Jennings2e PPT Ch04

8/3/2019 Jennings2e PPT Ch04

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Copyright 2009 McGraw-Hill Australia Pty LtdPPTs t/a Principles ofMicroeconomics 2e by Frank, Jennings and OlekalnsSlides prepared by Jayanath Ananda, La Trobe University

Chapter 4

Elasticity


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Learning Objectives

Define price elasticity of demand and describe factorsthat influence it

Explain the link between price elasticity of demandand spending on goods

Define cross price elasticity of demand

Define income elasticity of demand

Define price elasticity of supply and describe factorsthat influence it


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Outline

Defining price elasticity of demand

Measuring price elasticity of demand

Determinants of price elasticity of demand

Graphical interpretation of price elasticity Calculating the price elasticity of demand

Cross-price elasticity and income elasticity

Price elasticity of supply

Determinants of supply elasticity


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Price elasticity

A measure of the responsiveness of the quantitydemanded of a good to a change in the price ofthat good.


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Measuring price elasticity ofdemand

PriceinChangePercentage

DemandedQuantityinChangePercentage


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Price elasticity defined

Elastic demand Demand is elastic with respect to price if price elasticity of

demand is greater than 1

Inelastic demand Demand is inelastic with respect to price if price elasticity of

demand is less than 1

Unit elastic demand Demand is unit elastic with respect to price if price elasticity

of demand equals 1


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Elastic and inelastic demand


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Price elasticity of demand forsushi

% change in quantity demanded = 1

% change in price = 3

Inelastic:3

1

PriceinChange%

QuantityinChange%


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Determinants of price elasticity ofdemand

Substitution possibilities- Products that have no close substitutes tend to have highly

inelastic demand (e.g. table salt and snake anti-venom)

Budget share

- Big ticket items tend to have high price elasticity of demand(e.g. hot tubs)

Time- Replacing an inefficient air conditioner with an energy-efficient

one


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Price elasticity estimates forselected products


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Price elasticity demand at work

How effective will a fat tax be in solvingthe growing problem of obesity?


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A Graphical interpretation of priceelasticity

For small changes in price

PP

QQelasticityPrice

Where Q is the original quantity and P is theoriginal price

.


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Example Originally

Price (P) = $100

Quantity (Q) = 20

New Price (P) = $105

Quantity (Q) = 15

Elastic:5525

1005205


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slopeQ

PA

1atelasticityicePr


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Calculating price elasticity ofdemand

4

5

20

intercepthorizontal

interceptverticalslope

3

2

12

8

4

1x

3

8

A


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Calculating price elasticity ofdemand Question:

What is the price elasticity of demand

at the point B on the demand curve?


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Price elasticity and the steepnessof the demand curve

2

1

612

1

4

41D

2

126

1

4

42D


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Price elasticity and the steepnessof the demand curve

Observation

If two demand curves have a point in common, the steepercurve must be less elastic with respect to price at that point.


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Price elasticity at the midpoint of astraight-line demand curve

Observation:

The price elasticity of demand at the midpoint of any straight-line demand curve always takes the value of 1.


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Price elasticity regions along astraight-line demand curve

Observation

Demand is elasticity on the top half, unit elastic at the midpoint,and inelastic on the bottom half of a straight-line demand curve.


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Perfectly elastic demand

Demand is perfectly elastic with respect toprice if price elasticity of demand is infinite.This occurs when the demand curve ishorizontal.


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Perfectly elastic demand curve

)y(elasticitdemandelasticPerfectly


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Perfectly inelastic demand

Demand is perfectly inelastic withrespect to price if price elasticity ofdemand is zero. This occurs when

the demand curve is vertical.

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Copyright 2008 McGraw-Hill Australia Pty LtdPPTs t/a Microeconomics 2e by Frank, Jennings and OlekalnsSlides prepared by Jayanath Ananda, La Trobe University


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Perfectly inelastic demand curve

)0y(elasticitdemand

inelasticPerfectly


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Elasticity and total expenditure

Total expenditure = Px Q Market demand measures the quantity (Q) at

each price (P).

Total expenditure = Total revenue


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Copyright 2009 McGraw-Hill Australia Pty LtdPPTs t/a Principles ofMicroeconomics 2e by Frank, Jennings and Olekalns

Slides prepared by Jayanath Ananda, La Trobe University

Elasticity and total expenditure

How much do moviegoers spend onmovie tickets?

