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Chapter 6

Chapter 6. Elasticity. Price Elasticity of Demand. Measures buyers’ responsiveness to price changes Elastic demand Sensitive to price changes Large change in quantity demanded Inelastic demand Insensitive to price changes Small change in quantity demanded. LO1.

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Chapter 6

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  1. Chapter 6 Elasticity

  2. Price Elasticity of Demand • Measures buyers’ responsiveness to price changes • Elastic demand • Sensitive to price changes • Large change in quantity demanded • Inelastic demand • Insensitive to price changes • Small change in quantity demanded LO1

  3. Price Elasticity of Demand Formula • Formula for price elasticity of demand Ed= percentage change in quantity demanded of product X percentage change in price of product X LO1

  4. Price Elasticity of Demand Formula Continued • Use the midpoint formula • Ensures consistent results Change in price Change in quantity Ed= ÷ Sum of quantities/2 Sum of prices/2 LO1

  5. Price Elasticity of Demand Formula Concluded • Use percentages • Unit free measure • Compare elasticities across products • Eliminate the minus sign • Easier to compare elasticities LO1

  6. Interpretation of Elasticity of Demand • Ed > 1 demand is elastic • Ed = 1 demand is unit elastic • Ed < 1 demand is inelastic • Extreme cases • Ed = 0 demand is perfectly inelastic • Ed = ∞ demand is perfectly elastic LO1

  7. Extreme Cases P D1 Perfectly inelastic demand (Ed = 0) 0 Perfectly inelastic demand LO1

  8. Extreme Cases Continued P D2 Perfectly elastic demand (Ed = ∞) 0 Perfectly elastic demand LO1

  9. Total Revenue Test • Total Revenue = Price × Quantity • Total Revenue Test • Inelastic demand • P and TR move in the same direction • Elastic demand • P and TR move in opposite directions LO2

  10. P $3 2 1 Q 0 10 20 30 40 Total Revenue Test with Elastic Demand • Lower price and elastic demand • Blue gain exceeds yellow loss a b D1 LO2

  11. P $4 3 2 1 Q 0 10 20 Total Revenue Test with Inelastic Demand • Lower price and inelastic demand • Yellow loss exceeds blue gain c d D2 LO2

  12. P $3 2 1 Q 0 10 20 30 Total Revenue Test with Unit-Elastic Demand • Lower price and unit elastic demand • Blue gain equals yellow loss e f D3 LO2

  13. ] ] ] ] ] ] ] ] ] ] ] ] ] ] Total Revenue Test Continued 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 (3) Elasticity Coefficient (Ed) (4) Total Revenue (1) X (2) (5) Total-Revenue Test (2) Price per Ticket 1 2 3 4 5 6 7 8 $8 7 6 5 4 3 2 1 $ 8,000 14,000 18,000 20,000 20,000 18,000 14,000 8,000 5.00 2.60 1.57 1.00 0.64 0.38 0.20 Elastic Elastic Elastic Unit-elastic Inelastic Inelastic Inelastic LO2

  14. a b c d e f g h 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 Total Revenue Test Concluded $8 7 6 5 4 3 2 1 Elastic Ed > 1 Unit elastic Ed = 1 Price Inelastic Ed < 1 D Quantity demanded $20 18 16 14 12 10 8 6 4 2 Total revenue (Thousands of dollars) TR Quantity demanded LO2

  15. Summary of Price Elasticity of Demand LO2

  16. Determinants of Price Elasticity of Demand • Substitutability • More substitutes, demand is more elastic • Proportion of income • Higher proportion of income, demand is more elastic LO3

  17. Determinants of Price Elasticity of Demand Continued • Luxuries versus necessities • Luxury goods, demand is more elastic • Time • More time available, demand is more elastic LO3

  18. Selected Price Elasticities of Demand LO3

  19. Applications of Price Elasticity of Demand • Large crop yields • Inelastic demand, lower total revenue • Excise taxes • Inelastic demand, more total revenue • Decriminalization of illegal drugs • Inelastic demand, more total revenue LO3

  20. Price Elasticity of Supply • Measures sellers’ responsiveness to price changes • Elastic supply, producers are responsive to price changes • Inelastic supply, producers are not as responsive to price changes LO4

  21. Price Elasticity of Supply Formula • Formula for price elasticity of supply percentage change in quantity supplied of product X Es= percentage change in price of product X LO4

  22. Price Elasticity of Supply Continued • Es > 1 supply is elastic • Es = 1 supply is unit elastic • Es < 1 supply is inelastic • Additionally, • Es = 0 supply is perfectly inelastic LO4

  23. Price Elasticity of Supply and Time • Time is primary determinant of elasticity of supply • Time periods considered • Immediate market period • Short run • Long run LO4

  24. P Q The Immediate Market Period • Perfectly inelastic supply Sm Pm P0 D2 D1 Q0 LO4

  25. P Q The Short Run • Short run supply is more elastic than in the immediate market period Ss Ps P0 D2 D1 Q0 Qs LO4

  26. P Q The Long Run • Long run supply is even more elastic than in the short run SL Pl P0 D2 D1 Q0 Ql LO4

  27. Applications of Elasticity of Supply • Antiques • Inelastic supply • Reproductions • More elastic supply • Volatile gold prices • Inelastic supply LO4

  28. Cross Elasticity of Demand • Formula for cross elasticity of demand percentage change in quantity demanded of product X Exy = percentage change in price of product Y LO5

  29. Cross Elasticity of Demand Continued • Measures responsiveness of purchases of one good to change in the price of another good • Substitute goods if elasticity is positive • Complement goods if elasticity is negative • Independent goods if elasticity is 0 LO5

  30. Cross Elasticity of Demand Concluded • Applications of cross elasticity of demand • Should a company change a price? • Should the government allow a merger? LO5

  31. Income Elasticity of Demand • Formula for income elasticity of demand percentage change in quantity demanded Ei = percentage change in income LO5

  32. Income Elasticity of Demand Continued • Measures responsiveness of buyers to changes in their income • Normal goods if elasticity is positive • Inferior goods if elasticity is negative LO5

  33. Income Elasticity Insights • High income elasticities • Most affected by a recession • Low or negative income elasticity • Not affected that much by a recession LO5

  34. Cross and Income Elasticities LO5

  35. Elasticity and Pricing Power • Charge different prices to different buyers based on price elasticities • Business air travelers • Children discounts • College tuition

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