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micro economics chapter 06

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



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