perfectly Elastic and Perfectly Inelastic Demand
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Interpretation of Elasticity of Demand
Ed> 1 demand is elasticEd= 1 demand is unit elasticEd< 1 demand is inelasticExtreme cases
Perfectly inelastic
Perfectly elastic
LO1 4-27
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Price Elasticity Ranges
Elastic demand
% change in Q> % change in P; Ep> 1
Unit-elastic
% change in Q= % change in P; Ep= 1
Inelastic demand
% change in Q< % change in P; Ep< 1
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0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.91
010
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
190
200
Pricep
er
ride
Quantity of rides per day (in thousands)
Price Elasticities Along a Linear DemandCurve
eD= -.33
eD= -1.00
eD= -3.00
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ELASTICITY AND ITSAPPLICATION
30
Price Elasticity of Demand
Price elasticity
of demand
equals
P
Q
D
Q2
P2
P1
Q1
P risesby 10%
Q falls
by 15%
15%
10%= 1.5
Price elasticityof demand=
Percentage change in Qd
Percentage change in P
Example:
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Price Elasticity of Demand
Extreme Cases
Perfectly inelasticwhere a price change results in no change
whatsoever In the quantity demanded.Ed= 0
There is no response to a change in price.
Graphically, a line parallel to the vertical axis.
Example: insulin
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Extreme Cases
LO1
D1P
Perfectly inelastic demand
Perfectlyinelasticdemand(Ed = 0)
0
4-32
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ELASTICITY AND ITSAPPLICATION
33
Q1
P1
D
Perfectly inelastic demand
P
Q
P2
P fallsby 10%
Q changes
by 0%
0%
10%
= 0Price elasticity
of demand
=% change in Q
% change in P
=
Consumers
price sensitivity:
Dcurve:
Elasticity:
vertical
none
0
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Price Elasticity of Demand
Extreme Cases
Perfectly elastic
A small price reduction causes buyers to increase their purchases
from zero to all they can obtain. Ed = infinity
A line parallel to the horizontal axis.
Example: firms selling a commodity item in a purely competitive
market.
E t C
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Extreme Cases
LO1
Perfectly elastic demand
P
D2
Perfectlyelasticdemand
(Ed = )
0
4-35
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ELASTICITY AND ITSAPPLICATION
36
D
Perfectly elastic demand
P
Q
P1
Q1Pchanges
by 0%
Q changes
by any %
any %
0%
= infinity
Q2
P2=Consumers
price sensitivity:
Dcurve:
Elasticity:
infinity
horizontal
extreme
Price elasticity
of demand
=% change in Q
% change in P
=
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Summary of Price Elasticities of Demand
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Price Elasticity of Demand
The Total-Revenue Test
The importance of elasticity for firms relates to the effect of price
changes on total revenue and thus profits.
Total revenue (TR)is the total amount the seller receives from the
sale of a product in a particular time period; calculated bymultiplying the product price (P) by the quantity sold (Q).
TR = P X Q
Graphically, total revenue is represented by the P XQ rectangle lyingbelow a point on a demand curve. (area of the rectangle is found by
multiplying one side by the other).
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Price Elasticity of Demand
The Total-Revenue Test
If total revenue changes in the opposite direction from price,
demand is elastic.
If total revenue changes in the same direction as price, demand is
inelastic.
If total revenue does not change when price changes, demand is
unit-elastic.
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The Relationship Between Price Elasticity of Demand and Total
Revenues for Cellular Phone Service
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The Relationship Between Price Elasticity of Demand and Total
Revenues for Cellular Phone Service
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Price Elasticity of Demand
Elastic Demand
If demand is elastic, a decrease in price will increase total revenue.Even a lesser price is received per unit, enough additional units aresold to more than make up for the lower price.
The analysis is reversible: If demand is elastic, a price increase willreduce total revenue. The revenue gained on the higher-pricedunits will be more than offset by the revenue lost from the lowerquantity sold.
