Transcript Price Elasticity of Demand

Chapter 4
Elasticity of Demand
and Supply
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved4-1
1-1
Price Elasticity of Demand
• Measures buyers’ responsiveness to price
•
•
changes
Elastic demand
• Sensitive to price changes
• Large change in quantity
Inelastic demand
• Insensitive to price changes
• Small change in quantity
4-2
Price-Elasticity Coefficient
Formula
• Formula for price elasticity of demand
Ed =
Percentage change in quantity
demanded of product X
Percentage change in price
of product X
4-3
Price-Elasticity Coefficient
Formula
• Use the midpoint formula
• Ensures consistent results
Change in quantity
Ed =
Change in price
÷
Sum of quantities / 2
Sum of prices / 2
4-4
Price-Elasticity Coefficient
Formula
• Use percentages
• Unit-free measure
• Compare responsiveness across
•
products
Eliminate the minus sign
• Easier to compare elasticities
4-5
Interpretation of Elasticity of
Demand
• Ed > 1: demand is elastic
• Ed = 1: demand is unit elastic
• Ed < 1: demand is inelastic
• Extreme cases
• Perfectly inelastic
• Perfectly elastic
4-6
Extreme Cases
Extreme Cases
P
D1
Perfectly
inelastic
demand
(Ed = 0)
0
Perfectly inelastic demand
4-7
Extreme Cases
P
D2
Perfectly
elastic
demand
(Ed = ∞)
0
Perfectly elastic demand
4-8
Total Revenue Test
• Total revenue = Price × Quantity
• Inelastic demand
• P and TR move in the same direction
• Elastic demand
• P and TR move in opposite directions
4-9
Total Revenue Test
• Lower price and elastic demand
• Blue gain exceeds yellow loss
P
$3
a
2
b
D1
1
0
LO2
10
20
30
40
Q
4-10
Total Revenue Test
• Lower price and inelastic demand
• Yellow loss exceeds blue gain
P
$4
c
3
2
d
1
D2
0
10
20
Q
4-11
Total Revenue Test
• Lower price and unit elastic demand
• Blue gain equals yellow loss
P
$3
e
2
f
1
D3
0
10
20
30
Q
4-12
Total Revenue Test
Price Elasticity of Demand for Movie Tickets as Measured by
the Elasticity Coefficient and the Total Revenue Test
(1)
Total Quantity of
Tickets Demanded
per Week,
Thousands
(2)
Price per
Ticket
1
$8
2
7
5.00
14,000
Elastic
3
6
2.60
18,000
Elastic
4
5
1.57
20,000
Elastic
5
4
1.00
20,000
Unit Elastic
6
3
0.64
18,000
Inelastic
7
2
0.38
14,000
Inelastic
8
1
0.20
8,000
Inelastic
(3)
Elasticity
Coefficient
(Ed)
(4)
Total
Revenue
(1) × (2)
(5)
Total
Revenue
Test
$8,000
4-13
Price $
Elasticity and Total Revenue
Elastic
Ed > 1
8
7
6
5
4
3
2
1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
D
1
2
3
4
5
6
7
8
4-14
Determinants of Elasticity of
Demand
• Substitutability
• More substitutes, demand is more elastic
• Proportion of income
• Higher proportion of income, demand is more
elastic
• Luxuries versus necessities
• Luxury goods, demand is more elastic
• Time
• More time available, demand is more elastic
4-15
Price Elasticity of Demand
Selected Price Elasticities of Demand
Product or Service
Price Elasticity
of Demand (Ed)
Product or Service
Price Elasticity
of Demand (Ed)
Newspapers
.10
Milk
.63
Electricity (household)
.13
Household appliances
.63
Bread
.15
Liquor
.70
MLB tickets
.23
Movies
.87
Telephone service
.26
Beer
.90
Cigarettes
.25
Shoes
.91
Sugar
.30
Motor vehicles
1.14
Medical care
.31
Beef
1.27
Eggs
.32
China, glassware
1.54
Legal services
.37
Residential land
1.60
Automobile repair
.40
Restaurant meals
2.27
Clothing
.49
Lamb and mutton
2.65
Gasoline
.60
Fresh peas
2.83
4-16
Applications of Ed
•
•
•
•
College tuition
Large crop yields
• Inelastic demand, lower total revenue
Excise taxes
• Inelastic demand, more total revenue
Decriminalization of illegal drugs
• Inelastic demand, more total revenue
4-17
Price Elasticity of Supply
• Measures sellers’ responsiveness to
price changes
• Elastic supply: producers are
responsive to price changes
• Inelastic supply: producers are not
responsive to price changes
4-18
Price Elasticity of Supply
• Formula to compute elasticity
• Es > 1: supply is elastic
• Es < 1: supply is inelastic
Es =
Percentage change in quantity
supplied of product X
Percentage change in price
of product X
4-19
Price Elasticity of Supply
• Time is primary determinant of
•
elasticity of supply
Time periods considered
• Market period
• Short run
• Long run
4-20
Elasticity of Supply: The Market
Period
• Perfectly inelastic supply
P
Sm
Pm
P0
D2
D1
Q0
Q
4-21
•
Elasticity of Supply: The Short
Run
Supply is more elastic than in market
period
P
Ss
Ps
P0
D2
D1
Q0 Qs
Q
4-22
•
Elasticity of Supply: The Long
Run
Supply is even more elastic than in
the short run
P
Sl
Pl
P0
D2
D1
Q0
LO3
Ql
Q
4-23
Applications of Elasticity of
Supply
• Antiques
• Inelastic supply
• Reproductions
• More elastic supply
• Volatile gold prices
• Inelastic supply
4-24
Income Elasticity of Demand
• Measures responsiveness of buyers
•
•
to changes in income
Normal goods — positive sign
Inferior goods — negative sign
Percentage change
in quantity demanded
Ei =
Percentage change in income
4-25
Income Elasticity Insights
• High income elasticities
• Most affected by a recession
• Low or negative income
• Least affected by a recession
4-26
Cross-Elasticity of Demand
• Measures responsiveness of sales to
•
•
•
change in the price of another good
Substitutes — positive sign
Complements — negative sign
Independent goods — zero
Percentage change in quantity demanded of product X
Ex,y =
Percentage change in price of product Y
4-27
Cross-Elasticity of Demand
• Application
• Change the price?
• Allow a merger?
4-28