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Elasticity

Elasticity. Elasticity. What do you think? Could reducing the supply of illegal drugs cause an increase in drug-related burglaries?. Total Expenditure = P x Q S $2500 = $50 x 50 S’ $3200 = $80 x 40. S’. 80. S. 50. D. 40. 50.

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Elasticity

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  1. Elasticity

  2. Elasticity • What do you think? • Could reducing the supply of illegal drugs cause an increase in drug-related burglaries? Chapter 4: Elasticity

  3. Total Expenditure = P x Q S $2500 = $50 x 50 S’ $3200 = $80 x 40 S’ 80 S 50 D 40 50 The Effect of Extra Border Patrols on the Market for Illicit Drugs P($/ounce) Q(1,000s of ounces/day) Chapter 4: Elasticity

  4. Price Elasticity of Demand • Elasticity • A measure of the extent to which quantity demanded and quantity supplied respond to variations in price, income, and other factors. Chapter 4: Elasticity

  5. Price Elasticity of Demand • Defined • Generally • A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good • Formally • The percentage change in the quantity demanded that results from a 1 percent change in its price Chapter 4: Elasticity

  6. Price Elasticity of Demand • Measuring Price Elasticity of Demand Chapter 4: Elasticity

  7. Price Elasticity of Demand • Assume • The price of pork falls by 2% and the quantity demanded increases by 6% • Then the price elasticity of demand for pork is Chapter 4: Elasticity

  8. Price Elasticity of Demand • Measuring Price Elasticity of Demand • Observations • Price elasticity of demand will always be negative (i.e., an inverse relationship between price and quantity) • For convenience we drop the negative sign Chapter 4: Elasticity

  9. > 1: elastic When is < 1: inelastic = 1: unit elastic Price Elasticity of Demand • Measuring Price Elasticity of Demand Chapter 4: Elasticity

  10. Unit elastic Inelastic Elastic Elastic and Inelastic Demand Price elasticity of demand 0 1 2 3 Chapter 4: Elasticity

  11. Price Elasticity of Demand • What is the elasticity of demand for pizza? • Originally • Price = $1/slice • Quantity demanded = 400 slices/day • New • Price = $0.97/slice • Quantity demanded = 404 slices/day, then Chapter 4: Elasticity

  12. Price Elasticity of Demand • What is the elasticity of season ski passes? • Originally • Price = $400 • Quantity demanded = 10,000 passes/year • New • Price = $380 • Quantity demanded = 12,000 passes/year, then Chapter 4: Elasticity

  13. Price Elasticity of Demand • Determinants of Price Elasticity of Demand • Substitution possibilities • Budget share • Time Chapter 4: Elasticity

  14. Price Elasticity Estimates for Selected Products Good or service Price elasticity Green peas 2.80 Restaurant meals 1.63 Automobiles 1.35 Electricity 1.20 Beer 1.19 Movies 0.87 Air travel (foreign) 0.77 Shoes 0.70 Coffee 0.25 Theater, opera 0.18 Chapter 4: Elasticity

  15. Price Elasticity of Demand • What do you think? • Why is the price elasticity of demand more than 14 times larger for green peas than for theater and opera performances? Chapter 4: Elasticity

  16. Price Elasticity of Demand • Economic Naturalist • Will higher taxes on cigarettes curb teenage smoking? • Why was the luxury tax on yachts such a disaster? Chapter 4: Elasticity

  17. A Graphical Interpretationof Price Elasticity • For small changes in price Where Q is the original quantity and P is the original price Chapter 4: Elasticity

  18. A P P P - P Q D Q Q + Q A Graphical Interpretation of Price Elasticity of Demand Price Quantity Chapter 4: Elasticity

  19. A Graphical Interpretationof Price Elasticity • Example • Originally • Price (P) = $100 • Quantity (Q) = 20 • New • Price (P) = $105 • Quantity (Q) = 15 Chapter 4: Elasticity

  20. D A Calculating Price Elasticity of Demand 20 16 12 Price 8 4 1 2 3 4 5 Quantity Chapter 4: Elasticity

  21. D Question What is the price elasticity of demand when P = $4? A Calculating Price Elasticity of Demand 20 16 12 Price 8 4 1 2 3 4 5 Quantity Chapter 4: Elasticity

  22. 12 D1 6 4 D2 4 6 12 Price Elasticity and the Steepness of the Demand Curve What is the price elasticity of Demand for D1 & D2 when P = $4? Price Quantity Chapter 4: Elasticity

  23. For D2when P = $1 12 D1 6 4 D2 1 4 6 10 12 Price Elasticity and the Steepness of the Demand Curve Price Quantity Chapter 4: Elasticity

  24. Observation If two demand curves have a point in common, the steeper curve must be less elastic with respect to price at that point 12 D1 6 Price 4 D2 1 4 6 10 12 Quantity Price Elasticity and the Steepness of the Demand Curve Chapter 4: Elasticity

  25. Observation Price elasticity varies at every point along a straight-line demand curve a a/2 b/2 b Price Elasticity Regions along a Straight-Line Demand Curve Price Quantity Chapter 4: Elasticity

