Transcript EC1110 - Elasticity

SAYRE | MORRIS
Seventh Edition
CHAPTER 4
Elasticity
© 2012 McGraw-Hill Ryerson Limited
4-1
CHAPTER 4
Elasticity
Learning Objectives:
LO1: Understand the concept and calculate price elasticity
of demand
LO2: Understand the relationship between the slope of a
demand curve and elasticity and how this affects the total
revenue of the producer
LO3: Understand the determinants of price elasticity of
demand
© 2012 McGraw-Hill Ryerson Limited
4-2
CHAPTER 4
Elasticity
Learning Objectives:
LO4: Use real-world examples to demonstrate that the
concept of elasticity is a powerful tool
LO5: Understand the meaning and significance of elasticity
of supply, income elasticity, and cross-elasticity of
demand
© 2012 McGraw-Hill Ryerson Limited
4-3
LO1
Price Elasticity of Demand
•
a measure of how much quantity demanded
changes as a result of a change in price
% quantity demanded
p
%price
•
can be expanded to:
 Qd
 100
average Q d
p 
P
 100
average P
© 2012 McGraw-Hill Ryerson Limited
4-4
LO1
Price Elasticity of Demand
Example: airline tickets
Vancouver to Edmonton
Quantity
Price
of Tickets
Total
Revenue
$650
1000
$650 000
550
1100
605 000
Price
$650
550
Vancouver to Calgary
Quantity
of Tickets
Total Revenue
1000
1250
$650 000
687 500
100
%  Qd 
 100  9.5%
1050
%  Pr ice 
p 
$100
 100  16.7%
$600
%Q 9.5%

 0.57
%P 16.7%
© 2012 McGraw-Hill Ryerson Limited
4-5
LO1
Price Elasticity of Demand
Elasticity Coefficient
• a number that measures the responsiveness of
quantity demanded to a change in price
If coefficient is:
Demand is:
Greater than 1
Elastic
Less than 1
Inelastic
Equal to 1
Unitary
© 2012 McGraw-Hill Ryerson Limited
4-6
LO1
Price Elasticity of Demand
Inelastic Demand
• quantity demanded that is not very responsive to a
change in price
Elastic Demand
• quantity demanded that is quite responsive to a
change in price
© 2012 McGraw-Hill Ryerson Limited
4-7
LO1
Price Elasticity of Demand
Unitary Demand
• the point where the percentage change in quantity
is exactly equal to the percentage change in price
© 2012 McGraw-Hill Ryerson Limited
4-8
LO1
Self-Test
Set I
Set II
Price
$9
8
2
1
Quantity
1
2
8
9
a) Calculate the elasticity coefficients for each set.
b) In each set the change in price is $1 and the change in quantity is
1 unit. Why aren’t the coefficients the same?
© 2012 McGraw-Hill Ryerson Limited
4-9
LO1
Self-Test
Set I
Set II
Price
$9
8
2
1
Quantity
1
2
8
9
a) Calculate the elasticity coefficients for each set.
Set I
5.67. ε = (2–1) x100 / (9 – 8) x 100 = 66.66%/11.76%
1.5
8.5
Set II 0.18.
ε = (9–8) x100 / (2 – 1) x 100 = 11.76%/66.66%
8.5
1.5
© 2012 McGraw-Hill Ryerson Limited
4-10
LO1
Self-Test
Set I
Set II
Price
$9
8
2
1
Quantity
1
2
8
9
b) In each set the change in price is $1 and the change in quantity is
1 unit. Why aren’t the coefficients the same?
They are not the same because the $1 change in price is a small
% change in Set 1, but a big % change in Set 2. Similarly, 1
unit is a big % change in Set 1, but a small % change in Set 2.
© 2012 McGraw-Hill Ryerson Limited
4-11
LO1
Elasticity and Total Revenue
• If demand is elastic, an increase in price will
decrease revenue
• If demand is inelastic, an increase in price will
increase revenue
Vancouver to Edmonton
Price
Quantity Total Revenue: C
Vancouver to Calgary
Price
Quantity Total Revenue: D
$650
1000
$650 000
$650
1000
$650 000
750
900
675 000
750
750
562 500
inelastic
elastic
© 2012 McGraw-Hill Ryerson Limited
4-12
LO1
Elasticity and Total Revenue
If Demand is:
and Price …
inelastic (<1)
falls
then Total Revenue
…
falls
inelastic (<1)
rises
rises
elastic (>1)
falls
rises
elastic (>1)
rises
falls
unitary elastic (=1)
falls
stays the same
unitary elastic (=1)
rises
stays the same
© 2012 McGraw-Hill Ryerson Limited
4-13
LO1
Self-Test
What would happen to total revenue in each of the circumstances
below?
