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Do People Respond to Changes in the Price of Gasoline?
• During May 2010, the average price of gasoline had been $2.79 per gallon.
• During May 2011, the average price of gasoline was $3.76,
• U.S. consumers bought about 5 percent less gasoline than they had bought.
• Consumers found ways to cut back the quantity of gasoline they purchased.
the responsiveness of the amount purchased to a change in price.
Price Elasticityof demand =
% Q
% P=
% Change in quantity demanded% Change in Price
- or put more simply -
=
PED > 1 Elastic < 1 Inelastic
= 1 Unit Elastic
)()(
0
10
0
10
P
PP
Q
QQ =
)()(
0 1
0
0
10
P PP
Q
X
(b)
Price
Quantity/time
(a)
Price
Quantity/time
Mythicaldemandcurve
• Perfectly inelastic: An increase in Price
results in no change in Quantity
Different Elasticities
• Relatively inelastic: A percent increase in Price
results in a smaller % reduction in Quantity
Demand for Cigarettes
(c)
Price
Quantity/time
• Unitary elasticity: The percent change in
quantity demanded due to an increase in price is equal to
the % change in price.
Demand curve of unitary elasticity
= 1
(d)
Price
Quantity/time
• Relatively elastic: A % increase in Price
leads to a larger % reduction in Quantity.
Elasticity of Demand
(e)
Price
Quantity/time
• Perfectly elastic: Consumers will buy all of Farmer Hollings’s wheat at the market price, but none
will be sold above the market price.
Demand for Granny Smith Apples
Demand for Farmer Hollings’s wheat
Mid Points Formula
Price Elasticityof demand =
% Q
% P=
% Change in quantity demanded% Change in Price
- But use average Q and average P -
2)(
)(
2)(
)(
10
10
10
10
PP
PP
= =)()(
)()(
1010
1010
PPPP
QQQQ
Quan 1
100
20
12
150
45
32
Price 1
5
8
3
12
6
24
Quan 2
120
25
16
200
45
40
Price 2
3
7
0
10
8
2
Ch in Q
(Q1+Q2)/2
___
___
___
___
___
___
X
X
X
X
X
X
(P1+P2)/2 Ch in P
___
___
___
___
___
___
___
___
___
___
___
___
=
=
=
=
=
20/110 4/2 4/11
5/22.5
4/14
50/175
0/45
8/36
7.5/1
1.5/3
11/2
7/2
13/22
5/3
1/7
11/7
0
13/99
2. Necessity vs Luxury
What affects Elasticity???
3. Proportion of Income
1. Available Substitutes
4. Time to shop around
Some Estimated Price Elasticities of Demand
ProductEstimated Elasticity Product
Estimated Elasticity
Books (Barnes & Noble) −4.00 Bread −0.40
Books (Amazon) −0.60 Water (residential use) −0.38
DVDs (Amazon) −3.10 Chicken −0.37
Post Raisin Bran −2.50 Cocaine −0.28
Automobiles −1.95 Cigarettes −0.25
Tide (liquid detergent) −3.92 Beer −0.23
Coca-Cola −1.22 Residential natural gas −0.09
Grapes −1.18 Gasoline −0.06
Restaurant meals −0.67 Milk −0.04
Health insurance (low-incomehouseholds)
−0.65 Sugar −0.04
More Estimated Price Elasticities of DemandGoods and Services Elasticity
Housing 0.12Transatlantic air travel (economy class) 0.12Rail transit (rush hour) 0.15Electricity 0.20Taxi cabs 0.22Gasoline 0.35Transatlantic air travel (first class) 0.40Wine 0.55Beef 0.59Transatlantic air travel (business class) 0.62Kitchen and household appliances 0.63
More Estimated Price Elasticities of Demand
Goods and Services ElasticityCable TV (basic rural) 0.69Chicken 0.64Soft drinks 0.70Beer 0.80New vehicle 0.87Rail transit (off-peak) 1.00Computer 1.44Cable TV (basic urban) 1.51Cable TV (premium) 1.77Restaurant meals 2.27
CerealPrice Elasticity of
Demand
Post Raisin Bran −2.5
All family breakfast cereals
−1.8
All types of breakfast cereals
−0.9
The Price Elasticity of Demand for Breakfast Cereal
MIT economist Jerry Hausman
The price elasticity for a particular brand of raisin bran was larger in absolute value than the elasticity for all family cereals, and the elasticity for all family cereals was larger than the elasticity for all types of breakfast cereals.
