Transcript income elasticities of demand

Chapter 4
Elasticity
© 2002 South-Western
Economic Principles
• Demand Sensitivity
• Determinants of Demand
Sensitivity to Price Changes
• Price Elasticity of Demand
• Cross Elasticity
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Economic Principles
• Substitute and Complementary
Goods
• Normal and Inferior Goods
• Supply Elasticity
• Relationship Between Price
Elasticity of Supply and Tax
Revenues
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EXHIBIT 1A DEMAND RESPONSE TO PRICE CHANGE
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EXHIBIT 1B DEMAND RESPONSE TO PRICE CHANGE
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EXHIBIT 1C DEMAND RESPONSE TO PRICE CHANGE
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Exhibit 1: Demand Response to
Price Change
1. The demand curve in panel a
can be described as:
• Vertical.
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Exhibit 1: Demand Response to
Price Change
The demand curve is
vertical in panel a because:
• The demand for penicillin doesn’t change
– regardless of what price is charged.
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Exhibit 1: Demand Response to
Price Change
The demand curve in panel b can
be described as:
• Fairly steep.
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Exhibit 1: Demand Response to
Price Change
The demand curve in panel b
compares to the demand curve in
panel c:
• The demand curve in panel b is
steeper than in panel c.
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Exhibit 1: Demand Response to
Price Change
This tells us that the demand
response for spark plugs versus
Coca-Cola:
• When price is cut, the demand
response for Coca-Cola is greater than
the demand response for spark plugs.
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Demand Sensitivity
Demand Sensitivity:
• Demand sensitivity describes how consumer
demand reacts to changes in price.
• High sensitivity: a given change in price will
result in a large change in quantity demanded.
• Low sensitivity, or insensitivity: a given
change in price will result in little or no change
in quantity demanded.
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EXHIBIT 2
MARKET DEMAND FOR COCA-COLA AND
SPARK PLUGS
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Exhibit 2: Market Demand for
Coca-Cola and Spark Plugs
In Exhibit 2, which demand
curve, Panel a or b, has a steeper
slope?
• Panel a, the demand for Coca-Cola,
has a steeper slope.
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Exhibit 2: Market Demand for
Coca-Cola and Spark Plugs
Which panel depicts high
demand sensitivity?
• Panel a depicts high demand sensitivity.
• A decrease in the price of Coca-Cola results
in a large increase in quantity demanded.
• The slope of the demand curve is steep.
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What Factors Influence Demand
Sensitivity?
All else equal, the demand for
low-priced goods is less elastic
than high-priced goods.
When something is inexpensive
people are less price sensitive.
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What Factors Influence Demand
Sensitivity?
The elasticity of demand for
poor people is larger than for
rich people.
• Poor people are more sensitive to
price changes than rich people.
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What Factors Influence Demand
Sensitivity?
The price elasticity of demand for
basic goods (necessities) is not
larger than for less essential goods.
•There are fewer substitutes for basic goods
(such as bread, electricity, or gasoline) than
for less essential goods (such as slices of pizza
or specific brands of running shoes).
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What Factors Influence Demand
Sensitivity?
A product used as a compliment
with an essential good will have
the elasticity characteristics of
the essential good.
•If something is used in conjunction with
an essential good, then consumption will
not decline very much if price rises.
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What Factors Influence Demand
Sensitivity?
In which of the following situations
will the price elasticity of demand
be largest:
• When people have a brief period of
time to adjust
•When people have a long time period
to adjust.
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What Factors Influence Demand
Sensitivity?
In which of the following situations
will the price elasticity of demand
be largest:
• When people have a brief period of
time to adjust
•When people have a long time period
to adjust.
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From Sensitivity to Elasticity
The price elasticity of demand is
not the same thing as the slope of
the demand curve.
• The slope of the demand curve
will differ based on the units used
to measure price and quantity.
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From Sensitivity to Elasticity
The price elasticity of demand is
not the same thing as the slope of
the demand curve.
• We want a measure of sensitivity that
will be the same regardless of the units
used to measure price and quantity.
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From Sensitivity to Elasticity
The price elasticity of demand is
not the same thing as the slope of
the demand curve.
• Price elasticity of demand is the percent
change in quantity demanded divided by
the percentage change in price.
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From Sensitivity to Elasticity
Formula for computing the price
elasticity of demand:
• Ed = (Q2-Q1)/[(Q2+Q1)/2] divided by
(P2-P1)/[(P2+P1)/2]
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EXHIBIT 3A
PRICE
ELASTICITIES
OF DEMAND
FOR
F
OOTBALL
TICKETS
AND MILK
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EXHIBIT 3B
PRICE
ELASTICITIES
OF DEMAND
FOR
F
OOTBALL
TICKETS
AND MILK
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Exhibit 3: Price Elasticities of Demand
for Football Tickets and Milk
In Exhibit 3, elasticity of demand for
football tickets within the $4 to $3 price
range is 3.5. This means:
• A price elasticity of 3.5 means that a 1
percent change in price generates a 3.5
percent change in quantity demanded.
