6

Elasticity

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Demand

• Measures buyers’ responsiveness to

•

price changes

Formula for price elasticity of demand

Percentage Change in Quantity

Demanded

of

Product

X

Ed =

Percentage Change in Price

of Product X

LO1

Price Elasticity of Demand

Formula

• Eliminate the minus sign

• Easier to compare elasticities

LO1

Price Elasticity of Demand

• Elastic demand, Ed > 1

• Sensitive to price changes

• Large change in quantity for small price change

• Inelastic demand, Ed < 1

• Insensitive to price changes

• Small change in quantity for large price change

• Unit elastic demand, Ed = 1

– Equal changes in quantity and price

LO1

Extreme Cases

P

D1

Perfectly

inelastic

demand

(Ed = 0)

0

Perfectly inelastic demand

LO1

Extreme Cases

P

D2

Perfectly

elastic

demand

(Ed = ∞)

0

Perfectly elastic demand

LO1

Price Elasticity of Demand

• Can not use slope to determine

•

LO2

elasticity

Can use slope to determine relative

elasticity.

Total Revenue Test

• Total Revenue = Price X Quantity

• Inelastic demand

• P and TR move in the same direction

• Elastic demand

•

LO2

• P and TR move in opposite directions

Unit elastic demand

• TR doesn’t change when P changes

Total Revenue Test

Table 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the

Elasticity Coefficient and the Total-Revenue Test

(3)

Elasticity

Coefficient

(Ed)

(1)

Total Quantity of

Tickets Demanded per

Week, Thousands

(2)

Price per Ticket

1

$8

2

7

5.00

14,000

Elastic

3

6

2.60

18,000

Elastic

4

5

1.57

20,000

Elastic

5

4

1.00

20,000

Unit Elastic

6

3

0.64

18,000

Inelastic

7

2

0.38

14,000

Inelastic

8

1

0.20

8,000

Inelastic

LO2

(4)

Total

Revenue

(1) X (2)

(5)

Total

Revenue

Test

$8,000

Summary of Price Elasticity of

Demand

Table 6.2 Price Elasticity of Demand: A Summary

Absolute Value

of Elasticity

Coefficient

Demand Is:

Impact on Total Revenue of a:

Description

Price Increase Price Decrease

Qd changes by a

larger

percentage than

does price

Total Revenue

decreases

Total Revenue

increases

Greater than 1

(Ed > 1)

Elastic or

relatively

elastic

Equal to 1

(Ed = 1)

Unit or unitary Qd changes by

elastic

the same

percentage as

does price

Total revenue

is unchanged

Total revenue

is unchanged

Less than 1

(Ed < 1)

Inelastic or

relatively

inelastic

Total revenue

increases

Total revenue

decreases

LO2

Qd changes by a

smaller

percentage than

does price

Determinants of Elasticity of

Demand

• Substitutability

•

• More substitutes, demand is more elastic

Proportion of Income

• Higher proportion of income, demand is more

elastic

• Luxuries vs. Necessities

•

LO1

• Luxury goods, demand is more elastic

Time

• More time available, demand is more elastic

Price Elasticity of Demand

Table 6.3 Selected Price Elasticities of Demand

Product or Service

Price Elasticity

of Demand (Ed) Product or Service

Price Elasticity

of Demand (Ed)

Newspapers

.10

Milk

.63

Electricity (household)

.13

Household appliances

.63

Bread

.15

Liquor

.70

MLB Tickets

.23

Movies

.87

Telephone Service

.26

Beer

.90

Cigarettes

.25

Shoes

.91

Sugar

.30

Motor vehicles

1.14

Medical Care

.31

Beef

1.27

Eggs

.32

China, glassware

1.54

Legal Services

.37

Residential land

1.60

Automobile repair

.40

Restaurant meals

2.27

Clothing

.49

Lamb and mutton

2.65

Gasoline

.60

Fresh peas

2.83

LO1

Applications of Ed

• Large Crop Yields

• Inelastic demand, lower total revenue

• Excise Taxes

• Inelastic demand, more total revenue

• Decriminalization of Illegal Drugs

• Inelastic demand, more total revenue

• Decrease street crime

LO1

Price Elasticity of Supply

• Measures sellers’ responsiveness to

price changes

• Elastic supply (Es > 1 ), producers

are responsive to price changes

• Inelastic supply (Es < 1), producers

are not responsive to price changes

Es =

LO3

Percentage Change in Quantity

Supplied of Product X

Percentage Change in Price

of Product X

Price Elasticity of Supply

• Time is primary determinant of elasticity of

•

supply

Time periods considered

• Immediate Market period

• Can’t adjust any resources

• Short Run

• Able to adjust some resources

• Long Run

• Able to adjust all resources

LO3

Applications of Elasticity of

Supply

• Antiques

• Inelastic supply

• Reproductions

• More elastic supply

• Volatile gold prices

• Inelastic supply

LO3

Cross Elasticity of Demand

• Measures responsiveness of sales to

•

•

•

change in the price of another good

Substitutes – positive sign

Complements – negative sign

Independent goods - zero

Percentage change in quantity demanded of product X

Ex,y =

Percentage change in price of product Y

LO4

Income Elasticity of Demand

• Measures responsiveness of buyers

•

•

to changes in income

Normal goods – positive sign

Inferior goods – negative sign

Percentage change

in quantity demanded

Ei =

Percentage change in income

LO4

Elasticity

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Demand

• Measures buyers’ responsiveness to

•

price changes

Formula for price elasticity of demand

Percentage Change in Quantity

Demanded

of

Product

X

Ed =

Percentage Change in Price

of Product X

LO1

Price Elasticity of Demand

Formula

• Eliminate the minus sign

• Easier to compare elasticities

LO1

Price Elasticity of Demand

• Elastic demand, Ed > 1

• Sensitive to price changes

• Large change in quantity for small price change

• Inelastic demand, Ed < 1

• Insensitive to price changes

• Small change in quantity for large price change

• Unit elastic demand, Ed = 1

– Equal changes in quantity and price

LO1

Extreme Cases

P

D1

Perfectly

inelastic

demand

(Ed = 0)

