Transcript Elasticity of Deman Chapter 4 Section 3

Elasticity of Demand
Chapter 6 114-122
Mr. Henry
AP Economics
Understanding Definitions:
Which stretches or changes, more –
something that is elastic or inelastic?
• Something that is elastic…
Law of Demand:
other things equal, consumers will buy more
of a product when its price declines and less
when its price increases.
But the big question is:
How much more or less will they buy?
• Demand Elasticity is a measure that shows how a change in
quantity demanded responds to a change in price
• Economists say that demand is elastic when a given change in
prices causes a relatively larger change in quantity demanded
• Elastic goods and services generally have plenty of substitutes.
Can you think of examples of demand elasticity?
Demand Elasticity
&
Elastic Demand
Inelastic Demand
• For some products, demand may be inelastic, which
means that a given change in prices causes a
relatively smaller change in the quantity demanded.
• Inelastic goods have fewer substitutes and price
change doesn't affect quantity demanded as much.
• Examples of inelastic goods?
• Gas, electricity, water, drinks, clothing, tobacco, food,
and oil
According to the Federal Highway
Administration, the number of motor
vehicles has been rising by an estimated
3.69 million each year since 1960 with
the largest annual growth between 1998
and 1999 as well as between 2000 and
2001. Today there are over 254.4
million vehicles in America.
Unit Elastic
• If PEoD = 1 then Demand is Unit Elastic
• Unit Elastic is a type of elasticity where a change in
price causes a proportional change in quantity
demanded
• It is hard to cite examples of Unit Elastic items, but
the demand for movies, tires, and private
education is estimated to be nearly unit-elastic
Doing the math…Price Elasticity of Demand
The Midpoint Method has three formulas
Doing the math…Price Elasticity of Demand
• Elasticity = (% change in quantity demanded / % change in price)
Calculating the Percentage Change in Quantity Demanded
* We always ignore the negative sign when analyzing price elasticity and present the absolute
value, so PEoD is always positive.
Sample Problem
900-1100
------------1100+900/2
-200
------------1000
1.10-.90
------------.90+1.10/2
.20
------------.20
-.20
=1
.20
Sample Problem 2
Consumers see a price change in a product from $4 to $5 and demand goes
from 20 units to 10 units. Calculate & type of elasticity.
20-10 ÷ (20+10)/2
---------------4-5 ÷ (4+5) / 2
= 10/15 ÷ -1/4.50
= 67% ÷ 22%
= 3.04 (elastic)
Sample Problem 3
Question: Hollister.com wants to increase its total revenue. One strategy is to offer a 10%
discount on every shirt it sells. Hollister.com knows that its customers can be divided into two
distinct groups according to their likely responses to the discount. The accompanying table
shows how the two groups respond to the discount.
a. Using the midpoint method, calculate the price elasticities of demand for group A and group B
b. Explain how the discount will affect total revenue from each group
c. Suppose Hollister.com knows which group each customer belongs to when he/she logs on and
can choose whether or not to offer the 10% discount. If Hollister.com wants to increase its total
revenue, should discounts be offered to group B, to neither group, or to both groups?
a. Using the midpoint method, calculate the price elasticities of demand for group A and group B
b. Explain how the discount will affect total revenue from each group
c. Suppose Hollister.com knows which group each customer belongs to when he/she logs on and
can choose whether or not to offer the 10% discount. If Hollister.com wants to increase its total
revenue, should discounts be offered to group B, to neither group, or to both groups?
b. For group A, since the price elasticity of demand is .625 (6.25%) and demand is inelastic,
total revenue will decrease as a result of the discount. For group B, since the price elasticity
of demand is 1.25 (12.5%) and demand is elastic, total revenue will increase as a result of the
discount.
c. If Hollister.com wants to increase total revenue, it should definitely not offer the discount
to group A and it should definitely offer the discount to group B.
Elasticity
–Tomorrow we will continue to look
at Demand Elasticity
Elasticity
Summary Review from Yesterday
• Elastic
– Increased price implies decreased total revenue.
– Decreased price implies increased total revenue.
– Given the law of demand, increased quantity (decreased price)
implies increased total revenue.
– Marginal revenue is positive.
• Inelastic
– Increased price implies increased total revenue.
– Decreased price implies decreased total revenue.
– Given the law of demand, increased quantity (decreased price)
implies decreased total revenue.
– Marginal revenue is negative.
• Unit elastic is neither elastic nor inelastic so MR = 0.