a)  >1 and price falls
b)  <1 and price rises
c)  <1 and price falls
d)  >1 and price rises
e)  = 1 and price rises
© 2012 McGraw-Hill Ryerson Limited
4-14
LO1
Self-Test
What would happen to total revenue in each of the circumstances
below?
a)  >1 and price falls
TR rises
c)  <1 and price falls
TR falls
b)  <1 and price rises
TR rises
d)  >1 and price rises
TR falls
e)  = 1 and price rises
No change
© 2012 McGraw-Hill Ryerson Limited
4-15
LO2
Elasticity and Slope
Slope
• Rise over run
Elasticity
• Percentage change in quantity over percentage
change in price
© 2012 McGraw-Hill Ryerson Limited
4-16
© McGraw Hill Publishing Col, 2011
4-17
© McGraw Hill Publishing Col, 2011
4-18
LO2
Self-Test
a) Graph a demand curve using the data from the demand schedule
(make each square on both axes equal to 2).
b) What is the slope of this demand curve?
c) How could you demonstrate that the
elasticity of demand was not the same as
the slope?
© 2012 McGraw-Hill Ryerson Limited
Price
1
2
3
4
5
6
7
8
9
Quantity
18
16
14
12
10
8
6
4
2
4-19
LO2
Self-Test
a) Graph a demand curve using the data from the demand schedule
(make each square on both axes equal to 2).
$10
Price
$8
$6
$4
$2
$0
0
2
4
6
8
10
12
14
16
18
20
Quantity per period
© 2012 McGraw-Hill Ryerson Limited
Price
1
2
3
4
5
6
7
8
9
Quantity
18
16
14
12
10
8
6
4
2
4-20
LO2
Self-Test
b) What is the slope of this demand curve?
– 1/2
(∆P/∆Q) = 1/–2
c) How could you demonstrate that the
elasticity of demand was not the same as
the slope?
The elasticity coefficient for a price
change from, say, 4 to 5 is 0.82 which is
quite different from the slope of – 1/2. In
fact, elasticity varies along any curve
despite the fact that the slope is constant.
© 2012 McGraw-Hill Ryerson Limited
Price
1
2
3
4
5
6
7
8
9
Quantity
18
16
14
12
10
8
6
4
2
4-21
LO3
Determinants of Elasticity
Examples of elastic and inelastic demands:
Commodities That Have Elastic
Demands
fresh tomatoes (4.60)
Commodities That Have Inelastic
Demands
household electricity (0.13)
movies (3.41)
eggs (0.32)
lamb (2.65)
car repairs (0.36)
restaurant meals (1.63)
food (0.58)
china and tableware (1.54)
household appliances (0.63)
automobiles (1.14)
tobacco (0.86)
Source: H.S. Houthakker and Lester D. Taylor, Consumer Demand in the United States (Cambridge, MA:
Harvard University Press, 1970).
© 2012 McGraw-Hill Ryerson Limited
4-22
LO3
Determinants of Price Elasticity
The demand for a product is more elastic:
• the closer and the greater are the number of available
substitutes;
• the larger the percentage of one’s income that is spent on
the product; and
• the longer the time period involved.
© 2012 McGraw-Hill Ryerson Limited
4-23
LO3
Self-Test
Imagine that elasticity coefficients were recently measured in
Canada over a period of one year for the following products.
Indicate whether you think such a measurement would be elastic
(>1) or inelastic (<1) demand.
a) Sugar
d) Restaurant meals
b) Gasoline
e) Women’s hats
c) Ocean cruises
f) Alcohol
© 2012 McGraw-Hill Ryerson Limited
4-24
LO3
Self-Test
Imagine that elasticity coefficients were recently measured in
Canada over a period of one year for the following products.
Indicate whether you think such a measurement would be elastic
(>1) or inelastic (<1) demand.
a) Sugar
inelastic (<1)
b) Gasoline
inelastic (<1)
c) Ocean cruises
elastic ( >1)
d) Restaurant meals
elastic ( >1)
e) Women’s hats
elastic ( >1)
f) Alcohol
inelastic (<1)
© 2012 McGraw-Hill Ryerson Limited
4-25
LO4
Applications of Price Elasticity
Excise Tax
• a sales tax imposed on a particular product
© 2012 McGraw-Hill Ryerson Limited
4-26
LO4
Applications of Price Elasticity
• the more inelastic the demand for a product, the
larger is the percentage of a sales (or excise) tax
the consumer will pay
© 2012 McGraw-Hill Ryerson Limited
4-27
LO5
Elasticity of Supply
•
a measure of how much quantity supplied
changes as a result of a change in price
%  quantity supplied
s 
%  price
•
can be expanded to:
Qs
 100
average Qs
s 
P
 100
average P
© 2012 McGraw-Hill Ryerson Limited
4-28
LO5
Elasticity of Supply
Example: When price changes from $2 to $3, the
quantity supplied rises from 400 to 500.