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Exhibit 3: Price Elasticities of Demand
for Football Tickets and Milk
In Exhibit 3, elasticity of demand for
football tickets within the $4 to $3 price
range is 3.5. This means:
• Elasticities greater than 1.0 are
price elastic.
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Exhibit 3: Price Elasticities of Demand
for Football Tickets and Milk
In the $2 to $1 price range, elasticity
of demand for football tickets falls to
0.5. This means:
• A 0.5 price elasticity means that a 1
percent change in price generates a 0.5
percent change in quantity demanded.
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Exhibit 3: Price Elasticities of Demand
for Football Tickets and Milk
In the $2 to $1 price range, elasticity
of demand for football tickets falls to
0.5. This means:
• Elasticities less than 1.0 are
price inelastic.
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Exhibit 3: Price Elasticities of Demand
for Football Tickets and Milk
When the price of football tickets rises
from $1 to $2, quantity demanded
falls from 700 to 500. The price
elasticity of demand is:
• (Q2-Q1)/[(Q2+Q1)/2] =
(700-500)/[(700+500)/2] = 1/3.
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Exhibit 3: Price Elasticities of Demand
for Football Tickets and Milk
When the price of football tickets rises
from $1 to $2, quantity demanded
falls from 700 to 500. The price
elasticity of demand is:
• (P2-P1)/[(P2+P1)/2] =
(2-1)/[(2+1)/2] = 2/3
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Exhibit 3: Price Elasticities of Demand
for Football Tickets and Milk
When the price of football tickets rises
from $1 to $2, quantity demanded
falls from 700 to 500. The price
elasticity of demand is:
• Ed = (1/3)/(2/3) = ½.
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EXHIBIT 4
ELASTICITIES, PRICE, AND REVENUE
CHANGES
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Exhibit 4: Elasticities, Price, and
Revenue Changes
If demand is price inelastic and
price goes down, total revenue
decreases.
• When demand is price inelastic, the increase
in quantity is less than proportionate to the
decrease in price.
• Price falls more than quantity increases and
total revenue decreases.
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Cross Elasticity
Cross elasticity of demand:
• It is the ratio of a percentage change in
quantity demand of one good to a percentage
change in the price of another good.
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EXHIBIT 5
PRICE ELASTICITIES OF DEMAND FOR
SELECTED GOODS
Source: Edward Mansfield, Microeconomics (New York: W. W. Norton, 1997); Robert Hall and Mark Lieberman, Economics (Cincinnati: SouthWestern College Publishing, 1998); Gary Brester and Michael Wohlgenant, “Estimating Interrelated Demands for Meat Using New Measures for
Ground and Table Cut Beef,” American Journal of Agricultural Economics (November 1991); and Heinz Kohler, Intermediate Economics: Theory and
Applications (new York: Scott, Foresman, 1986).
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Exhibit 5: Price Elasticities of
Demand for Selected Goods
Which of the following has the
largest price elasticity of demand:
• Corn
• Cigarettes
• Movies
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Exhibit 5: Price Elasticities of
Demand for Selected Goods
Which of the following has the
largest price elasticity of demand:
• Corn
• Cigarettes
• Movies
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EXHIBIT 6
PRICE ELASTICITIES OF DEMAND IN THE
SHORT RUN AND LONG RUN
Source: H. S. Houthakker and Lester Taylor, Consumer Demand in the United States, 1929–1970 (Cambridge, Mass.: Harvard University Press,
1970); Richard Voith, “The Long-Run Elasticity of Demand for Commuter Rail Transportation,” Journal of Urban Economics (November 1991); and
James Griffen and Henry Steele, Energy Economics and Policy (New York: Academic Press, 1980).
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Exhibit 6: Price Elasticities of
Demand in the Short Run and Long
Run
Which of the following has the
smallest price elasticity of
demand in the long run:
• Gasoline
• Jewelry and watches
• Hospital care
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Exhibit 6: Price Elasticities of
Demand in the Short Run and Long
Run
Which of the following has the
smallest price elasticity of
demand in the long run:
• Gasoline
• Jewelry and watches
•Hospital care
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EXHIBIT 7
CROSS ELASTICITIES BETWEEN
SUBSTITUTES
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Exhibit 7: Cross Elasticities Between
Substitutes
In Exhibit 7, the demand for
Tums increase when the price of
Rolaids increased because:
• Tums and Rolaids are substitute goods -goods that can replace each other.
• When the price of Rolaids increases, some
consumers are willing to switch to a cheaper
substitute -- Tums.
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Exhibit 7: Cross Elasticities Between
Substitutes
In Exhibit 7, the demand for
Tums increase when the price of
Rolaids increased because:
• Cross elasticities for substitute goods are
positive.
• A decrease (or increase) in the price of one
good generates a corresponding decrease (or a
corresponding increase) in the quantity
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demanded of the other.
