Transcript Elasticity of Demand

Unit 4
Chap.5 - Price Floors and Price Ceilings
Chap.6 - Elasticity
Government Intervention in Pricing
 Price Floor
 Price is set higher than Market Equilibrium
 Surplus
 Price Ceiling
 Price is set lower than Market Equilibrium
 Shortage
Example of Price Ceiling
 Rent Controls in Large Cities
 Maximum rent that can be charged is
below market equilibrium
 Seinfeld Episode
Example of Price Ceiling
Market Equilibrium: Qty supplied = Qty demanded at ???
Example of Price Ceiling
At Price Ceiling of $1,100, Qty demanded = ??? And Qty supplied = ???
Example of Price Ceiling
 Rent Controls in Large Cities
 Maximum rent that can be charged is below
market equilibrium
 Qty demanded increases
 Qty supplied decreases
 Shortage!!!
Example of Price Ceiling
 When might rent controls be a good
idea??
 When do rent controls fail??
Example of Price Floor
 Minimum Wage
 Minimum wage that can be charged is
above market equilibrium
Example of Price Floor
Market Equilibrium: Qty supplied = Qty demanded at ???
Example of Price Floor
At Price Floor of $7.25, Qty demanded = ??? And Qty supplied = ???
Example of Price Floor
 Minimum Wage
 Minimum wage that can be charged is
above market equilibrium
 Qty demanded decreases
 Qty supplied increases
 Surpus!!!
Law of Demand
 The Law of Demand tells us that for
an increase in price, there will be a
decrease in quantity demanded, but it
does not tell us by how much
quantity demanded will decrease.
Elasticity of Demand
 Price elasticity of demand measures the
magnitude of change in quantity
demanded due to a change in price – It
tells us how much!
 ED = % change in Quantity Demanded
% change in Price
Elasticity of Demand Equation
Change in Quantity
Sum of Quantity
2
ED =
Change in Price
Sum of Price
2
Elasticity of Demand Example
 If the price of Diet Coke increases
from $2.50 to $3.00 for a 12 pack,
then the quantity demanded will
decrease from 1000 to 900 12 packs.
Elasticity of Demand Example
 The percent change in quantity demanded is:
1000 - 900
1000 + 900
2
100
=
=
1900
2
100
950
= .11
Elasticity of Demand Example
 The percent change in price is:
$3.00 - $2.50
$3.00+ $2.50
2
$0.50
=
=
$5.50
2
$0.50
$2.75
= .18
Elasticity of Demand Example
 The ED will be equal to the percent
change in quantity demanded divided
by the percent change in price.
 ED = .11 / .18 = .61
Elasticity of Demand Example
 An ED of 0.61 means that every 1%
change in price will result in a 0.61%
change in quantity demanded.
For this example, a 1% increase in
the price of a 12 pack of Coke leads
to a 0.61% decrease in the sale of a
12 pack of Coke.
Elasticity
 When ED > 1
 % change in Q > % change in P
 Demand is Elastic
 When ED < 1
 % change in Q < % change in P
 Demand is Inelastic
 When ED = 1
 % change in Q = % change in P
 Demand is Unit Elastic
Elasticity and Total Revenue
 When demand is elastic
 Consumers are very price sensitive
 An increase in price leads to a decrease in total
revenue as many customers will no longer purchase
this product.
 A decrease in price leads to an increase in total
revenue as many new customers will now buy this
product.
Elasticity and Total Revenue
Let’s take a look at what happens to total revenue when
price falls from $10 down to $5. Here, the price elasticity
of demand is equal to 2.34.
Elasticity and Total Revenue
-$300
+$100
The decrease in price means less revenue gained for each of the first 60
units sold, or a decrease in revenue of $5 * 60 = -$300.
The decrease in price means more revenue gained by the sale of an
additional 20 units (as sales increase from 60 to 80) at $5 * 20 = $100.
Elasticity and Total Revenue
 When demand is inelastic
 Consumers are very price insensitive
 An increase in price leads to an increase in total
revenue as many customers will keep buying this
product even at the higher price.
 A decrease in price leads to a decrease in total
revenue as your customers will now buy this
product at a lower price.
Elasticity and Total Revenue
Let’s take a look at what happens to total revenue when
price falls from $20 down to $15.
Here, the price
elasticity of demand is equal to 0.427.
Elasticity and Total Revenue
-$100
+$300
The decrease in price means less revenue gained for each of the first 20
units sold, or a decrease in revenue of $5 * 20 = -$100.
The decrease in price means more revenue gained by the sale of an
additional 20 units (as sales increase from 20 to 40) at $15 * 20 = +$300.
Elasticity and Total Revenue
 When demand is unit elastic
 Consumers are price neutral
 An increase in price leads to no change in total
revenue as some customers will keep buying this
product even at the higher price while some
customers will stop buying the product.
 A decrease in price leads to no change in total
revenue as your current customers will now be
paying a lower price, but this will be offset by the
new customers you will gain who will start buying
your product.
Elasticity of Demand Example
 Calculate the price elasticity for the
following. State whether the price elasticity of
demand is elastic, unit elastic, or inelastic.
Will revenue rise, decline, or stay the same
with the given change in price?
 The price of a Boston Red Sox baseball
game rises from $8 to $12 a game. The
quantity of tickets sold falls from 160,000
tickets to 144,000.