Qs
 100
average Qs
s 
P
 100
average P
100
 100  22.2%
450

  0.55
1
 40%
 100
2.5
© 2012 McGraw-Hill Ryerson Limited
4-29
LO5
© 2012 McGraw-Hill Ryerson Limited
4-30
LO5
Perfectly Inelastic Supply
© 2012 McGraw-Hill Ryerson Limited
4-31
LO5
Income Elasticity
•
the responsiveness of quantity demanded to a
change in income
%  quantity demanded (Qd )
Y 
%  income (Y)
•
can be expanded to:
Qd
 100
average Qd
Y 
Y
 100
average Y
© 2012 McGraw-Hill Ryerson Limited
4-32
LO5
Income Elasticity
If coefficient is: Type of Good:
Demand is:
Greater than 1
Normal –
Luxury good
Income elastic
Less than 1 but
greater than 0
Normal –
Necessity
Income inelastic
Less than 0
Inferior good
Negative income
elasticity
© 2012 McGraw-Hill Ryerson Limited
4-33
LO5
Income Elasticity
TABLE 4.9 Differences in Spending between the Richest
and Poorest Groups in Canada, 1996
Income Inelastic
Category
Food
Shelter
Public
transport
Household
operation
Tobacco &
alcohol
Lowest
income
percentile
Highest income
percentile
20.1%
34.6
15.9%
21.9
2.0
1.7
7.2
6.6
3.9
2.8
Income Elastic
Category
Lowest income Highest income
percentile
percentile
Furniture
Clothing
Private
transport
Recreation
Education
2.7%
4.4
4.3%
7.3
9.6
4.9
1.3
17.6
9.1
2.2
Source: Based on Statistics Canada, Family Expenditure in Canada, 1996, catalogue no. 62-555-XPB, released on July 28, 1998.
© 2012 McGraw-Hill Ryerson Limited
4-34
LO5
Self-Test
You are given the following data. Assume that the prices of X and
Y do not change:
Income
$10 000
15 000
Quantity Demanded Quantity Demanded
of X
of Y
200
50
350
54
a) Calculate the income elasticity for products X and Y.
b) Are products X and Y normal goods?
© 2012 McGraw-Hill Ryerson Limited
4-35
LO5
Self-Test
You are given the following data. Assume that the prices of X and
Y do not change:
Income
$10 000
15 000
Quantity Demanded Quantity Demanded
of X
of Y
200
50
350
54
a) Calculate the income elasticity for products X and Y.
X: + 1.36;
ε = (350–200) x100/(15 000 – 10 000) x 100 +54.5%/+40%
275
12 500
Y = + 0.19.
ε = (54–50) x100 / (15 000 – 10 000) x100 = +7.6%/+40%
52
12 500
© 2012 McGraw-Hill Ryerson Limited
4-36
LO5
Self-Test
You are given the following data. Assume that the prices of X and
Y do not change:
Income
$10 000
15 000
Quantity Demanded Quantity Demanded
of X
of Y
200
50
350
54
b) Are products X and Y normal goods?
Yes. Both products have a positive co-efficient; product X
is a luxury with a co-efficient greater than 1, Y is a
necessity with a co-efficient between 0 and 1.
© 2012 McGraw-Hill Ryerson Limited
4-37
LO5
Cross Elasticity
•
responsiveness of the change in Qd of product A
to a change in the price of product B
% quantity demanded of product A
AB 
% price of product B
•
can be expanded to:
 QdA
 100
A
average Qd
AB 
 PB
 100
B
average P
© 2012 McGraw-Hill Ryerson Limited
4-38
LO5
Cross Elasticity
Price
$1.50
2.10
Margarine
Quantity Demanded
per Week (lb.)
5000
3200
Price
$3.00
3.00
Butter
Quantity Demanded
per Week (lb.)
1000
2000
 QdA
 100
A
average Qd
AB 
 PB
 100
B
average P
 1000
 100  67%
1500
AB 

 2
 0.60
 33%
 100
1.80
© 2012 McGraw-Hill Ryerson Limited
4-39
LO5
Cross Elasticity
If coefficient is:
Goods are:
Positive
Substitutes
Negative
Complements
© 2012 McGraw-Hill Ryerson Limited
4-40
LO5
© 2012 McGraw-Hill Ryerson Limited
4-41
Chapter 4 Summary
•
•
•
•
•
Definition, calculation, and determinants of price
elasticity of demand
Difference between slope and elasticity
Relationship between elasticity and total revenue
Real world examples of elasticity
Elasticity of supply, income elasticity, and crosselasticity of demand
© 2012 McGraw-Hill Ryerson Limited
4-42