Chapter 18: Elasticity

1. Chapter 18: Elasticity • Price elasticity • demand • supply • Cross elasticity • Income elasticity

2. Basic idea • We know when P Qd Qs holding other factors constant

3. but how much? • if price doubles how much does Qd fall? • by 10% • by 50% • by 300%? • price elasticity tells us

4. 4) a- consider theses two points (1,35) and (2,130) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 2-1/130-35 , M= 1/95 Y= (1/95)X + b so, 1=(1/95) * 35 + b B= 60/95 Qs= (1/95)P + 60/95

5. 4) b- consider theses two points (1,530) and (2,400) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 2-1/400-530 , M= -1/130 Y= (-1/130)X + b so, 1=(-1/130) * 530 + b B= 660/130 Qd= (-1/130)P + 660/130

6. 4) C, we know that at the equilibrium Qs = Qd, so • Qs= (1/95)P + 60/95 • Qd= (-1/130)P + 660/130 • (1/95)P + 60/95 = (-1/130)P + 660/130 • { (1/95) + (1/130)}P = {(660/130)-(60/95)} • P = 244

7. 1- consider theses two points (20,400) and (30,250) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 30-20/250-400 , M= 10/-150 Y= (10/-150)X + b so, 20=(10/-150) * 400+ b B= 7000/150 Qs= (10/-150) P+ 7000/150

8. 2)- consider theses two points (20,500) and (30,400) Line equation is Y= M X + b (Y is the price and X is the quantity) M= (Y2-Y1)/(X2-X1) M= 30-20/400-500 , M= 10/-100 Y= (10/-100)X + b so, 20=(10/-150) * 500+ b B= 8000/100 Qd= (10/-100) P+ 8000/100

9. At equilibrium Qs = Qd • (10/-150) P+ 7000/150=(10/-100) P+ 8000/100 • ??

10. I. Price Elasticity of Demand example • mocha latte at Starbucks • price rises from $3 to $5 per cup • Qd falls from 15 to 5 cups per hr.

11. equation % change in Qd % change in P

12. % change in Qd new Qd - initial Qd x 100 average Qd midpoint method

13. example 5 cups - 15 cups x 100 (5+15)/2 cups -10 cups = -100% x 100 10 cups

14. % change in P new P - initial P x 100 average P midpoint method

15. example $5 - $3 x 100 ($5+$3)/2 $2 = 50% x 100 $4

16. demand elasticity % change in Qd % change in P -100% = -2 50%

17. If price of latte increases 1%, Qd of latte decreases 2%

18. demand elasticity • a unit-free measure • compare all goods & services • changes for different points on the demand curve

19. if price elasticity of demand(absolute value) • = 1 unit elastic % change Qd = % change P • > 1 elastic % change Qd > %change P sensitive to P changes

20. < 1 inelastic % change Qd < %change P not sensitive to P changes

21. P D Q elastic demand(>1) • flatter curve small change in P big change in Qd

22. P D Q inelastic demand(<1) • steep curve big change in P small change in Qd

23. P D Q perfectly inelastic demand • vertical line change in P no change in Qd

24. P D Q perfectly elastic demand • horizontal line any change in P Qd falls to zero

25. effect on total revenue • total revenue (TR) = P x Q • if demand is elastic, • TR falls as price rises • if demand is inelastic, • TR rises as price rises

26. example: cup of latte • initial P=$3, Qd = 15. TR = $3 x 15 = $45 • new P = $5, Qd = 5 TR = $5 x 5 = $25 • demand for latte is elastic TR falls as P rises

27. what makes demand elastic or inelastic? 1. is it a luxury or necessity • if luxury, demand is elastic • if necessity, demand is inelastic

28. example • mocha latte at Starbucks is a luxury • a liver transplant is not

29. 2. definition of good • latte at Starbucks, narrow definition= many substitutes (other brands of coffee, tea) demand is elastic • coffee in general, broad definition = fewer substitutes demand is less elastic

30. 3. time since price change • short time no time to adjust, demand is inelastic • long time time to adjust, demand is elastic

31. example • Price of gas per gallon • the day price rises • demand inelastic • years later • demand much more elastic as carpool or buy smaller car

32. factors 1-3 all get at same issue: • can consumers substitute a cheaper good easily? • if yes, demand is elastic • if no, demand is inelastic

33. 4. Is item large part of your budget? • if yes, then demand elastic (forced to change behavior) • if no, then demand inelastic (no need to change behavior)

34. example • soap • if price doubles, will you buy less? • rent • if rent doubles? -- stay on campus? -- more roommates?

35. II. Price Elasticity of Supply % change in Qs % change in P

36. example • bunch of roses • P = $40/bunch, Qs = 6 (million bunches) • P = $60, Qs = 15

37. % change Qs 15 - 6 x 100 (6+15)/2 9 = 86% x 100 10.5

38. % change P 60 - 40 x 100 (60+40)/2 20 = 40% x 100 50

39. supply elasticity % change in Qs % change in P 86% = 2.15 40%

40. if price rises 1%, Qs rises 2.15% • unit-free measure • depends on points chosen on the supply curve

41. if price elasticity of supply • = 1 unit elastic % change Qs = % change P • > 1 elastic % change Qs > %change P sensitive to P changes

42. < 1 inelastic % change Qs < %change P not sensitive to P changes

43. P S Q inelastic supply • steep curve big change in P small change in Qs

44. P S Q perfectly inelastic supply • vertical line change in P no change in Qs

45. P S Q elastic supply • flatter curve small change in P big change in Qs

46. P S Q perfectly elastic supply • horizontal line any change in P Qs falls to zero

47. what makes supply elastic or inelastic? 1. production possibilities Can you make more easily? NO then supply is inelastic YES then supply is elastic

48. example • oceanfront property • can’t make more • inelastic supply • salt • almost an infinite amount • elastic supply

49. 2. time since price change • it takes time to produce • if a short time, supply is inelastic • if a long time supply is elastic

50. example • hotel rooms • takes time to build • supply inelastic in short-run, elastic in long-run