0

Perfectly inelastic demand

LO1

Extreme Cases

P

D2

Perfectly

elastic

demand

(Ed = ∞)

0

Perfectly elastic demand

LO1

Price Elasticity of Demand

• Can not use slope to determine

•

LO2

elasticity

Can use slope to determine relative

elasticity.

Total Revenue Test

• Total Revenue = Price X Quantity

• Inelastic demand

• P and TR move in the same direction

• Elastic demand

•

LO2

• P and TR move in opposite directions

Unit elastic demand

• TR doesn’t change when P changes

Total Revenue Test

Table 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the

Elasticity Coefficient and the Total-Revenue Test

(3)

Elasticity

Coefficient

(Ed)

(1)

Total Quantity of

Tickets Demanded per

Week, Thousands

(2)

Price per Ticket

1

$8

2

7

5.00

14,000

Elastic

3

6

2.60

18,000

Elastic

4

5

1.57

20,000

Elastic

5

4

1.00

20,000

Unit Elastic

6

3

0.64

18,000

Inelastic

7

2

0.38

14,000

Inelastic

8

1

0.20

8,000

Inelastic

LO2

(4)

Total

Revenue

(1) X (2)

(5)

Total

Revenue

Test

$8,000

Summary of Price Elasticity of

Demand

Table 6.2 Price Elasticity of Demand: A Summary

Absolute Value

of Elasticity

Coefficient

Demand Is:

Impact on Total Revenue of a:

Description

Price Increase Price Decrease

Qd changes by a

larger

percentage than

does price

Total Revenue

decreases

Total Revenue

increases

Greater than 1

(Ed > 1)

Elastic or

relatively

elastic

Equal to 1

(Ed = 1)

Unit or unitary Qd changes by

elastic

the same

percentage as

does price

Total revenue

is unchanged

Total revenue

is unchanged

Less than 1

(Ed < 1)

Inelastic or

relatively

inelastic

Total revenue

increases

Total revenue

decreases

LO2

Qd changes by a

smaller

percentage than

does price

Determinants of Elasticity of

Demand

• Substitutability

•

• More substitutes, demand is more elastic

Proportion of Income

• Higher proportion of income, demand is more

elastic

• Luxuries vs. Necessities

•

LO1

• Luxury goods, demand is more elastic

Time

• More time available, demand is more elastic

Price Elasticity of Demand

Table 6.3 Selected Price Elasticities of Demand

Product or Service

Price Elasticity

of Demand (Ed) Product or Service

Price Elasticity

of Demand (Ed)

Newspapers

.10

Milk

.63

Electricity (household)

.13

Household appliances

.63

Bread

.15

Liquor

.70

MLB Tickets

.23

Movies

.87

Telephone Service

.26

Beer

.90

Cigarettes

.25

Shoes

.91

Sugar

.30

Motor vehicles

1.14

Medical Care

.31

Beef

1.27

Eggs

.32

China, glassware

1.54

Legal Services

.37

Residential land

1.60

Automobile repair

.40

Restaurant meals

2.27

Clothing

.49

Lamb and mutton

2.65

Gasoline

.60

Fresh peas

2.83

LO1

Applications of Ed

• Large Crop Yields

• Inelastic demand, lower total revenue

• Excise Taxes

• Inelastic demand, more total revenue

• Decriminalization of Illegal Drugs

• Inelastic demand, more total revenue

• Decrease street crime

LO1

Price Elasticity of Supply

• Measures sellers’ responsiveness to

price changes

• Elastic supply (Es > 1 ), producers

are responsive to price changes

• Inelastic supply (Es < 1), producers

are not responsive to price changes

Es =

LO3

Percentage Change in Quantity

Supplied of Product X

Percentage Change in Price

of Product X

Price Elasticity of Supply

• Time is primary determinant of elasticity of

•

supply

Time periods considered

• Immediate Market period

• Can’t adjust any resources

• Short Run

• Able to adjust some resources

• Long Run

• Able to adjust all resources

LO3

Applications of Elasticity of

Supply

• Antiques

• Inelastic supply

• Reproductions

• More elastic supply

• Volatile gold prices

• Inelastic supply

LO3

Cross Elasticity of Demand

• Measures responsiveness of sales to

•

•

•

change in the price of another good

Substitutes – positive sign

Complements – negative sign

Independent goods - zero

Percentage change in quantity demanded of product X

Ex,y =

Percentage change in price of product Y

LO4

Income Elasticity of Demand

• Measures responsiveness of buyers

•

•

to changes in income

Normal goods – positive sign

Inferior goods – negative sign

Percentage change

in quantity demanded

Ei =

Percentage change in income

LO4

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