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Welcome to Day 8

Welcome to Day 8. Principles of Microeconomics. Price elasticity is the ratio of the percent change in quantity demanded to the percent change in price. Elasticity of demand = percent change in quantity demanded divided by percent change in price. Ed = %  Qd % P.

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Welcome to Day 8

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  1. Welcome to Day 8 Principles of Microeconomics

  2. Price elasticity is the ratio of the percent change in quantity demanded to the percent change in price.Elasticity of demand = percent change in quantity demanded divided by percent change in price.Ed = %Qd % P

  3. So a t-shirt shop notices that when they raise their price by 5%, they lose 10% of their customers. What is their elasticity of demand?-10% = -25%

  4. What does the -2 mean?For every 1 percent they raise their price, their sales drop by 2%. The elasticity of demand number always means that for every 1% they raise their price, their sales drop by X%

  5. Another store checks their data and sees when they raise their price by 10%, they lose 5% of their sales. What is their elasticity of demand?-5% = -0.510%

  6. For every 1% they raise their price, they lose 0.5% of their sales. What if the stores lowered their price? Then a store with an elasticity of -2 should gain 2% in sales for every 1% drop in price. A store with an elasticity of -0.5 should gain 0.5% more sales with every 1 percent drop in price.

  7. Unfortunately, the data does not usually come in percentage terms. Usually you know the starting and ending prices, and the starting and ending quantities, and have to convert these to percentages.

  8. Here’s how to do that.%Qd = (Q2-Q1)/[(Q1+Q2)/2] %P= (P2-P1)/[(P1+P2)/2]

  9. So the elasticity formula in all its glory is Ed = (Q2-Q1)/[(Q1+Q2)/2] (P2-P1)/[(P1+P2)/2]The textbook writes it this way

  10. Notice that we are calculating percentage changes in an unusual way. Usually, you would just divide the change by the starting value, not the average of the starting and ending value. By doing it this way, we get the same elasticity answer if the price goes up from $10 to $12 or down from $12 to $10.

  11. The own price elasticity number will always be negative by the math, but it is common to drop the negative sign and write it as its absolute value. So -2 becomes 2.

  12. What is the range of possible own price elasticities? 0 Ed < 1 then Inelastic Demand Ed = 1 then Unit Elastic Demand 1 Ed > 1 then Elastic Demand 8

  13. Total Revenue for a store isTR = P x QImagine a store with a very inelastic demand, say 0.3 If they raise their price 10%, their sales drop by 3%. Does their revenue go up or down?

  14. TR ? = P 10% x Q 3%TR goes down.Whenever the elasticity is below 1, the percent drop in purchases is always less than the percent rise in price and revenue always rises when price rises.

  15. What if the elasticity is greater than one? Then the percentage drop in sales is always greater than the percent rise in price and the revenue always fall. TR ? = P 3% x Q 10%TR goes down.

  16. Inelastic DemandRaise price revenue goes up.Lower price revenue goes down.Elastic DemandRaise price revenue goes down.Lower price revenue goes up.

  17. And if the demand is unit elastic?Then the percentage change in price equals the percentage change in sales, and revenue remains unchanged.Unit Elastic Demand (Ed = 1) Raise price revenue stays the same.Lower price revenue stays the same.

  18. What happens if zero customers stop buying when the price rises? Ed = %Qd % PEd = 0.This is called perfectly inelastic demand.

  19. Note that an Ed = 0 does not mean the store has 0 customers, it means it loses 0 customers then it raises its price.

  20. And what if the store loses every customer when it raises its price the tiniest possible amount?As %P goes to 0, %Qd stays constant. This fraction is going to infinity. Ed = %Qd % P

  21. Perfectly Inelastic Demand Curve Perfectly Elastic Demand Curve

  22. What determines if the elasticity is high or low?1) Number and closeness of substitutes.2) Percentage of budget spent on the good.3) Time.

  23. 1) Number and closeness of substitutes.The more and better substitutes available for a good, the more consumers buy these substitutes in place of the good when the price of the good rises.