The Relationship between Price Elasticity and Total Revenue
When demand is inelastic, a cut in price will decrease total revenue.
At point A total revenue = $4,000.
At point B, total revenue falls to $3.70 × 1,050 gallons, or $3,885.
If demand is ... then ...
elastic P↑ TR↓
elastic P↓ TR↑
inelastic P↑TR↑
inelastic P↓TR↓
unit elastic P↑TR→
unit elastic P↓TR→
Elasticity Is Not Constant along a Linear Demand Curve
Elasticity and Revenue with a Linear Demand Curve
Quan 1
2
3
4
5
6
7
8
Price 8
7
6
5
4
3
2
1
Elasticity
___
___
___
___
___
___
___
Total Revenue
___
___
___
___
___
___
___
___
=
=
=
=
=
=
=
X
X
X
X
X
X
X
X
Elasticity and 3D TVs
The price elasticity of demand for 3D televisions was higher than Sony had expected.
3D televisions were introduced in the U.S. in early 2010,
Sony believed that sales would be strong despite prices being several hundred dollars higher than for other high-end ultra-thin televisions.
Demand turned out to be more elastic than expected, and by December firms were cutting prices 40 percent or more in an effort to increase revenue.
Dsr
P2
Q1
P1
B
Q2
Resource price
Quantity
the easier it is to switch to substitute inputs, and/or, the more elastic the demand for the products the resource helps to produce.
With time, the demand for a resource becomes more elastic (Dsr Dlr):
Q3
The long-run demand for a resource is almost always more elastic than demand in the short-run.
Time and the Elasticity of Demand for Resources
Dlr
A
C
Income Elasticity• the responsiveness of a product’s
demand to a change in income.
Income Elasticityof demand =
% Change in quantity demanded
% Change in Income
• A normal good has a positive income elasticity of demand.– As income increases, the demand
for normal goods increases.• Goods with a negative income
elasticity are inferior goods.– As income expands, the demand
for inferior goods will decline.
High Income Elasticity2.46 Private education2.45New Cars1.57Recreation and amusements1.54Alcohol
Income Elasticity of DemandLow Income Elasticity
- 0.20 0.38 Fuel0.20 Electricity0.46Fish (haddock)0.51 Food0.64 Tobacco0.69Hospital care
Margarine
Cross Price Elasticity• the responsiveness of a product’s
demand to a change in the price of another good.
Cross Price Elasticity =
% Change in Qx
% Change in Py
• A complement has a negative cross price elasticity.
– As Py increases, the demand for Y decreases, and demand for goods that are consumed with Y also decreases.
• A substitute has a positive cross price elasticity– As Py increases, the demand for Y decreases,
and demand for goods that can be consumed instead of Y also decreases.
Price elasticity of demand for beer −0.23
Cross-price elasticity of demand between beer and wine 0.31
Cross-price elasticity of demand between beer and spirits 0.15
Income elasticity of demand for beer −0.09
Income elasticity of demand for wine 5.03
Income elasticity of demand for spirits 1.21
Price Elasticity, Cross-Price Elasticity, and Income Elasticity in the Market for
Alcoholic Beverages
The demand for beer, an inferior good, is inelastic.
Both wine and spirits are categorized as luxuries because their income elasticities are greater than 1.
a. Market Period
What affects Supply Elasticity???
b. Short Run
1. Time
c. Long Run
Supply Elasticities
Supply Elasticities
Supply Elasticities
Time and Resource Supply Elasticity
S
P2
Q1
P1
Q2
Resource price
Quantity
The supply of CPA services for example
If CPA wages increase from P1 to P2, the short-run response will be an increase in CPA services from Q1 to Q2. Some CPAs work more and some come out of retirement.
At the higher wage P2, Q3 CPA services are supplied to the market.
The long-run supply of a resource is almost always more elastic than short-run supply.
Given time, supply of the resource (CPAs) becomes more elastic. (Ssr Slr) as more individuals choose this field of training.