Other things equal, when price and total revenue move in oppositedirections, demand is elastic. Edis greater than 1 The percentagechange in quantity demanded is greater than the percentagechange in price.
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Consider ThisA Bit of a Stretch
For some products, a price change causes a substantial stretch of
quantity demanded. When this stretch in in percentage terms
exceeds the percentage change in price, demand is elastic.
For other products, quantity demanded stretches very little in
response to the price change. When this stretch in percentageterms in less than the percentage change in price, demand is
inelastic.
Elastic demand displays considerable quantity stretch
Inelastic demand displays relatively little quantity stretch
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Price Elasticity of Demand
Inelastic Demand
If demand is inelastic, a price decrease will reduce total revenue.The increase in sales will not fully offset the decline in revenue perunit, and total revenue will decline.
The loss in revenue from the lower unit price is larger than the gainin revenue from the accompanying increase in sales.
Price has fallen, and total revenue has also declined.
Conversely, if demand is inelastic, a price increase will increase total
revenue. Other things equal, when price and total revenue move inthe same direction, demand is inelastic. Edis less than 1 thepercentage change in quantity demanded is less than thepercentage change in price.
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Price Elasticity of Demand
Unit Elasticity
An increase or a decrease in price leaves total revenue unchanged.
The loss in revenue from a lower unit price is exactly offset by the
gain in revenue from the accompanying increase in sales.
Conversely, the gain in revenue from a higher unit price is exactlyoffset by the revenue loss associated with the accompanying
decline in the amount demanded.
Other things equal, when price changes and total revenue remainsconstant, demand is unit-elastic Edis 1 The percentage change in
quantity equals the percentage change in price.
Total Revenue Test
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Total Revenue Test
LO2
$3
2
1
0 10 20 30 40 Q
P
a
b
D1
Lower price and elastic demandBlue gain exceeds orange loss
4-46
Total Revenue Test
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Total Revenue Test
LO2
$4
3
2
1
0 10 20 Q
P
c
d
D2
Lower price and inelastic demand
Orange loss exceeds blue gain
4-47
Total Revenue Test
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Total Revenue Test
LO2
$3
2
1
0 10 20 30 Q
P
e
f
D3
Lower price and unit elastic demandBlue gain equals orange loss
4-48
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Price Elasticity of Demand
Price Elasticity along a Linear Demand Curve
Elasticity typically varies over different price ranges of the same
demand curve.
Demand is more price elastic toward the upper left than toward the
lower right. In the upper-left segment of the demand curve, the percentage
change in quantity is large because the original reference quantity is
small.
Similarly, the percentage change in price is small in that segment
because the original reference price is large.
The relatively large percentage change in price yields a large Ed, an
elastic demand.
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Price Elasticity of Demand
Price Elasticity along a Linear Demand Curve
The reverse holds true for the lower-right segment of the demand
curve. Here the percentage change in quantity is small because the
original reference quantity is large; similarly, the percentage change
in price is large because the original reference price is small. The relatively small percentage change in quantity divided by the
relatively large percentage change in price results in a small Ed, an
inelastic demand.
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Price Elasticity of Demand
Price Elasticity along a Linear Demand Curve
The slope of the demand curveits flatness or steepnessis not a
sound basis for judging elasticity. The catch is that the slope of the
curve is computed from absolutechanges in price and quantity,
while elasticity involves relativeorpercentagechanges in price andquantity.