  24. Good substitutes high elasticityPoor substitutes low elasticityTell me some high and low elasticity items.

  25. 2) The percentage of your budget spent on the good.When the price of the car you are thinking of buying doubles, you are more likely to back off buying it than when the price of a candy bar doubles. The greater the percentage of your budget spent on the good, the higher its elasticity of demand.

  26. 3) TimeThe more time you have to respond, the higher the elasticity of demand. What can you do if the price of gas rises?

  27. The textbook tells us that the short-run elasticity of demand for oil in the United States is .06, but the long-run elasticity is .45

  28. Reviewing the 3 factors that determine elasticity of demand.1) Number and closeness of substitutes.2) Percentage of budget spent on the good.3) Time.

  29. Income elasticity of demand is the percentage change in quantity demanded at a specific price divided by the percentage change in income that produced the demand change, all other things unchanged. Ei= %D D = Demand % I I = Income

  30. What does the income elasticity number tell you?It is the percent change in purchases if there is a 1 percent rise in income. For example, an answer of 0.7 means for every 1% rise in income, people buy 0.7 percent more of the good.

  31. When the income elasticity is positive, that means people buy more of the good when their income goes up or less when their income goes down. In other words, a normal good.When the income elasticity is negative, people buy less when their income goes up, in other words, an inferior good.

  32. Cross price elasticity of demand is the percentage change in the quantity demanded of one good or service at a specific price divided by the percentage change in the price of a related good or service. EX,Y= %Dx % Py

  33. Remember how to find the percentage change in X. It is the change in X divided by the average of the starting and ending quantities of X. And don’t forget to check for the sign.

  34. Cross-price elasticityis positive when the two goods are substitutes.It is negative when the two goods are complements.

  35. What we learned today.1. What own price elasticity is and how to calculate it.2. What inelastic and elastic demand mean and how they affect revenue when price rises.3. What income elasticity and cross price elasticity are.

  36. Welcome to Day 9 Principles of Microeconomics

  37. What we learned yesterday.1. What own price elasticity is and how to calculate it.2. What inelastic and elastic demand mean and how they affect revenue when price rises.3. What income elasticity and cross price elasticity are.

  38. Price elasticity of supply is the ratio of the percentage change in quantity supplied of a good or service to the percentage change in its price, all other things unchanged.

  39. The terminology from the elasticity of demand transfers over to the elasticity of supply. Es > 1 is Elastic SupplyEs < 1 is Inelastic Supply Es = 0 is Perfectly Inelastic SupplyEs = Infinity is Perfectly Elastic Supply.

  40. Supply Curves and Their Price Elasticities

  41. The more time suppliers have to build more factories, the greater the increase in the amount of the good will be in response to a given higher price.

  42. Which supply curve has the larger elasticity? S1 S2 P2 P1 Q Cars

  43. Elasticity and the War on DrugsHow can we spend so much money and manpower and drugs still be so readily available? http://www.drugsense.org/cms/wodclock

  44. How do we represent the war on drugs in a supply and demand diagram?Is the elasticity of demand for most illegal drugs going to be high or low?Does cocaine have good substitutes or few substitutes?

  45. D1 is low elasticity. D2 is high elasticity. D1 Q2B Q1 Q2A

  46. How much cocaine has been destroyed? What is the drop in usage? D Q1 Q2

  47. Q1 to Q2 is the drop in usage = 25,000Amount destroyed = 125,000 D Q1 Q2

  48. So what has happened? Used to be 150,000 made and bought for 20 bucks. Now 250,000 is made, half is destroyed, and 125,000 is bought for $40. The main effect of destroying drugs in this model is that more is made.

  49. What is the elasticity of cocaine in this model? Q1-Q2/[(Q1+Q2)/2] divided by P2-P1/[(P1+P2)/2] is(25,000/ 137,500)/(20/30)= .18/.67 = .2What if the elasticity is high?

  50. Q1 to Q2 is the drop in usage = 60,000Amount destroyed = 90,000 D Q2 Q1

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