Elasticity and its Application

1. Elasticity and its Application Economics P R I N C I P L E S O F 5 N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich

2. Calculating Percentage Changes So, we instead use the midpoint method: end value – start value x 100% midpoint 0 • The midpoint is the number halfway between the start & end values, the average of those values. • It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way! ELASTICITY AND ITS APPLICATION

3. Calculating Percentage Changes Using the midpoint method, the % change in P equals = 40.0% x 100% 12 – 8 $250 – $200 10 = 22.2% x 100% $225 40/22.2 = 1.8 0 • The % change in Q equals • The price elasticity of demand equals ELASTICITY AND ITS APPLICATION

4. A C T I V E L E A R N I N G 1Calculate an elasticity Use the following information to calculate the price elasticity of demand for hotel rooms: if P = $70, Qd = 5000 if P = $90, Qd = 3000 4

5. 50% = 2.0 25% A C T I V E L E A R N I N G 1Answers Use midpoint method to calculate % change in Qd (5000 – 3000)/4000 = 50% % change in P ($90 – $70)/$80 = 25% The price elasticity of demand equals 5

6. Price Elasticity and Total Revenue If demand is elastic, then price elast. of demand > 1 % change in Q > % change in P The fall in revenue from lower Q is greater than the increase in revenue from higher P, so revenue falls. Percentage change in Q Price elasticity of demand = Percentage change in P 0 Revenue = P x Q ELASTICITY AND ITS APPLICATION

7. Price Elasticity and Total Revenue Elastic demand(elasticity = 1.8) P If P = $200, Q = 12 and revenue = $2400. $250 $200 If P = $250, Q = 8 and revenue = $2000. D Q 12 8 0 increased revenue due to higher P Demand for your websites lost revenue due to lower Q When D is elastic, a price increase causes revenue to fall. ELASTICITY AND ITS APPLICATION

8. Price Elasticity and Total Revenue Now, demand is inelastic: elasticity = 0.82 P If P = $200, Q = 12 and revenue = $2400. $250 $200 D If P = $250, Q = 10 and revenue = $2500. Q 12 10 0 increased revenue due to higher P Demand for your websites lost revenue due to lower Q When D is inelastic, a price increase causes revenue to rise. ELASTICITY AND ITS APPLICATION

9. Supply, Demand, and Government Policies Economics P R I N C I P L E S O F 6 N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich

10. The market for hotel rooms P S D 0 Q A C T I V E L E A R N I N G 1Price controls Determine effects of: A. $90 price ceiling B. $90 price floor C. $120 price floor 10

11. The market for hotel rooms P S Price ceiling D shortage = 30 0 Q A C T I V E L E A R N I N G 1A. $90 price ceiling The price falls to $90. Buyers demand 120 rooms, sellers supply 90, leaving a shortage. 11

12. The market for hotel rooms P S D 0 Q A C T I V E L E A R N I N G 1B. $90 price floor Eq’m price is above the floor, so floor is not binding. P = $100, Q = 100 rooms. Price floor 12

13. The market for hotel rooms P S surplus = 60 Price floor D 0 Q A C T I V E L E A R N I N G 1C. $120 price floor The price rises to $120. Buyers demand 60 rooms, sellers supply 120, causing a surplus. 13

14. The market for hotel rooms P S D 0 Q A C T I V E L E A R N I N G 2Effects of a tax Suppose govt imposes a tax on buyers of $30 per room. Find new Q, PB, PS, and incidence of tax.

15. The market for hotel rooms P S PB = Tax PS = D 0 Q A C T I V E L E A R N I N G 2Answers Q = 80 PB = $110 PS = $80 Incidence • buyers: $10 • sellers: $20

16. Consumers, Producers, and the Efficiency of Markets Economics P R I N C I P L E S O F 7 N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich

17. A C T I V E L E A R N I N G 1Consumer surplus demand curve P A.Find marginal buyer’s WTP at Q = 10. B.Find CS for P = $30. $ Suppose P falls to $20.How much will CS increase due to… C.buyers entering the market D.existing buyers paying lower price Q 17

18. A C T I V E L E A R N I N G 1Answers demand curve P A. At Q = 10, marginal buyer’s WTP is $30. B.CS = ½ x 10 x $10 = $50 $ P falls to $20. C. CS for the additional buyers = ½ x 10 x $10 = $50 D. Increase in CS on initial 10 units= 10 x $10 = $100 Q 18

19. A C T I V E L E A R N I N G 2Producer surplus supply curve P A. Find marginal seller’s cost at Q = 10. B.Find total PS for P = $20. Suppose P rises to $30.Find the increase in PS due to… C. selling 5 additional units D. getting a higher price on the initial 10 units Q 19

20. A C T I V E L E A R N I N G 2Answers supply curve P A. At Q = 10,marginal cost = $20 B.PS = ½ x 10 x $20 = $100 P rises to $30. C. PS on additional units= ½ x 5 x $10 = $25 D. Increase in PS on initial 10 units= 10 x $10 = $100 Q 20

21. Application: The Costs of Taxation Economics P R I N C I P L E S O F 8 N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich

22. P $ S P = D Q A C T I V E L E A R N I N G 1Answers to A The market for airplane tickets CS = ½ x $200 x 100 = $10,000 PS = ½ x $200 x 100 = $10,000 Total surplus = $10,000 + $10,000 = $20,000 22

23. P $ S PB = PS = D Q A C T I V E L E A R N I N G 1Answers to B A $100 tax on airplane tickets CS = ½ x $150 x 75 = $5,625 PS = $5,625 Tax revenue = $100 x 75 = $7,500 Total surplus = $18,750 DWL = $1,250 23

24. Application:International Trade Economics P R I N C I P L E S O F 9 N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich

25. P S $3000 $1500 D Q 200 600 400 A C T I V E L E A R N I N G 1Analysis of trade 0 Without trade,PD = $3000, Q = 400 In world markets, PW = $1500 Under free trade, how many TVs will the country import or export? Identify CS, PS, and total surplus without trade, and with trade. Plasma TVs 25

26. P S $3000 $1500 imports D Q 200 600 A C T I V E L E A R N I N G 1Answers 0 Under free trade, • domestic consumers demand 600 • domestic producers supply 200 • imports = 400 Plasma TVs 26

27. P S gains from trade $1500 imports D Q A C T I V E L E A R N I N G 1Answers 0 Without trade, CS = A PS = B + C Total surplus = A + B + C With trade, CS = A + B + D PS = C Total surplus = A + B + C + D Plasma TVs A $3000 B D C 27