Q3
Slr
C
A
B
Table 6.7 Summary of Elasticities
Price Elasticity of Demand
Absolute Valueof Price Elasticity
Effect on Total Revenueof an Increase in Price
Elastic Greater than 1 Total revenue falls
Inelastic Less than 1 Total revenue rises
Unit elastic Equal to 1 Total revenue unchanged
price in change Percentagedemandedquantity in change Percentage
Formula:
2PP
)P(P
2QQ
)Q(QFormula Midpoint
21
12
12
12:
Cross-Price Elasticity of Demand
Types of Products Value of Cross-Price Elasticity
Substitutes Positive
Complements Negative
Unrelated Zero
good another of price in change Percentagegood one of demandedquantity in change Percentage
Formula:
Income Elasticity of Demand
Types of Products Value of Income Elasticity
Normal and a necessity Positive but less than 1
Normal and a luxury Positive and greater than 1
Inferior Negative
income in change Percentagedemandedquantity in change Percentage
Formula:
Table 6.7 Summary of Elasticities
Price Elasticity of Supply
Value of Price Elasticity
Elastic Greater than 1
Inelastic Less than 1
Unit elastic Equal to 1
price in change Percentagesuppliedquantity in change Percentage
Formula:
Table 6.7 Summary of Elasticities
The actual burden of a tax depends on the elasticity of supply and demand.
• As supply becomes more inelastic, then more of the burden will fall on sellers.
• As demand becomes more inelastic, then more of the burden will fall on buyers.
Elasticity and Incidence of a Tax
110
D
Luxury boatmarket
194
80
Gasolinemarket
S
$1.60
$1.50$1.45
Quantity(thousands
of boats)
Quantity(millions of gallons)
Price
Price(thousand $)
Tax Burden and Elasticity
90
100
5 10 15 20
D
S plus tax
200
$1.55
$1.65S
S plus tax• Consider the market for Gasoline and Luxury Boats individually.
• In the gas market, the demand is relatively more inelastic than its supply; hence, buyers bear a larger share of the burden of the tax.• In the luxury boats market, the supply curve is relatively more inelastic than its demand; hence, sellers bear a larger share of the tax burden.
• We begin in equilibrium.• If we impose a $.20 tax on gasoline suppliers, the supply curve moves vertically the amount of the tax. Price goes up $.15 and output falls by 6 million gallons per week.• If we impose a $25K tax on Luxury Boat suppliers, the supply curve moves vertically the amount of the tax. Price goes up by $5K and output falls by 5 thousand units.
And the Drug Problem
Demand
Price
P1
Q1
Supply
Quantity
Inelastic Demand - necessity
Change supply:
Inelastic Demand
Price
decrease
increaseP1
P2
P3
Q2Q1Q3
Supply
Quantity
or Q then P
Q then P
eradication
legalization
If Sarah’s income rises by 20 percent, and, as a result, she purchases 40 percent more designer clothing, her income elasticity for designer clothing is
a. 0.5.b. 1.0.c. 2.0.d. seriously distorted.
Suppose the state of New York imposes a one dollar per pack tax on cigarettes, which increases their price by 30 percent, and as a result, the quantity sold declines by 20 percent. The price elasticity of demand for cigarettes is equal to
a. –0.20.b. –0.67.c. –1.50.d. –3.00.
Studies indicate that the demand for fresh tomatoes is much more elastic than the demand for salt. These findings reflect that
a.tomatoes are a necessity while salt is a luxury.b. it takes longer for consumers to adjust to a change
in the price of salt than to a change in the price of tomatoes.
c.salt will not spoil as easily as fresh tomatoes.d. more good substitutes exist for fresh tomatoes
than for salt.If a Krispy Kreme doughnut shop near campus increases its prices by 5 %, but revenues from its sales are unchanged, the price elasticity of demand for the services offered by the doughnut shop must be
a. elastic.b. of unitary elasticity.c. inelastic.d. equal to 0.5.
If the price of gasoline goes up, and Dan now buys fewer candy bars because he has to spend more on gas, this would best be explained by
a. the substitution effect.b. the income effect.c. the highly elastic demand for gasoline.d. weight watchers effect.
Which of the following is true for this demand curve?
a. An increase in price from $2 to $3 will reduce total expenditures on the product.
b. In the $2 to $3 range, the price elasticity of the demand curve is approximately unitary.
c. At a price of $2, the price elasticity of the demand curve equals approximately –2.5.
d. In the $2 to $3 range, the demand curve is inelastic.
