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Price Elasticities of Demand

Learn about price elasticity of demand, influences on elasticity, midpoint method calculations, and types of demand elasticity. Explore how to compute elasticity and its impact on total revenue.

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Price Elasticities of Demand

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  1. Price Elasticities of Demand

  2. Definition: • Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers’ plans remain the same • To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price

  3. New price – Initial price Percent change in price = x 100 Initial Price Percentage Price in Change • Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price?

  4. New price – Initial price Percent change in price = x 100 Initial Price Percentage Change in Price • Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price?

  5. Percentage Change in Price • Elasticity compares the percentage change in the quantity demanded with the percentage change in price • Midpoint Method -- To calculate the percentage change that does not depend on the direction of the price change

  6. New price – Initial price Percent change in price = x 100 (New Price + Initial Price) ÷ 2 Percentage Price in Change • Midpoint Method Calculation • Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price.

  7. Percentage Change in Price • Average price is the same regardless of whether the price rises or falls

  8. New price – Initial price Percent change in price = x 100 (New Price + Initial Price) ÷ 2 Percentage Change in Quantity Demanded • Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. • Uses the midpoint formula again

  9. Percentage Change in Quantity Demanded • When the price of a good rises, the quantity demanded of it decreases • A positive change in price bring a negative change in the quantity demanded • When the price of a good falls, the quantity demanded of it increases • Negative change in price brings a positive change in the quantity demanded

  10. Elastic and Inelastic Demand • Elastic Demand – when the percentage change in the quantity demanded exceeds the percentage change in price • Unit Elastic Demand – percentage change in the quantity demanded equals the percentage change in price • Inelastic Demand – percentage change in the quantity demanded is less than the percentage change in price

  11. Elastic Demand • Perfectly Elastic Demand – an almost zero percentage change in the price brings a very large percentage change in the quantity demanded • Consumers are willing to buy any quantity of the good at a given price but none at a higher price

  12. Perfectly Elastic Demand

  13. Elastic Demand • A percentage change in the quantity demanded exceeds the percentage change in price

  14. Unit Elastic Demand • The percentage change in the quantity demanded equals the percentage change in price

  15. Inelastic Demand • Percentage change in the quantity demanded is less than the percentage change in price

  16. Perfectly Inelastic Demand • Percentage change in the quantity demanded is zero for any percentage change in price

  17. Influences on Price Elasticity of Demand • Two influences: • Availability of substitutes • Proportion of income spent

  18. Influences on Price Elasticity of Demand • Demand for good is elastic if a substitute is easy to find • Soft drink containers • Demand for good is inelastic if a substitute is hard to find • Oil substitutes?

  19. Influences on Price Elasticity of Demand • Three factors that influence the ability to find a substitute for a good: • Whether good is a luxury or a necessity • How narrowly it is defined • Amount of time available to find a substitute for it

  20. Price Elasticity of Demand • The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good • Toothpaste?

  21. Percentage change in quantity demanded Price elasticity of demand = Percentage change in the price Computing Price Elasticity of Demand • If the price elasticity of a demand is greater than 1, the demand is elastic • If the price elasticity of demand equals 1, demand is unit elastic • If the price elasticity of demand is less than 1, demand is inelastic

  22. Computing Price Elasticity of Demand

  23. Elasticity Along a Linear Demand Curve • Slope measures responsiveness. But slope and elasticity are not the same thing! • Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies. • Along a linear demand curve, demand is: • Unit elastic at the midpoint of the curve. • Elastic above the midpoint of the curve. • Inelastic below the midpoint of the curve.

  24. Elasticity Along a Linear Demand Curve

  25. Total Revenue and the Price Elasticity of Demand • Total revenue is the amount spent on a good and received by its sellers and equals the price of the good multiplied by the quantity sold • Starbucks Latte -- $3 • Demand is 15 cups an hour • Total Revenue is $45 an hour • Total Revenue Test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change

  26. Total Revenue and the Price Elasticity of Demand • If demand is elastic: • A given percentage rise in price brings a larger percentage decrease in the quantity demanded. • And total revenue decreases. • If demand is inelastic: • A given percentage rise in price brings a smaller percentage decrease in the quantity demanded. • And total revenue increases.

  27. Total Revenue Test Total revenue test: • If price and total revenue change in the opposite directions, demand is elastic. • If a price change leaves total revenue unchanged, demand is unit elastic. • If price and total revenue change in the same direction, demand is inelastic.

  28. Total Revenue Test • At $3 a cup, the quantity demanded is 15 cups an hour. • Total revenue is $45 an hour. • When the price rises to $5 a cup, the quantity demanded decreases to 5 cups an hour. • Total revenue decreases to $25 an hour. • Demand is elastic.

  29. Total Revenue Test • At $50 a book, the quantity demanded is 5 million books. • Total revenue is $250 million. • When the price rises to $75 a book, the quantity demanded decreases to 4 million books. • Total revenue increases to $300 million. • Demand is inelastic.

  30. Addiction and Elasticity • Nonusers’ demand for addictive substances is elastic. • So a moderately higher price leads to a substantially smaller number of people trying a drug. • Existing users’ demand for addictive substances is inelastic. • So even a substantial price rise brings only a modest decrease in the quantity demanded.

  31. Price Elasticities of Demand Notes

  32. Definition: • Price elasticity of demand is • To determine price elasticity of demand: compare the % change in the quantity demanded with the percentage change in price

  33. – = x Percentage Price in Change • Starbucks raised the price of a latte from $3 to $5 a cup. What is the percentage change in price?

  34. – = x Percentage Change in Price • Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the percentage change in price?

  35. Percentage Change in Price • Elasticity compares the percentage change in the quantity demanded with the percentage change in price • Midpoint Method --

  36. – = x ( + ) ÷ 2 Percentage Price in Change • Midpoint Method Calculation • Starbucks Latte price changing from $5 to $3. $5 for a new price and $3 for the initial price.

  37. Percentage Change in Price

  38. New price – Initial price Percent change in price = x 100 (New Price + Initial Price) ÷ 2 Percentage Change in Quantity Demanded • Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from 15 cups to 5 cups an hour. • Uses the midpoint formula again

  39. Percentage Change in Quantity Demanded • When the price of a good rises, the quantity demanded of it decreases • When the price of a good falls, the quantity demanded of it increases

  40. Elastic and Inelastic Demand • Elastic Demand – • Unit Elastic Demand – • Inelastic Demand –

  41. Elastic Demand • Perfectly Elastic Demand – • Consumers are willing to buy any quantity of the good at a given price but none at a higher price

  42. Perfectly Elastic Demand

  43. Elastic Demand

  44. Unit Elastic Demand

  45. Inelastic Demand

  46. Perfectly Inelastic Demand

  47. Influences on Price Elasticity of Demand • Two influences: • Availability of ________________ • Proportion of ___________spent

  48. Influences on Price Elasticity of Demand • Demand for good is elastic if a substitute is easy to find • Demand for good is inelastic if a substitute is hard to find

  49. Influences on Price Elasticity of Demand • Three factors that influence the ability to find a substitute for a good:

  50. Price Elasticity of Demand • The greater the proportion of income spend on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic it is the demand for that good

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