Total Revenue Test
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Total Revenue Test
LO2
Price Elasticity of Demand for Movie Tickets as Measured by the ElasticityCoefficient and the Total-Revenue Test
(1)Total Quantity of
Tickets Demanded perWeek, Thousands
(2)Price per Ticket
(3)Elasticity
Coefficient(Ed)
(4)Total
Revenue(1) X (2)
(5)Total
RevenueTest
1 $8 $8,000
2 7 5.00 14,000 Elastic3 6 2.60 18,000 Elastic
4 5 1.57 20,000 Elastic
5 4 1.00 20,000 Unit Elastic
6 3 0.64 18,000 Inelastic
7 2 0.38 14,000 Inelastic
8 1 0.20 8,000 Inelastic
4-52
Elasticity and Total Revenue
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Elasticity and Total Revenue
LO2
0 1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8
Quantity Demanded
Quantity Demanded
Price
TotalRe
venue
(Thousands
ofDollars)
$20181614
1210
8642
$8
7
65
4
3
2
1
a
b
c
de
fg
h
ElasticE
d> 1Unit Elastic
Ed= 1
InelasticE
d< 1
D
TR
4-53
5/24/2018 Chapter 4 Elasticity
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Price Elasticity of Demand
Price Elasticity and the Total-Revenue Curve
The total revenue curve first slopes upward, then reaches a
maximum, and finally turns downward.
Lowering price in the elastic range of demand increases total
revenue. Conversely, increasing the price in that range reduces totalrevenue. Price and total revenue change in opposite directions,
confirming that demand is elastic.
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Price Elasticity of Demand
Price Elasticity and the Total-Revenue Curve
The $5 - $4 price range of the demand curve reflects unit elasticity.
When price decreases or increases, total revenue remains the
same. Price has changed and total revenue has remained constant,
confirming that demand is unit-elastic.
In the inelastic range of the demand curve, lowering the price
decreases total revenue. Raising the price boosts total revenue.
Price and total revenue move in the same direction, confirming that
demand is inelastic.
Summary of Price Elasticity of Demand
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Summary of Price Elasticity of Demand
LO2
Price Elasticity of Demand: A Summary
Absolute Valueof ElasticityCoefficient Demand Is: Description
Impact on Total Revenue of a:
Price Increase Price Decrease
Greater than 1(Ed > 1)
Elastic orrelatively
elastic
Qdchanges by alarger
percentage thandoes price
Total Revenuedecreases
Total Revenueincreases
Equal to 1(Ed= 1)
Unit or unitaryelastic
Qd changes bythe samepercentage asdoes price
Total revenueis unchanged
Total revenueis unchanged
Less than 1(Ed< 1)
Inelastic orrelativelyinelastic
Qdchanges by asmallerpercentage thandoes price
Total revenueincreases
Total revenuedecreases
4-56
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Price Elasticity of Demand
Determinants of Price Elasticity of Demand
Substitutability
Generally, the larger the number of substitute goods that are
available, the greater the price elasticity of demand.
The demand for Snickers candy bar is highly elastic.
Proportion of Income
Other things equal, the higher the price of a good relative to
consumers incomes, the greater the price elasticity of demand. A10 percent increase in the price of a house is significant. Price
elasticity tends to be high.
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Price Elasticity of Demand
Determinants of Price Elasticity of Demand
Luxuries versus Necessities
In general, the more that a good is considered to be a luxury
rather than a necessity, the greater is the price elasticity of
demand. Vacation travel can easily be forgone.
Salt is highly inelastic
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Price Elasticity of Demand
Determinants of Price Elasticity of Demand
Time
Generally, product demand is more elastic the longer the time
period under consideration. Consumers often need time to adjust
to changes in prices. In the short-run, demand for gasoline is more inelastic (Ed= .2)
than in the long-run (Ed= .7).
Price Elasticity of Demand
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Price Elasticity of Demand
LO1
Selected Price Elasticities of Demand
Product or Service
Price Elasticity
of Demand (Ed) Product or Service
Price Elasticity
of Demand (Ed)Newspapers .10 Milk .63
Electricity (household) .13 Household appliances .63
Bread .15 Liquor .70
MLB Tickets .23 Movies .87
Telephone Service .26 Beer .90
Cigarettes .25 Shoes .91
Sugar .30 Motor vehicles 1.14
Medical Care .31 Beef 1.27
Eggs .32 China, glassware 1.54
Legal Services .37 Residential land 1.60
Automobile repair .40 Restaurant meals 2.27
Clothing .49 Lamb and mutton 2.65
Gasoline .60 Fresh peas 2.834-60
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Price Elasticity of Demand
Applications of Price Elasticity of Demand
Excise Taxes
The government pays attention to elasticity of demand when it
selects goods and services on which to levy excise taxes.