EXHIBIT 8
CROSS ELASTICITIES OF DEMAND FOR
SUBSTITUTE GOODS
Source: Edwin Mansfield, Microeconomics (New York: W. W. Norton, 1997); F. Gasmi, J. J. Laffont, and Q. Vuong, “Econometric Analysis of
Collusive Behavior in a Soft Drink Market,” Journal of Economics and Management Strategy (Summer 1992); and Gary Brester and Michael
Wohlgenant, “Estimating Interrelated Demands for Meats Using New Measures for Ground and Table Cut Beef,” American Journal of Agricultural
Economics (November 1991).
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Exhibit 8: Cross Elasticities of
Demand for Substitute Goods
Which of the following are the
closest substitutes, according to
Exhibit 8:
• Butter and margarine
• Poultry and ground beef
• Natural gas and electricity
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Exhibit 8: Cross Elasticities of
Demand for Substitute Goods
Which of the following are the
closest substitutes, according to
Exhibit 8:
• Butter and margarine
• Poultry and ground beef
• Natural gas and electricity
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Exhibit 8: Cross Elasticities of
Demand for Substitute Goods
Butter and margarine the
closest substitutes because:
• They
have the largest cross
elasticity of demand.
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EXHIBIT 9A CROSS ELASTICITIES BETWEEN
COMPLEMENTS
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EXHIBIT 9B CROSS ELASTICITIES BETWEEN
COMPLEMENTS
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Exhibit 9: Cross Elasticities
Between Complements
When the price of flights decreases,
the demand for hotel rooms:
• The demand for hotel rooms will increase,
because people fly more and need more
hotel rooms.
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Income Elasticity
Income elasticity:
• It is the ratio of the percentage
change in quantity demanded to the
percentage change in income.
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Income Elasticity
Income elasticity:
• A good is considered income elastic
when a 1 percent change in income
generates a greater than 1 percent
change in quantity demanded.
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Income Elasticity
Income elasticity:
• A good is considered income
inelastic when a 1 percent change in
income generates a less than 1
percent change in quantity
demanded.
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EXHIBIT 10 AIR TRAVEL
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Exhibit 10: Air Travel
The demand curve in Exhibit 10
shift from Dy to D’y even though
price remains constant because:
• In Exhibit 10, the demand for air travel
is income elastic. As income increases, the
demand for flights increases, even though
the price of flights remains unchanged.
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EXHIBIT 11
INCOME ELASTICITIES OF DEMAND
Source: Edwin Mansfield, Microeconomics (New York: W. W. Norton, 1997); and F. Chalemaker, “Rational Addictive Behavior and Cigarette
Smoking,” Journal of Political Economy (August 1991).
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Exhibit 11: Income Elasticities of
Demand
The income elasticity of demand
for electricity so much lower than
for furniture because:
• Electricity is a necessity, while
furniture is a luxury.
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EXHIBIT 12 COMPARISON OF INCOME ELASTICITIES
OF DEMAND FOR FOOD, BY COUNTRY
Source: Ching-Fun and James Peale Jr., “Income and Price Elasticities,” in Advances in Econometrics Supplement, ed. Henri Thell (Greenwich,
Conn.: JAI Press, 1989); and Y. Wu, E. Li, and S. N. Samuel, “Food Consumption in Urban China: An Empirical Analysis,” Applied Economics (June
1995).
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Exhibit 12: Comparison of Income Elasticities
of Demand for Food, by Country
The type of countries which tend
to have the lowest income
elasticity for food are:
• Industrialized countries.
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EXHIBIT 13A ELASTICITIES OF SUPPLY
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EXHIBIT 13B ELASTICITIES OF SUPPLY
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EXHIBIT 13C ELASTICITIES OF SUPPLY
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Exhibit 13: Elasticities of Supply
In Exhibit 13, the different supply
curves have different price
elasticities because:
• Panel a depicts the market-day supply curve.
• At any price suppliers are unable to adjust
supply.
• The price elasticity of supply is 0.
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Exhibit 13: Elasticities of Supply
In Exhibit 13, the different supply
curves have different price
elasticities because:
• Panel b depicts the short-run supply curve.
• Suppliers are willing, but not able, to meet all
the demand.
• Suppliers can only increase production with
existing capacity.
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• Price elasticity is 0.47.
Exhibit 13: Elasticities of Supply
In Exhibit 13, the different supply
curves have different price
elasticities because:
• Panel c depicts the long-run supply curve.
• Suppliers encounter no obstacles in adjusting
quantity supplied to price.
• The price elasticity is 1.64.
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EXHIBIT 14A WHAT GETS TAXED?
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EXHIBIT 14B WHAT GETS TAXED?
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Exhibit 14: What Gets Taxed
If government imposes a per
unit tax, the type of demand
(elastic or inelastic) which will
generate the most revenue is:
• Inelastic.
• Quantity will not decline very much when
the tax raises the price of the product.
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