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Chapter 18: Elasticity

Chapter 18: Elasticity. Price elasticity demand supply Cross elasticity Income elasticity. Basic idea. We know when P. Qd. Qs. holding other factors constant. but how much?. if price doubles how much does Qd fall? by 10% by 50% by 300%? price elasticity tells us.

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Chapter 18: Elasticity

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  1. Chapter 18: Elasticity • Price elasticity • demand • supply • Cross elasticity • Income elasticity

  2. Basic idea • We know when P Qd Qs holding other factors constant

  3. but how much? • if price doubles how much does Qd fall? • by 10% • by 50% • by 300%? • price elasticity tells us

  4. 4) a- consider theses two points (1,35) and (2,130) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 2-1/130-35 , M= 1/95 Y= (1/95)X + b so, 1=(1/95) * 35 + b B= 60/95 Qs= (1/95)P + 60/95

  5. 4) b- consider theses two points (1,530) and (2,400) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 2-1/400-530 , M= -1/130 Y= (-1/130)X + b so, 1=(-1/130) * 530 + b B= 660/130 Qd= (-1/130)P + 660/130

  6. 4) C, we know that at the equilibrium Qs = Qd, so • Qs= (1/95)P + 60/95 • Qd= (-1/130)P + 660/130 • (1/95)P + 60/95 = (-1/130)P + 660/130 • { (1/95) + (1/130)}P = {(660/130)-(60/95)} • P = 244

  7. 1- consider theses two points (20,400) and (30,250) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 30-20/250-400 , M= 10/-150 Y= (10/-150)X + b so, 20=(10/-150) * 400+ b B= 7000/150 Qs= (10/-150) P+ 7000/150

  8. 2)- consider theses two points (20,500) and (30,400) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 30-20/400-500 , M= 10/-100 Y= (10/-100)X + b so, 20=(10/-150) * 500+ b B= 8000/100 Qd= (10/-100) P+ 8000/100

  9. At equilibrium Qs = Qd • (10/-150) P+ 7000/150=(10/-100) P+ 8000/100 • ??

  10. I. Price Elasticity of Demand example • mocha latte at Starbucks • price rises from $3 to $5 per cup • Qd falls from 15 to 5 cups per hr.

  11. equation % change in Qd % change in P

  12. % change in Qd new Qd - initial Qd x 100 average Qd midpoint method

  13. example 5 cups - 15 cups x 100 (5+15)/2 cups -10 cups = -100% x 100 10 cups

  14. % change in P new P - initial P x 100 average P midpoint method

  15. example $5 - $3 x 100 ($5+$3)/2 $2 = 50% x 100 $4

  16. demand elasticity % change in Qd % change in P -100% = -2 50%

  17. If price of latte increases 1%, Qd of latte decreases 2%

  18. demand elasticity • a unit-free measure • compare all goods & services • changes for different points on the demand curve

  19. if price elasticity of demand(absolute value) • = 1 unit elastic % change Qd = % change P • > 1 elastic % change Qd > %change P sensitive to P changes

  20. < 1 inelastic % change Qd < %change P not sensitive to P changes

  21. P D Q elastic demand(>1) • flatter curve small change in P big change in Qd

  22. P D Q inelastic demand(<1) • steep curve big change in P small change in Qd

  23. P D Q perfectly inelastic demand • vertical line change in P no change in Qd

  24. P D Q perfectly elastic demand • horizontal line any change in P Qd falls to zero

  25. effect on total revenue • total revenue (TR) = P x Q • if demand is elastic, • TR falls as price rises • if demand is inelastic, • TR rises as price rises

  26. example: cup of latte • initial P=$3, Qd = 15. TR = $3 x 15 = $45 • new P = $5, Qd = 5 TR = $5 x 5 = $25 • demand for latte is elastic TR falls as P rises

  27. what makes demand elastic or inelastic? 1. is it a luxury or necessity • if luxury, demand is elastic • if necessity, demand is inelastic

  28. example • mocha latte at Starbucks is a luxury • a liver transplant is not

  29. 2. definition of good • latte at Starbucks, narrow definition= many substitutes (other brands of coffee, tea) demand is elastic • coffee in general, broad definition = fewer substitutes demand is less elastic

  30. 3. time since price change • short time no time to adjust, demand is inelastic • long time time to adjust, demand is elastic

  31. example • Price of gas per gallon • the day price rises • demand inelastic • years later • demand much more elastic as carpool or buy smaller car

  32. factors 1-3 all get at same issue: • can consumers substitute a cheaper good easily? • if yes, demand is elastic • if no, demand is inelastic

  33. 4. Is item large part of your budget? • if yes, then demand elastic (forced to change behavior) • if no, then demand inelastic (no need to change behavior)

  34. example • soap • if price doubles, will you buy less? • rent • if rent doubles? -- stay on campus? -- more roommates?

  35. II. Price Elasticity of Supply % change in Qs % change in P

  36. example • bunch of roses • P = $40/bunch, Qs = 6 (million bunches) • P = $60, Qs = 15

  37. % change Qs 15 - 6 x 100 (6+15)/2 9 = 86% x 100 10.5

  38. % change P 60 - 40 x 100 (60+40)/2 20 = 40% x 100 50

  39. supply elasticity % change in Qs % change in P 86% = 2.15 40%

  40. if price rises 1%, Qs rises 2.15% • unit-free measure • depends on points chosen on the supply curve

  41. if price elasticity of supply • = 1 unit elastic % change Qs = % change P • > 1 elastic % change Qs > %change P sensitive to P changes

  42. < 1 inelastic % change Qs < %change P not sensitive to P changes

  43. P S Q inelastic supply • steep curve big change in P small change in Qs

  44. P S Q perfectly inelastic supply • vertical line change in P no change in Qs

  45. P S Q elastic supply • flatter curve small change in P big change in Qs

  46. P S Q perfectly elastic supply • horizontal line any change in P Qs falls to zero

  47. what makes supply elastic or inelastic? 1. production possibilities Can you make more easily? NO then supply is inelastic YES then supply is elastic

  48. example • oceanfront property • can’t make more • inelastic supply • salt • almost an infinite amount • elastic supply

  49. 2. time since price change • it takes time to produce • if a short time, supply is inelastic • if a long time supply is elastic

  50. example • hotel rooms • takes time to build • supply inelastic in short-run, elastic in long-run

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