Legislatures tend to seek out products that have inelasticdemandliquor, gasoline, cigaretteswhen levying excise taxes.
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ELASTICITY AND ITS
APPLICATION 62
Appendix
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Dr. Fidel Gonzalez (SHSU)
Price Elasticity of Demand
The Price Elasticity of Demand is given by the following formula:
Where Ed= elasticity of demand.
Remember that the Law of Demand says that price and quantity demanded move in
opposite directions. This means that if the percentage change in the price is positive (price
goes up) then the percentage change in the quantity demanded is negative (the quantity
demanded goes down). That is, the numerator will be negative and the denominator willbe positive, therefore the Ed will be negative. Notice that when the percentage change in
the price is negative the percentage change in the quantity will be positive and the Ed will
also be negative.
In other words, the Ed will always be negative because of the Law of Demand.
Percentage change in the Quantity Demanded
Percentage change in the PricedE
The price elasticity of demand tells us how much the quantity demanded changes when
the price changes. We are going to use percentage changes to measure the change in all
prices and quantities.
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Dr. Fidel Gonzalez (SHSU)
Price Elasticity of Demand
Since Ed is always negative we are going to get rid of the negative sign and report Ed as a
positive number. This is achieved by using the absolute number concept. Remember from
you High School classes that any number can be converted into a positive one if we
place the absolute number operator around it ||.
For example, |-5| =5 and |5|=5 . Therefore, our new definition of Ed is the following:
Since, I do not want to write percentage change every time I write the formula for Ed I
will use the following expression for Ed
Percentage change in the Quantity DemandedPercentage change in the Price
dE
% QD% P
dE
where % means percentage change, QD is quantity demanded, and P is price.
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Dr. Fidel Gonzalez (SHSU)
Price Elasticity of Demand
For example if the Price of Pepsi goes up by 5% and as a response the Quantity
Demanded goes down by 10% then the Price Elasticity of Demand for Pepsi is:
This has an interesting interpretation. Ed=2 indicates that the percentage change in the
quantity demanded is twice a big as the percentage change in the price. In other words,
the quantity demanded is very sensitive to changes in the price because in this case thequantity demanded changed more (in percentage terms) than the change in the price.
In general the elasticity can be interpreted as follows: the percentage change in the
Quantity Demanded is Ed times the percentage change in the Price.
In the example above Ed=2 so we concluded that QD is sensitive to changes in P. In general,
whenever the percentage change in the QD demand is greater than the percentage changein P we are going to say the demand is sensitive to changes in the price.
A sensitive demand is called Elastic, and insensitive demand is called Inelastic.
-10%2
5%dE
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Dr. Fidel Gonzalez (SHSU)
Price Elasticity of Demand
Hence,
If Ed > 1 then Elastic since |%QD| >| %P| (sensitive demand, the Quantity Demandresponds more than proportional to changes in the Price)
If Ed < 1 then Inelastic since |%QD|
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Dr. Fidel Gonzalez (SHSU)
Mid-point Formula and Ed:
When computing elasticities we need to obtain the percentage change in the price and the
percentage change in the quantity demanded. However, percentage changes are tricky
because their value depend on the original value.The formula to get a percentage change is the following
Final Value - Original Value
OriginalValuePercentage Change =
1 2For example consider P 10 and P =20. The percentage will be different depending on
whether the P goes from 10 to 20 or from 20 to 10
When the prices goes from 10 to 20:
20 - 10 10Percentage Change =
10
1 100%
10When the prices goes from 20 to 10:
10 - 20 10Percentage Change = 0.5 50%
20 20
Mid-point Formula and Ed:
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d po t o u a a d d:
This is a problem because it means that we will get different value of the Ed depending on
whether the price increases or decreases. Note that in both percentage changes the
absolute value of the numerator is 10. However, what changes is the value of the
denominator, in one case is 10 and in the other one is 20.
