Price Elasticity of Demand• Measurement of a good’s
responsiveness to a change in price• The price effect is greater for some
goods than for others• Examples:
Price Elasticity of Demand• Large Price Effect → Elastic
Ex:
• Small Price Effect → InelasticEx:
Other Examples?
Factors Affecting Elasticity of Demand• Wants = more elastic, needs = more inelastic
• Time:• Can purchase be delayed?• Time to adjust…• Longer price change persists = more elastic (long run)• Immediately after price change = more inelastic (short
run)• Availability, Suitability, Price of Substitutes
• More/better/cheaper substitutes = more elastic• Ex: Ibuprofen vs. Insulin
• Percentage of Budget• Larger % = more elastic• Ex: New Car for me vs. LeBron James
Testing for Elasticity of Demand
• Graphical Comparison
The flatter the curve, the more Elastic the good.The steeper the curve, the more Inelastic the good.***ONLY APPLICABLE WHEN COMPARING 2 CURVES
Inelastic
Elastic
Testing for Elasticity of Demand• Total Revenue Test --- TR = P x Q• Example:• If P and TR move in the same
direction, demand isinelastic
• If P and TR move in oppositedirections, demand iselastic
• Gas?• Grade upgrade certificates?
$3
2
1
0 10 20 30 40 Q
P
•Lower price and elastic demand• Blue gain exceeds gold loss
a
b
D1
The Total Revenue Test
6-7
$4
3
2
1
0 10 20 Q
P
•Lower price and inelastic demand• Gold loss exceeds blue gain
c
d
D2
The Total Revenue Test
6-8
$3
2
1
0 10 20 30 Q
P
•Lower price and unit-elastic demand• Blue gain equals yellow loss
e
fD3
The Total Revenue Test
6-9
• As long as Total Revenue is increasing with every decrease in price, Demand is elastic**Marginal Revenue is positive
• When Total Revenue begins to decrease with every decrease in price, Demand becomes inelastic**Marginal Revenue is negative
Price Elasticity of Demand•Price-elasticity coefficient and formula
Percentage Change in QuantityDemanded of Product X
Percentage Change in Priceof Product X
Ed =
6-11
Price Elasticity of Demand•Calculate percentage change•Restate formula
Change in Quantity Demanded of X
Original Price of X
Ed =
Change in Price of X
Original Quantity Demanded of X
÷
6-12
Price Elasticity of Demand• Calculation problem
• $4-$5 is 25% increase• $5-$4 is 20% decrease
• Starting point matters• Midpoint formula
Change in QuantityEd = Sum of Quantities/2
÷Change in Price
Sum of Prices/26-13
Elasticity and the TR Curve
0 1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8
Quantity Demanded
Quantity Demanded
Pri
ceT
ota
l Rev
enu
e(T
ho
usa
nd
s o
f D
olla
rs)
$201816141210
8642
$87654321
a
bc
de
fg
h
ElasticEd > 1
Unit ElasticEd = 1
InelasticEd < 1
D
TR
6-14
Price Elasticity of Demand• Why use percentages?
• Unit free measure• Dollars vs. pennies
• Compare responsiveness across products• JBCs vs. Porsches
• Elimination of the (-) sign• Extreme cases
• Perfectly inelastic demand• Perfectly elastic demand
6-15
Interpretations of Elasticity
Elastic Demand
Inelastic Demand
Unit Elasticity
Ed = .04.02 = 2
Ed = .01.02 = .5
Ed = .02.02 = 1
6-16
Extending Elasticity of Demand• How does elasticity of demand affect us?• What do these have in common?
• Government taxes inelastic goods… Why?• Why doesn’t govt. tend to tax elastic goods?
““Government's view of the economy could be summed up Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.”regulate it. And if it stops moving, subsidize it.”
-Ronald Reagan-Ronald Reagan
Homework:
•Read pgs. 143-149 and complete Review question #6 and Problems #5 and 7
20
Copyright ACDC Leadership 2015
Elasticity of Supply• Elastic – easy/quick to produce – lower
marginal cost for each additional unit produced
• Inelastic – harder/slower to produce – higher marginal cost for each additional unit produced
• Elasticity of supply increases as producers have more time to adjust to a price change
• Ex: 1979 Today
Factors Affecting Elasticity of Supply
1. Ease of Productioneasier = more elastic
2. Responsiveness to price
changequicker adjustment =
more elastic
3. Timemore time to adjust =
more elastic
Price Elasticity of Supply
Percentage Change in QuantitySupplied of Product X
Percentage Change in Priceof Product X
Es =
Responsiveness to price changes by producers
6-23
Elasticity of Supply changes over time
• Market Period – immediately after a change in price• Perfectly inelastic supply
• Short Run – up to a few months after a change in price• Inelastic or somewhat elastic supply• Fixed plant size
• Long Run – many months/years after a price change• Perfectly Elastic supply• Adjustable plant size
P
Q
Price Elasticity of SupplyThe Market Period• Perfectly inelastic supply
D1 D2
Sm
Q0
Pm
P0
GreatestPrice
Impact
6-25
Price Elasticity of Supply
The Short Run• Inelastic supply
P
Q
D1 D2
Ss
Q0
Ps
P0
Qs
LowerPrice
Impact
6-26
Fixed land.Some fixed capital.More labor?More fertilizer?
Price Elasticity of Supply
The Long Run• Elastic supply
P
Q
D1 D2
Sl
Q0
Pl
P0
Ql
LeastPrice
Impact
6-27
Price Elasticity of Supply•Applications•Antiques and reproductions
• Limited, inelastic supply• Strong demand• Resulting high price
•Volatile gold prices• Inelastic supply• Shifting demand
•Kidneys 6-28
Cross Elasticity of Demand
•Responsiveness of sales to change in price of another good
Percentage Change in QuantityDemanded of Product X
Percentage Change in Priceof Product Y
Exy =
6-29
Cross Elasticity of Demand• Substitute goods
• Positive sign • Complementary goods
• Negative sign• Independent goods
• Zero or near zero• Coke and Sprite Example• Mergers
6-30
Practice Problem• Let’s look at 2 goods, Widgets and Wadgets. Given the
following information:1. Calculate the price elasticity of demand for widgets. Is
demand for widgets elastic, inelastic, or unit elastic?2. Calculate the cross elasticity of demand for wadgets as
they relate to widgets. Would wadgets be considered complements, substitutes, or independent of widgets?
P₁ P₂ Q₁ Q₂
Widgets $3 $5 47 21
Wadgets $2 $2 12 3
Income Elasticity of Demand
• Responsiveness of sales to change in income• Income increases 20%, and quantity decreases
15% then the good is a(n)…• INFERIOR GOOD
• Normal goods – positive sign• Inferior goods– negative sign • How can this help you profit from a recession?
Percentage Change in QuantityDemanded
Percentage Change in IncomeEi =
6-32
33
2010 Question 6
Copyright ACDC Leadership 2015
2008 Audit Question 34