Original price = $2

Quantity sold = 500 tickets/day Total expenditure = $2 x 500 = $1000/day

New price = $4

Quantity sold = 400 tickets/day

Total expenditure = $4 x 400 = $1600/day

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Eff t f i i i t t l


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Effect of an increase in price on totalexpenditure when price is low

Observation:

An increase in price from $2 to $4 per ticket increases totalexpenditure on tickets from $1000/day to $1600/day.

Eff t f i i i t t l


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Effect of an increase in price on totalexpenditure when price is high

Observation:

An increase in price from $8 to $10 per ticket results in a fall intotal expenditure on tickets from $1600/day to $1000/day.

C t ti t t l dit


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Constructing a total expenditurecurve for movie tickets

Steps:1. Calculate total expenditure for a sample of points

on the demand curve

2. Plot total expenditure at each of the price pointson a graph

3. Sketch the curve by joining these points


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Demand curve for movie tickets

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Copyright 2008 McGraw-Hill Australia Pty LtdPPTs t/a Microeconomics 2e by Frank, Jennings and Olekalns


T l di f i f


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Total expenditure as a function ofprice

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Copyright 2008 McGraw-Hill Australia Pty LtdPPTs t/a Microeconomics 2e by Frank, Jennings and Olekalns


Total expenditure as a function of


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Total expenditure as a function ofprice

Observation:For goods whose demand curve is a straight line, total expenditurereaches a maximum at the price corresponding to the midpoint ofthe demand curve.


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Effect of elastic demand on totalexpenditure

Rock band example If the price elasticity of demand is more than 1, should a

rock band raise or lower its price to increase totalrevenue?

Eff t f l ti d d t t l


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Then Total revenue = $20 x 5000 =

$100 000/week

If Pis increased 10%, Qwill decrease 30%

Total revenue = $22 x 3500 = $77 000/week

If Pis lowered 10%, Qwill increase 30%

Total revenue = $18 x 6500 = $177 000/week

Effect of elastic demand on total


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Rules:1. When price elasticity is greater than 1, changes in

price and changes in total expenditure alwaysmove in opposite directions

2. When price elasticity is less than 1, changes inprice and changes in total expenditures alwaysmove in the same direction.

Effect of elastic demand on total


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Cross-price elasticity of demand

Percentage by which the quantitydemanded of a good changes inresponse to a 1 per cent change in

the price of the second good E.g. Percentage by which the quantity of peanuts

demanded changes in response to a 1% change in theprice of cashews


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Income elasticity of demand

Percentage by which the quantitydemanded of a good changes inresponse to a 1 per cent change in

income Percentage by which the quantity of peanutdemanded changes in response to a 1% change inincome


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Cross-price elasticity of demand

Suppose that the demand for hamburgersdepends on the level of advertising. Define theadvertising expenditure elasticity of demand forhamburgers.

Substitute and complimentary


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Substitute and complimentarygoods

When the cross-price elasticity of demand ispositive, the two goods are substitutes

When the cross-price elasticity of demand isnegative, the two goods are compliments


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Normal and inferior goods

A normal good has positive income elasticity ofdemand

An inferior good has negative income elasticity ofdemand


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Price elasticity of supply

The percentage change in quantity supplied thatoccurs in response to a 1 per cent change in price

PPQQsupplyofelasticityPrice

slope

1

Q

PsupplyofelasticityPrice

Supply curve for which price


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Supply curve for which priceelasticity declines as quantity rises

2124A

35135B

Supply curve for which price


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Supply curve for which priceelasticity is constant

1412124 A

1515155 B


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A perfectly elastic supply curve

Insert Fig 4.15What is the price elasticity of supply of lemonade?

The elasticity of supply is infinite at every point along a horizontalsupply curve


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Determinants of supply elasticity

Flexibility of inputs Mobility of inputs

Ability to produce substitute inputs

Time


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Elasticity in action

Why are petrol prices so much more volatile thancar prices? Differences in markets

Demand for petrol is more inelastic.

Petrol market has larger and more frequent supply shifts


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Copyright 2009 McGraw-Hill Australia Pty LtdPPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns

Elasticity in action

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Jennings2e PPT Ch04