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Chapter 5 Elasticity: A Measure of Response

Chapter 5 Elasticity: A Measure of Response. 1. THE PRICE ELASTICITY OF DEMAND. Learning Objectives Explain the concept of price elasticity of demand and its calculation.

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Chapter 5 Elasticity: A Measure of Response

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  1. Chapter 5 Elasticity: A Measure of Response

  2. 1. THE PRICE ELASTICITY OF DEMAND Learning Objectives • Explain the concept of price elasticity of demand and its calculation. • Explain what it means for demand to be price inelastic, unit price elastic, price elastic, perfectly price inelastic, and perfectly price elastic. • Explain how and why the value of the price elasticity of demand changes along a linear demand curve. • Understand the relationship between total revenue and price elasticity of demand. • Discuss the determinants of price elasticity of demand.

  3. 1. THE PRICE ELASTICITY OF DEMAND • The price elasticity of demand is the percentage change in quantity demanded of a particular good or service divided by the percentage change in the price of that good or service, all other things unchanged. eD = % change in quantity demanded % change in price

  4. 1.1 Computing the Price Elasticity of Demand • arc elasticity is a measure of elasticity based on percentage changes relative to the average value of each variable between two points.EQUATION 1.2

  5. Responsiveness and Demand Movement from Point A to B (or B to A) shows that a $.10 change in price changes the number of rides per day by 20,000. A B

  6. 1.2 Price Elasticities Along a Linear Demand Curve eD = -3.00 eD = -1.00 eD = -.33

  7. 1.3 The Price Elasticity of Demand and Changes in Total Revenue • Total Revenue (TR=P*Q)is a firm’s output multiplied by the price at which it sells that output. • Price elastic refers to a situation in which the absolute value of the price elasticity of demand is greater than 1. • Unit price elastic refers to a situation in which the absolute value of the price elasticity of demand is equal to 1. • Price inelastic refers to a situation in which the absolute value of the price of elasticity of demand is less than 1.

  8. Changes in Total Revenue and a Linear Demand Curve Elastic Region Unit elastic A B Inelastic Region E F

  9. 1.3 The Price Elasticity of Demand and Changes in Total Revenue

  10. 1.4 Constant Price Elasticity of Demand Curves • Perfectly inelastic (insensitive to price changes)refers to a situation in which the price elasticity of demand is zero. • Perfectly elastic (sensitive to price changes)refers to a situation in which the price elasticity of demand is infinite.

  11. Demand Curves with Constant Price Elasticity

  12. 1.5 Determinants of the Price Elasticity of Demand • Availability of substitutes • If there are lots of close substitute goods to choose from consumers can switch easily • Importance in household budgets • Price of good relative to income • Time • In the short run it is often difficult to find substitutes.

  13. 2. RESPONSIVENESS OF DEMAND TO OTHER FACTORS • Learning Objectives • Explain the concept of income elasticity of demand and its calculation. • Classify goods as normal or inferior depending on their income elasticity of demand. • Explain the concept of cross price elasticity of demand and its calculation. • Classify goods as substitutes or complements depending on their cross price elasticity of demand.

  14. 2.1 Income Elasticity of Demand • 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. EQUATION 2.1

  15. 2.1 Income Elasticity of Demand

  16. 2.2 Cross Price Elasticity of Demand • 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. EQUATION 2.2

  17. 2.2 Cross Price Elasticity of Demand

  18. 3. PRICE ELASTICITY OF SUPPLY • Learning Objectives • Explain the concept of elasticity of supply and its calculation. • Explain what it means for supply to be price inelastic, unit price elastic, price elastic, perfectly price inelastic, and perfectly price elastic. • Explain why time is an important determinant of price elasticity of supply. • Apply the concept of price elasticity of supply to the labor supply curve.

  19. 3. PRICE ELASTICITY OF SUPPLY • 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.EQUATION 3.1

  20. Increase in Apartment Rents Depends on How Responsive Supply Is S1 S2 R1 R2 R0 D2 D1 Q0 Q2 Q1

  21. Increase in Apartment Rents Depends on How Responsive Supply Is S eS = ∞ S eS = 0

  22. 3.1 Time: An Important Determinant of the Elasticity of Supply • In the short run supply is likely to be inelastic. • In the long run supply is likely to be more elastic.

  23. Selected Elasticity Estimates

  24. Selected Elasticity Estimates

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