04 Elasticity Mc. Graw-Hill/Irwin Copyright © 2012 by The Mc. Graw-Hill Companies, Inc. All rights reserved.
Chapter Objectives Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show 6 -2 • Price Elasticity of Demand How It Can Be Applied • The Usefulness of the Total Revenue Test for Price Elasticity of Demand • Price Elasticity of Supply and How It Can Be Applied • Cross Elasticity of Demand Income Elasticity of Demand • Consumer Surplus, Producer Surplus, and Efficiency Losses Copyright 2008 The Mc. Graw-Hill Companies
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms Think about it……… The law of demand says consumers will buy more when prices go down and less when prices go up. . … HOW MUCH MORE OR LESS? DOES IT MATTER? To whom? Price elasticity, with respect to demand, provides an answer. . End Show 6 -3 Copyright 2008 The Mc. Graw-Hill Companies
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Measures Responsiveness to Price Changes Elasticity Coefficient= % delta Q divided by % delta P P Elasticity =. 5, therefore, relatively inelastic…. P 1 P 2 D Q 1 Q 2 Key Terms End Show 6 -4 . 01. 02 Copyright 2008 The Mc. Graw-Hill Companies Q
PRICE ELASTICITY OF DEMAND Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Commonly Expressed as… P The percentage change in quantity The percentage change in price % Q d % P P 2 P 1 Key Terms Q 2 Q 1 End Show 6 -5 Copyright 2008 The Mc. Graw-Hill Companies D Elasticity is. 5 Q
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show 6 -6 Price Elasticity of Demand • Measuring Responsiveness to Price Changes • Relatively Elastic or Inelastic • Price-Elasticity Coefficient and Formula O 6. 1 Ed = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product X Copyright 2008 The Mc. Graw-Hill Companies
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word • Formula Restated Ed = End Show 6 -7 Original Quantity Demanded of X ÷ Change in Price of X Original Price of X • Using Averages • Midpoint Formula Ed = Key Terms Change in Quantity Demanded of X Change in Quantity Sum of Quantities/2 Copyright 2008 The Mc. Graw-Hill Companies ÷ W 6. 1 Change in Price Sum of Prices/2
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Price Elasticity of Demand • Why Use Percentages? • Elimination of the Minus Sign • Interpretations of Ed Elastic Demand Ed = . 04. 02 =2 Ed = . 01. 02 =. 5 Ed = . 02 =1 Inelastic Demand Unit Elasticity Key Terms End Show 6 -8 Copyright 2008 The Mc. Graw-Hill Companies
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Extreme Cases Perfectly Inelastic Demand P Q Perfectly Elastic Demand P 0 6 -9 Perfectly Inelastic Demand (Ed = 0) 0 Key Terms End Show D 1 Copyright 2008 The Mc. Graw-Hill Companies Perfectly Elastic Demand (Ed = ∞) D 2 Q
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show 6 -10 • • • Determinants of Price Elasticity of Demand Substitutability Proportion of Income Luxuries versus Necessities Time Applications: – Large Crop Yields – Excise Taxes – Decriminalization of Illegal Drugs Copyright 2008 The Mc. Graw-Hill Companies
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word The Total Revenue Test • Total Revenue (TR) TR = P x Q Elastic Demand W 6. 2 P $3 a 2 b 1 D 1 Key Terms 0 End Show 6 -11 10 Copyright 2008 The Mc. Graw-Hill Companies 20 30 40 Q
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word The Total Revenue Test • Total Revenue (TR) TR = P x Q Inelastic Demand P W 6. 2 c $4 3 2 d 1 Key Terms End Show D 2 0 6 -12 Copyright 2008 The Mc. Graw-Hill Companies 10 20 Q
Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word The Total Revenue Test • Total Revenue (TR) TR = P x Q Unit-Elastic W 6. 2 P e $3 2 f 1 D 3 Key Terms 0 End Show 6 -13 Copyright 2008 The Mc. Graw-Hill Companies 10 20 30 Q
Elasticity on a Linear Demand Curve Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Price Elasticity of Demand for Movie G 6. 1 Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test (1) Total Quantity of Tickets Demanded Per Week, Thousands (2) Price Per Ticket 1 2 3 4 5 6 Key Terms 7 End Show 8 6 -14 Copyright 2008 The Mc. Graw-Hill Companies 8 ] 7 ] 6 ] 5 ] 4 ] 3 ] 2 ] 1 (3) Elasticity Coefficient (Ed) 5. 00 2. 60 1. 57 1. 00 0. 64 0. 38 0. 20 (4) Total Revenue (1) X (2) $8, 000 ] 14, 000 ] 18, 000 ] 20, 000 ] 18, 000 ] 14, 000 ] 8, 000 (5) Total-Revenue Test Elastic Unit Elastic Inelastic Graphically…
Key Terms End Show $8 a 7 b 6 c 5 d 4 e 3 f 2 g 1 h D 0 1 2 3 4 5 6 7 8 Quantity Demanded Total Revenue (Thousands of Dollars) Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Price Elasticity and the Total. Revenue Curve $20 18 16 14 12 10 8 6 4 2 Copyright 2008 The Mc. Graw-Hill Companies Elastic Ed > 1 Unit Elastic Ed = 1 TR 0 1 2 3 4 5 6 7 8 Quantity Demanded 6 -15 Elastic Ed > 1 Unit Elastic Ed = 1 Inelastic Ed < 1