  26. Price Quantity Perfectly Elastic Demand Curve Chapter 4: Elasticity

  27. Price Quantity Perfectly Inelastic Demand Curve Chapter 4: Elasticity

  28. Elasticity and Total Expenditure • Total Expenditure = P x Q • Market demand measures the quantity (Q) at each price (P) • Total Expenditure = Total Revenue Chapter 4: Elasticity

  29. D Total Expenditure = $1,000/day A The Demand Curve for Movie Tickets 12 10 8 6 Price ($/ticket) 4 2 0 1 2 3 4 5 6 Quantity (100s of tickets/day) Chapter 4: Elasticity

  30. D Total Expenditure = $1,600/day B The Demand Curve for Movie Tickets 12 10 8 6 Price ($/ticket) 4 2 0 1 2 3 4 5 6 Quantity (100s of tickets/day) Chapter 4: Elasticity

  31. Elasticity and Total Expenditure • What do you think? • Will increasing the market price always increase total revenue? Chapter 4: Elasticity

  32. Total Expenditure = $1,600/day D The Demand Curve for Movie Tickets 12 10 8 6 Price ($/ticket) 4 2 0 1 2 3 4 5 6 Quantity (100s of tickets/day) Chapter 4: Elasticity

  33. Total Expenditure = $1,000/day D The Demand Curve for Movie Tickets 12 10 8 6 Price ($/ticket) 4 2 0 1 2 3 4 5 6 Quantity (100s of tickets/day) Chapter 4: Elasticity

  34. Elasticity and Total Expenditure • General Rule • A price increase will increase total revenue when the % change in P is greater than the % change in Q. Chapter 4: Elasticity

  35. 12 10 8 6 Price ($/ticket) 4 2 0 1 2 3 4 5 6 Quantity (100s of tickets/day) The Demand Curve for Movie Tickets Chapter 4: Elasticity

  36. Total Expenditure as a Function of Price Price ($/ticket) Total expenditure ($/day) 12 0 10 1,000 8 1,600 6 1,800 4 1,600 2 1,000 0 0 Chapter 4: Elasticity

  37. 12 1,800 1,600 10 8 1,000 6 Total expenditure ($/day) Price ($/ticket) 4 2 0 0 2 4 6 8 10 12 1 2 3 4 5 6 Price ($/ticket) Quantity (100s of tickets/day) Total Expenditure as a Function of Price Total revenue is at a maximum at the midpoint on a straight-line demand curve Chapter 4: Elasticity

  38. Elasticity and Total Expenditure • What do you think? • Should a rock band raise or lower its price to increase total revenue? • Assume Chapter 4: Elasticity

  39. Elasticity and Total Expenditure • What do you think? • Should a rock band raise or lower its price to increase total revenue? • Then • Total revenue = $20 x 5,000 = $100,000/week • If P is increased 10%, Q will decrease 30% • Total revenue = $22 x 3,500 = $77,000/week • If P is lowered 10%, Q will increase 30% • Total revenue = $18 x 6,500 = $177,000/week Chapter 4: Elasticity

  40. Elasticity and Total Expenditure • Rule • When price elasticity is greater than 1, changes in price and changes in total expenditures always move in opposite directions. • When price elasticity is less than 1, changes in price and changes in total expenditures always move in the same direction. Chapter 4: Elasticity

  41. Elasticity and the Effect of a Price Change on Total Expenditure Chapter 4: Elasticity

  42. Elasticity and Total Expenditure • Cross-Price Elasticity of Demand • The percentage by which quantity demanded of the first good changes in response to a 1 percent change in the price of the second good Chapter 4: Elasticity

  43. Elasticity and Total Expenditure • Cross-Price Elasticity of Demand • Substitute Goods • When the cross-price elasticity of demand is positive • Complement Goods • When the cross-price elasticity of demand is negative Chapter 4: Elasticity

  44. Elasticity and Total Expenditure • Income Elasticity of Demand • The percentage by which quantity demanded changes in response to a 1 percent change in income Chapter 4: Elasticity

  45. Elasticity and Total Expenditure • Income Elasticity of Demand • Normal Goods • Income elasticity is positive • Inferior Goods • Income elasticity is negative Chapter 4: Elasticity

  46. The Price Elasticity of Supply • Price Elasticity of Supply • The percentage change in the quantity supplied that occurs in response to a 1 percent change in price Chapter 4: Elasticity

  47. S B 10 A 8 4 2 3 A Supply Curve for Which Price Elasticity Declines as Quantity Rises Price 0 Quantity Chapter 4: Elasticity

  48. S B 5 A 4 P Q 12 15 Calculating the Price Elasticity of Supply Graphically Price 0 Quantity Chapter 4: Elasticity

  49. The Price Elasticity of Supply • Observation • The price elasticity of supply will always equal 1 at any point along a straight-line supply curve that passes through the origin. Chapter 4: Elasticity

  50. S Elasticity = 0 at every point along a vertical supply curve A Perfectly Inelastic Supply Curve What is the price elasticity of supply of land within the borough limits of Manhattan? Price ($/acre) 0 Quantity of land in Manhattan (1,000s of acres) Chapter 4: Elasticity

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