Price Elasticity of Demand
•
%> 1 then Demand is Price Elastic (Demand is sensitive to price changes)
% change in price results in a larger % change in quantity demanded
Ed= .04/.02 = 2
•
If PEoD = 1 then Demand is Unit Elastic
% change in price and % change in quantity demanded are the same
Ed= .02/.02 = 1
•
If PEoD % < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)
% change in price produces a smaller % change in quantity demanded
Ed= .01/.02 = .5
Alfred Marshall
1842-1924
His book, Principles of Economics (1890), was the
dominant economic textbook in England for many
years. It brings the ideas of supply and demand,
marginal utility, and costs of production into a
coherent whole. He is known as one of the founders
of economics and is credited with defining PED.
Determinants of Demand Elasticity
• Three questions can be asked about a product to give
us a good idea about the product’s demand elasticity
• Can the purchase be delayed? Cannot postpone the
purchase of a product = usually inelastic
• Are Adequate Substitutes Available? Can consumers
switch back and forth between the product and its
substitute = elastic
• Does the purchase use a large portion of income? If
amount is large = then demand tends to be elastic
• If amount of income is small = demand tends to be
inelastic (ie 5% increase in candy bar vs. a car)
Determinants of Demand Elasticity
• Can the purchase be delayed? Cannot postpone the purchase of
a product = usually inelastic
• Are Adequate Substitutes Available? Can consumers switch
back and forth between the product and its substitute = elastic
• Does the purchase use a large portion of income? If amount is
large = then demand tends to be elastic
Total Revenue Test
• In economics, the Total Revenue Test is a means for determining
whether demand is elastic or inelastic. If demand is elastic, a
decrease in price will increase total revenue. Even though a
lesser price is received per unit, enough additional units are sold
to more than make up for the lower price. If demand is inelastic,
a price decrease will reduce total revenue. The increase in sales
will not fully offset the decline in revenue per unit, and total
revenue will decline.
• Total Revenue is TR=P (product price) xQ (quantity sold)
• Are there any items that you notice / feel never go on sale??
• Price $2; Quantity Demanded 10; TR=$20
Notice if price declines from
$2 to $1, the qty. demanded
becomes 40 and TR=$40, so
TR has increased from $20 to
$40
At $4 Qd was 10 units (TR 40)
At $1 Qd was 20 units (TR 20)
Bad day at the shop 
At $3 Qd was 10 units (TR 30)
At $1 Qd was 30 units (TR 30)
Hope you didn’t spend much
on advertising! 
AP Review
• If a store raises its prices by 20 percent and its
total revenue increases by 10 percent, the
demand it faces in this price range must be
A. Inelastic
B. Elastic
C. Unit Elastic
D. Perfectly Elastic
E. Perfectly Inelastic
A. Inelastic
AP Review
• Demand is elastic if
A. Consumers respond strongly to changes in the product’s
price
B. A large percentage change in price brings about a small
percentage change in quantity demanded
C. A small percentage change in price brings about a small
percentage change in quantity demanded
D. The quantity demanded is not responsive to price
changes
E. The demand curve is vertical
A. Consumers respond strongly to changes in the product’s
price
AP Review
• When a firm raises the price of its product, what
happens to total revenue?
A. If demand is elastic, total revenue decreases
B. If demand is unit elastic, total revenue increases
C. If demand is inelastic, total revenue decreases
D. If demand is elastic, total revenue increases
E. If demand is unit elastic, total revenue
decreases
A. If demand is elastic, total revenue decreases
AP Review
• The basic formula for the price elasticity of demand
coefficient is:?
A. Absolute decline in qty demanded/absolute
increase in price
B. % change in qty demanded / % change in price
C. Absolute decline in price / absolute increase in qty
demanded
D. % change in price / % change in qty demanded
E. 𝑥 + 𝑎 𝑛 = 𝑛𝑘=0 𝑛𝑘 𝑥 𝑘 𝑎𝑛−𝑘
B. If demand is elastic, total revenue decreases
FYI E is the bionomial theorom – please see your math teacher on that
one.
AP Review
• Suppose the price of NetFlix increased from $16.20 to
$19.80 and as a result the number of NetFlix subscribers
decreased from 224,000 to 176,000. Along this portion of
the demand curve, price elasticity of demand is:
A. 0.8
B. 1.2
C. 1.6
D. 8.0
E. 9.3
B. 1.2
(Is NetFlix elastic, inelastic, or unit elasticity in this example?)
AP Review
• An antidrug policy which reduces the supply of bricks (ie
heroin) might:
A. Increase street crime because the addict’s demand for heroin
is highly inelastic
B. Reduce street crime because the addict’s demand for heroin
is highly elastic
C. Reduce street crime because the addict’s demand for heroin
is highly inelastic
D. Increase street crime because the addict’s demand for heroin
is highly elastic
E. Reduce street crime because the addict’s demand for heroin
is unit elasticity
B. Increase street crime because the addict’s demand for heroin is
highly inelastic