Transcript Good Price elasticity

Review
Summary
1. Elasticity is a general measure of responsiveness that can be
used to answer various questions.
2. The price elasticity of demand — the percent change in the
quantity demanded divided by the percent change in the price
(dropping the minus sign) — is a measure of the
responsiveness of the quantity demanded to changes in the
price.
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Review
Summary
3. The responsiveness of the quantity demanded to price can
range from perfectly inelastic demand, where the quantity
demanded is unaffected by the price, to perfectly elastic
demand, where there is a unique price at which consumers
will buy as much or as little as they are offered. When
demand is perfectly inelastic, the demand curve is vertical;
when it is perfectly elastic, the demand curve is horizontal.
4. The price elasticity of demand is classified according to
whether it is more or less than 1. If it is greater than 1,
demand is elastic; if it is exactly 1, demand is unit-elastic; if
it is less than 1, demand is inelastic. This classification
determines how total revenue, the total value of sales,
changes when the price changes.
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Review
Summary
5. The price elasticity of demand depends on whether there are
close substitutes for the good, whether the good is a necessity
or a luxury, the share of income spent on the good, and the
length of time that has elapsed since the price change.
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Price Elasticity of Demand
Some Estimated Price Elasticities of Demand
Good
Inelastic demand
• Eggs
• Beef
• Stationery
• Gasoline
Elastic demand
• Housing
• Restaurant meals
• Airline travel
• Foreign travel
Price elasticity
-0.1
-0.4
-0.5 |Price elasticity of demand| < 1
-0.5
-1.2
-2.3
-2.4 |Price elasticity of demand| > 1
-4.1
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Intro to Cross-Price EoD
Intro:
The cross-price elasticity of demand measures the effect
of a change in one good’s price on the quantity of
another good demanded.
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Cross-Price Elasticity
Cross Price Elasticity of Demand
EQX , PY
%QX

%PY
d
If EQX,PY > 0, then X and Y are gross substitutes because as the
price of good Y increases, the demand for good X increases. This
can happen from either of two effects.
• Good X substitutes for Good Y. For example, as the price of Y
= apples increases, the demand for X = oranges increases because
consumers substitute oranges for apples.
• Good X is needed because it is affordable. For example, as the
price of Y = College education increases, freshmen students must
economize and consume more affordable goods, like X = Ramen
Noodles.
• Since there are two effects, their sum is called the gross effect.
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Cross-Price Elasticity
Cross Price Elasticity of Demand
EQX , PY
%QX

%PY
d
If EQX,PY < 0, then X and Y are gross complements because as the
price of good Y increases, the demand for good X decreases.
This can happen from either of two effects.
• Good Y complements Good X. For example, as the price of Y =
bread increases, the demand for X = butter decreases because
consumers need less butter when there is less bread.
• Good X is not wanted because it is unaffordable. For example,
as the price of Y = college education increases, freshmen students
must economize and consume fewer unaffordable goods, like X =
Chix Fillet.
• Since there are two effects, their sum is called the gross effect.
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Intro to Income Elasticity EoD
Intro:
The income elasticity of demand is the percent change in the
quantity of a good demanded when a consumer’s income changes
divided by the percent change in income. If the income elasticity
is greater than 1, a good is income elastic; if it is positive and less
than 1, the good is income-inelastic.
% change in demand divided by the % change in income
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Income Elasticity
Income Elasticity
EQX , M
%QX

%M
d
If EQX,M > 0, then X is a normal good. Higher income M
implies higher demand.
If EQX,M < 0, then X is a inferior good. Higher income M
implies lower demand.
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Normal goods have a positive income elasticity of demand so as consumers’ income
rises more is demanded at each price i.e. there is an outward shift of the demand curve
Normal necessities have an income elasticity of demand of between 0 and +1 for
example, if income increases by 10% and the demand for fresh fruit increases by 4%
then the income elasticity is +0.4. Demand is rising less than proportionately to income.
Luxury goods and services have an income elasticity of demand > +1 i.e. demand
rises more than proportionate to a change in income – for example a 8% increase in
income might lead to a 10% rise in the demand for new kitchens. The income elasticity
of demand in this example is +1.25.
Inferior Goods
Inferior goods have a negative income elasticity of demand meaning that demand
falls as income rises. Typically inferior goods or services exist where superior goods
are available if the consumer has the money to be able to buy it. Examples include the
demand for cigarettes and low-priced own label foods in supermarkets.
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Elasticity Applications
Business Applications of Elasticity
• Pricing and managing cash flows.
• Effect of changes in competitors’ prices.
The income elasticity of demand is usually strongly positive for
•Fine wines and spirits, high quality chocolates and luxury holidays overseas.
•Sports cars
•Consumer durables - audio visual equipment, smart-phones
•Sports and leisure facilities (including gym membership and exclusive sports clubs).
In contrast, income elasticity of demand is lower for
•Staple food products such as bread, vegetables and frozen foods.
•Mass transport (bus and rail).
•Beer and takeaway pizza!
•Income elasticity of demand is negative (inferior) for cigarettes and urban bus services.
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Review
Cross elasticity of demand measures how sensitive
purchases of a specific product are to changes in:
a. The price of some other product
b. The price of that same product
c. Income
d. The general price level
e. If it is a normal or inferior good
a. The price of some other product
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Elasticity Applications
Example 1: Pricing and Cash Flows
• According to an FTC Report by Michael Ward, AT&T’s own
price elasticity of demand for long distance services is -8.64.
• AT&T needs to boost revenues in order to meet it’s marketing
goals.
• If AT&T lowered price by 3 percent, what would happen to
the volume (Hint quantity) of long distance telephone calls
routed through AT&T?
EQX , PX
%QX

%PX
Economics Review
d
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Elasticity Applications
Answer
• Calls would increase by 25.92 percent.
EQX , PX
% Q X
 8.64 
% PX
d
% Q X
 8.64 
 3%
d
 3%   8.64   % QX
d
% Q X  25.92%
d
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Controversy: Gambling
Controversy: Gambling
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Controversy: Gambling
A lottery is a form of gambling which involves the drawing of lots for
a prize. Some governments outlaw it, while others endorse it to the
extent of organizing a national or state lottery. At the beginning of the
20th century, most forms of gambling, including lotteries and
sweepstakes, were illegal in many countries, including the U.S.A. and
most of Europe. This remained so until after World War II. In the
1960s casinos and lotteries began to appear throughout the world as a
means to raise revenue in addition to taxes.
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Controversy: Gambling
Lotteries and gambling are an effective way to raise revenue because
there are few substitutes. As the government taxes any good, it raises
the price, and so consumers lower demand, which lowers tax revenue.
But with few substitutes, the demand for gambling is very inelastic,
and so consumers’ demand is only slightly lower, which means tax
revenue is only slightly lower.
Lotteries and gambling are controversial, however, if you believe
most gamblers are irrational. If irrational, a gambler could hurt
themselves by saying yes to gambling when they should have said no.
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