To solve this problem we are going to use the Mid-point formula. What this formula does is
to change the denominator of the percentage change formula.
Final Value - Original Value
Final Value + Original Value2
Mid-Point Formula Percentage Change =
A you can tell all we have done is to change the denominator of the percentage change to
the average of the original and final value (thats why it is called the mid-point formula, the
average is the midpoint). In our previous example:
10 - 20 10Mid-point Percentage Change = 0.67 67%
20 + 10 15
2
Notice that we will always get the value 67% (positive or negative) regardless if whether P
increase or decrease. FOR ALL OUR ELASTICITY CALCULATIONS WE WILL USE THE MID-
POINT FORMULA.
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Perfectly Inelastic Demand:
There are two extreme cases that we will consider. The first one is when the QD does not
change at all when the price changes. This is the case of goods that you must buy. For
example, a crack addict needs to buy crack regardless of the price. A person that needs alife-saving medicine they have to get it. In this case the demand is not sensitive at all to
price changes. We will call these cases: Perfectly Inelastic Demand
10
Price of crack
QD of crack
For the crack addict it does not matter if the prices is $100,
$500 or $1000; he always buys 10 units of crack. Hisdemand is then perfectly inelastic.
A perfectly inelastic demand is represented by a completely
vertical demand curve.
Question: What is the value of the Ed when the demand is
perfectly inelastic
100
500
1,000
D
Answer:
In this case the QD never changes so: % in QD = 0
Therefore,
0Ed= 0
% in P
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Perfectly Elastic Demand:
The other extreme cases is when the QD changes infinity the price changes just a little
but. This is the case of goods that you do not really need and that have plenty of perfect
substitutes. For example, blue and navy blue pens. If the price of blue pens increases youdo not buy any of them and instead buy only navy blue pens. We will call these cases:
Perfectly Elastic Demand
Price of blue pens
QD of blue pens
The consumer will only purchase pens at $20 or less. If the
price drops below $20 the consumer will purchase and
infinite amount of pens.
Question: What is the value of the Ed when the demand is
perfectly elastic
10
20
40
D
Answer:
In this case the change in QD is infinity so: % in QD =Therefore,
Ed=% in P
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Ed Along the Demand Curves
The Ed is not only different for demand curves with different slope, Ed also changes along
the demand curve.
In other words, we can look at two demand curves and figure out which demand curve is
more elastic by comparing slopes, but the specific value of Ed will change along each
individual demand.
Moreover, Ed > 1 for the top part of the demand curve, Ed=1 in the middle and Ed1
Ed=1
Ed
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Ed Along the Demand Curves
Question: Why is Ed>1 in the top part of the demand curve and Ed
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Income Elasticity of Demand
Where EI= income elasticity of demand.
Note that we are not using absolute value in the formula for EI. This is because in this case
the sign of EI matters. If EI >0 then we know that Income and QD move in the same
direction and the good is normal. If EI 1, this means that the percentage change in QD is less than the percentage
change in Income, these goods are considered luxuries.
Moreover EI < 1, this means that the percentage change in QD is greater than the
percentage change in Income, these goods are considered necessities.
Percentage change in the Quantity DemandedPercentage change in Income
IE
We are now going to consider the effect of income on the quantity demanded. The income
elasticity of demand is given by the following formula:
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Cross Price Elasticity of Demand
Where Ecp= cross-price elasticity of demand.
Note that we are not using absolute value in the formula for Ecp. This is because in this
case the sign of Ecp matters.
If Ecp >0 then we know that the price of good 1 and QD of good 2 move in the same
direction and the goods are substitutes.
If Ecp>0 then we know that the price of good 1 and QD of good 2 move in the opposite
direction and the goods are complements.
Percentage change in the Quantity Demanded of good 2
Percentage change in price of good 1cpE
We are now going to consider the effect of the price of another on the quantity demanded
of the good. This is the cross-price elasticity of demand is given by the following formula: