Price Elasticity of Demand and Supply

1. Price Elasticity ofDemand and Supply • Key Concepts • Summary ©2005 South-Western College Publishing

2. What will this chapter teach me? This chapter teaches you to calculate the percentage change in the quantity demanded when the price changes by a given percentage. Then you will see how this relates to total revenue.

3. How is the percent increase or decrease of two numbers calculated? Percent change is the difference between the two numbers divided by the original number

4. Suppose the price of a rock concert increases by 10%, what effect will this have on sales? That all depends on the price elasticity of demand for this rock concert

5. What is elasticity? A term economists use to describe responsiveness, or sensitivity, to a change in price

6. What is priceelasticity of demand? The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price

7. Price Elasticity of Demand %  in Q demanded %  in price Ed =

8. Supposing a university’s enrollment drops by 20% because tuition rises by 10%, what is the price elasticity of demand?

9. Ed = -.20 +.10 -20% +10% = = 2

10. Why is elasticity 2 in the previous example and not -2? Economists drop the negative sign because we know from the law of demand that quantity demanded and price are inversely related

11. If there is an increase from 3 units to 5, what is the percentage increase? 2/3 = 66%

12. If there is a decrease from 5 units to 3, what is the percentage decrease? 2/5 = 40%

13. Problem - When we move along a demand curve between two points, we get different answers to elasticity depending on whether we are moving up or down the demand curve

14. P A 2 • B D 3 Q

15. Economists can solve this problem of different base points by using the midpoints as the base points of changes in prices and quantity demanded

16. Price elasticity equals the  in quantity demanded sum of quantities/2 divided by  in price sum of prices/2

17. What is elastic demand? A condition in which the percentage change in quantity demanded is greater than the percentage change in price

18. P Elastic Demand Ed > 1 $40 A $30 B $20 $10 Q 10 20 30 40

19. Why is the demand curve in the previous slide elastic? The percentage change in the quantity demanded is greater than the percentage change in price

20. Elastic Demand Increase in total revenue Price decrease

21. % change in Q = .66 = 10 25 10 15 .40 % change in P = = % change in Q % change in P .66 .40 Ed = = Ed = 1.65

22. Inelastic Demand Ed < 1 $40 A $30 B $20 $10 10 20 30 40

23. Why is the demand curve in the previous slide inelastic? The percentage change in the quantity demanded is less than the percentage change in price

24. Inelastic Demand Decrease in total revenue Price decrease

25. % change in Q = = .38 5 13 10 25 % change in P = .40 = % change in Q % change in P .38 .40 Ed = =

26. What is a unitary elastic demand curve? The percentage change in the quantity demanded is equal to the percentage change in price

27. Unitary Elastic Demand Ed = 1 $40 E $30 F D $20 $10 10 20 30 40

28. Unitary Elastic Demand No change in total revenue Price decrease

29. What is a perfectly elastic demand curve? A condition in which a small percentage change in price brings about an infinite percentage change in the quantity demanded

30. $40 $30 $20 8 Perfectly Elastic Demand Ed = $10 10 20 30 40

31. Perfectly Elastic Demand Infinite change in quantity demanded Price change

32. What is a perfectly inelastic demand curve? A condition in which the quantity demanded does not change as the price changes

33. Perfectly Inelastic Demand Ed = 0 $40 $30 $20 $10 10 20 30 40

34. Perfectly Inelastic Demand Zero change in quantity demanded Price change

35. If a college raises tuition, what happens to revenue? If demand is elastic - total revenue goes down If demand is inelastic - total revenue goes up

36. If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1

37. If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1

38. If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1

39. Price Elasticity of Demand Ranges $40 $35 Elastic $30 $25 $20 Inelastic $15 Unitary elastic $10 $5 5 10 15 20 25 30 35 40 45

40. Total Revenue Curve $400 $350 Elastic $300 Inelastic $250 $200 Unitary Elastic $150 $100 $50 5 10 15 20 25 30 35 40 45

41. What factors influence demand sensitivity? • Availability of substitutes • Share of budget on the product • Adjustment to a price change over time

42. What do substitutes have to do with a price change? The more substitutes a product has, the more sensitive consumers are to a price change, and the more elastic the demand curve

43. A B D D Which demand curve is for a vital medicine and which is for candy?

44. Why is A the demand curve for medicine? Because medicine is a necessity with few substitutes, and the price can change with little effect on the quantity demanded

45. Why is B the demand curve for candy? Because candy has many substitutes, a price change can bring about a big change in the quantity demanded

46. What does the share of one’s budget have to do with a price change? The larger the purchase is to one’s budget, the more sensitive consumers are to a price change, and the more elastic the demand curve

47. What does time have to do with sensitivity? The longer consumers have to adjust, the more sensitive they are to a price change, and the more elastic the demand curve

48. What are other elasticity measures? Income elasticity of demand Cross-elasticity of demand

49. What is Income elasticity of demand? The ratio of the percentage change in the quantity demanded of a good to a given percentage change in income

50. Income Elasticity of Demand %  in Q demanded %  in income Ed =