Summary of 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 Less than 1 (Ed < 1) Inelastic or relatively inelastic Total revenue increases Total revenue decreases LO 2 Qd changes by a smaller percentage than does price 4 -16
Price Elasticity of Supply Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Es = Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X Perfectly Inelastic Supply Market Period: Not Enough Time to Shift Resources P Greatest Price Impact Sm Pm P 0 Key Terms D 1 D 2 End Show Q 0 6 -17 Copyright 2008 The Mc. Graw-Hill Companies Q O 6. 2
Price Elasticity of Supply Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Es = Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X Inelastic Supply Es < 1 Short Run: Resources Not Easily Shifted to Alternative Uses P Lower Price Impact Ss Ps P 0 Key Terms D 1 D 2 End Show Q 0 Qs 6 -18 O 6. 2 Copyright 2008 The Mc. Graw-Hill Companies Q
Price Elasticity of Supply Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Es = Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X Elastic Supply Es > 1 Long Run: Resources Easily Shifted to Alternative Uses P Sl Least Price Impact Pl P 0 Key Terms D 1 D 2 End Show Q 0 Ql 6 -19 Copyright 2008 The Mc. Graw-Hill Companies Q O 6. 2
Applications of Elasticity of Supply • Antiques • Inelastic supply • Reproductions • More elastic supply • Volatile gold prices • Inelastic supply LO 3 4 -20
Cross Elasticity of Demand Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show 6 -21 Exy = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product Y • Substitute Goods – Positive Sign • Complementary Goods. Negative Sign • Independent Goods – Zero or Near-Zero Value Copyright 2008 The Mc. Graw-Hill Companies
Income Elasticity of Demand Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Ei = Percentage Change in Quantity Demanded Percentage Change in Income • Normal Goods – Positive Sign • Inferior Goods. Negative Sign Key Terms End Show 6 -22 Copyright 2008 The Mc. Graw-Hill Companies
Ex, y and Ei Cross and Income Elasticities of Demand Value of Coefficient Cross elasticity: Positive (Ewz > 0) Negative (Exy < 0) Description Quantity demanded of W changes in same direction as change in price of Z Type of Good(s) Substitutes Quantity demanded of X changes in Complements opposite direction from change in price of Y Income elasticity: Positive (Ei >0) Quantity demanded of the product changes in same direction as change in income Normal or superior Negative (Ei<0) Quantity demanded of the product changes in opposite direction from change in income Inferior LO 4 4 -23
Income Elasticity Insights • High income elasticities • Most affected by a recession • Low or negative income • Least affected by a recession LO 4 4 -24
Elasticity and Pricing Power: Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show 6 -25 Why Different Consumers Pay Different Prices • All Buyers in a Highly Competitive Market Pay the Same Price Regardless of Their Elasticities • Difficulty in Applying Different Prices • Observe Differences in Group Elasticities – Business Travelers – Leisure Travelers – Discounting for Children – Different Net Prices for College Tuition Copyright 2008 The Mc. Graw-Hill Companies
Producer Surplus Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Producer surplus P 1 S Equilibrium price Q 1 Key Terms End Show LO 2 6 -26 Copyright 2008 The Mc. Graw-Hill Companies 5 -26
Efficiency Revisited Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Consumer surplus S P 1 Producer surplus D Q 1 Key Terms End Show LO 2 6 -27 Copyright 2008 The Mc. Graw-Hill Companies 5 -27
Efficiency Losses Key Terms a Efficiency loss from underproduction Price (per bag) Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word S d b e D c Q 2 Q 1 Quantity (bags) End Show LO 2 6 -28 Copyright 2008 The Mc. Graw-Hill Companies 5 -28
Efficiency Losses a Efficiency loss from overproduction Key Terms S f Price (per bag) Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word b g D c Q 1 Q 3 Quantity (bags) End Show LO 2 6 -29 Copyright 2008 The Mc. Graw-Hill Companies 5 -29
Key Terms Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total. Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms • price elasticity of demand • midpoint formula • elastic demand • inelastic demand • unit elasticity • perfectly inelastic demand • perfectly elastic demand • total revenue test (TR) • total-revenue test End Show 6 -30 Copyright 2008 The Mc. Graw-Hill Companies • price elasticity of supply • market period • short run • long run • cross-elasticity of demand • income elasticity of demand
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