# Elasticity_1_2003_version

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Elasticity of Demand and Supply

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Elasticity : Elasticity How responsive are you??? Adapted from http://welkerswikinomics.com/blog/ww-study-guides-3 /

PowerPoint Presentation : Of the products shown here, identify those to which consumers are highly responsive to a change in price and those to which consumers are highly unresponsive to changes in price. Highly responsive Highly Unresponsive

Elasticity of Demand : Elasticity of Demand Elasticity : a measure of the responsiveness of consumers or producers to a change in price of a good, the price of a related good, or income.

Elasticity of Demand : Elasticity of Demand Important questions relating to elasticity: 1) Why do buyers of some products respond to price increases by reducing their purchases more than the buyers of other products? 2) Why do higher market prices for some products cause producers to greatly increase their output while price rises for other products cause only limited increase in output? 3) Why does the demand for some products rise a great deal when household income increases while the demand for other products rises just a little?

Price Elasticity of Demand : Price Elasticity of Demand Price Elasticity of Demand : The responsiveness (or sensitivity) of consumers to a change in price. In other words, how much more or less of a good do consumers demand when the price changes

Elasticity of Demand : Elasticity of Demand The Determinants of Price Elasticity of Demand: The following factors determine whether demand for a good or service is elastic, unit elastic, or inelastic. The number of substitutes available. The more substitutes, more elastic demand, as consumers can replace a good whose price has gone up with one of its now relatively cheaper substitutes. The proportion of income the purchase of a good represents. If a good represent a higher proportion of a conumer's income, his demand tends to be more elastic. Luxury or necessity? If a good is a necessity, changes in price tend not to affect quantity demand, i.e. demand is inelastic. If it's a luxury that a consumer can go without, consumers tend to be more responsive. If a product is addictive or habit forming, demand tends to be inelastic. The amount of time a consumer has to respond to the price change. If prices remain high over a longer period of time, consumers can find substitutes or learn to live without, so demand is more elastic over time. S P L A T

PowerPoint Presentation : Formula to calculate the = PED coefficient (PED=Price Elasticity Of Demand) Δ Q of good Y original Q of Y ÷ Δ P of good Y original P of Y Price elasticity of demand equals the percentage change in quantity demanded of product X over the percentage change in the price of product X. Or more simply… %Δ Q Ed = % Δ P Example: A war in the Middle East causes oil supplies to fall, increasing the price per barrel from \$100 to \$120. Oil consumption in France falls from 1m barrels to 900,000 barrels. Calculate the PED for oil in France 900,000 - 1m 1m 120 - 100 100 .10 .20 = .5 The PED for oil in France is 0.5 Interpretation: French consumers are relatively unresponsive to an increase in the price of oil. As price goes up by 20%, they only demand 10% less oil. % Δ Q % Δ P

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 x x Quantity of _____________ Price of _____ 0 % Δ Price % Δ Quantity To Find Percentage Change Current Price/Quantity – Base Price/Quantity ÷ Base Price/Quantity X 100 = % Δ ELASTICITY of Demand % Δ Quantity ÷ % Δ Price \$7-\$9= -\$2 ÷ \$9 Δ -22% (%Δ in Price) 3-1=2 ÷ 1 200% Elasticity is % Δ Q/% Δ P 200%/-22%= 9.9 Demand is Elastic (VERY RESPONSIVE) Price DECREASED 22%

Elasticity of Demand : Elasticity of Demand If Elasticity is 1 then the good is Unit Elastic – No demand sensitivity to price changes (a one to one trade-off). If Elasticity is greater than 1 then demanders are sensitive to price changes – Demand is Elastic. If Elasticity is greater than 0 but less than 1, then demanders are NOT sensitive to prices changes – Demand is Inelastic.

Elasticity of Demand : Elasticity of Demand IMPORTANT NOTE: When we calculate the PRICE ELASTICITY OF DEMAND , IGNORE the negative sign. When we calculate Income Elasticity of Demand AND Cross Price Elasticity of Demand we NEED TO KEEP THE NEGATIVE SIGN, IF IT APPREARS!!

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 % Δ Quantity ELASTICITY of Demand % Δ Quantity ÷ % Δ Price x x Calculate E d going from Point A to Point B THEN Calculate Ed going from Point B to Point A. Are the Elasticities different? Is Demand Elastic, Inelastic, Or Unit Elastic? “A” “B”

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 % Δ Quantity ELASTICITY of Demand % Δ Quantity ÷ % Δ Price x x Calculate E d going from Point A to Point B THEN Calculate Ed going from Point B to Point A. Are the Elasticities different? Is Demand Elastic, Inelastic, Or Unit Elastic? “A” “B”

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 % Δ Quantity ELASTICITY of Demand % Δ Quantity ÷ % Δ Price x x “B” “A” Calculate E d going from Point A to Point B THEN Calculate Ed going from Point B to Point A. Are the Elasticities different? Is Demand Elastic, Inelastic, Or Unit Elastic?

Elasticity : Elasticity WHAT TO DO??? How do we know what the true Elasticity is between two points if we get a different number each time? ANOTHER formula---The MID-POINT FORMULA

PowerPoint Presentation : Goods Estimated Elasticity of Demand Inelastic Salt 0.1 Matches 0.1 Toothpicks 0.1 Airline travel, short-run 0.1 Gasoline, short-run 0.2 Gasoline, long-run 0.7 Residential natural gas, short-run 0.1 Residential natural gas, long-run 0.5 Coffee 0.25 Fish (cod) consumed at home 0.5 Tobacco products, short-run 0.45 Legal services, short-run 0.4 Physician services 0.6 Taxi, short-run 0.6 Automobiles, long-run 0.2 Approximately Unitary Elasticity Movies 0.9 Housing, owner occupied, long-run 1.2 Shellfish, consumed at home 0.9 Oysters, consumed at home 1.1 Private education 1.1 Tires, short-run 0.9 Tires, long-run 1.2 Radio and television receivers 1.2 Elastic Restaurant meals 2.3 Foreign travel, long-run 4.0 Airline travel, long-run 2.4 Fresh green peas 2.8 Automobiles, short-run 1.2 - 1.5 Chevrolet automobiles 4.0 Fresh tomatoes 4.6

Mid-point Formula : Mid-point Formula Because the calculated elasticity is different depending on which Price/Quantity combination you start at, we need a way to figure out elasticity between two points, regardless of which points you start at… Midpoint Formula: Q 2 – Q 1 /(Q 2 + Q 1 /2) ÷ P 2 – P 1 /(P 2 – P 1 /2) Put into words- --”Take the difference between the two Quantities and divide it by the AVERAGE of the two Quantities THEN DIVIDE this number by the difference in the two Prices divided by the AVERAGE of the two Prices”= MIDPOINT. REMEMBER: It is ALWAYS QUANTITY OVER THE PRICE!!!!!

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 % Δ Quantity x x Mid-Point Formula for Elasticity Q2 – Q1/(Q2 + Q1/2) ÷ P2 – P1/(P2 – P1/2) “A” “B” Calculate the midpoint between A and B

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 % Δ Quantity x x “A” “B” Mid-Point Formula for Elasticity Q2 – Q1/(Q2 + Q1/2) ÷ P2 – P1/(P2 – P1/2) Calculate the midpoint between A and B

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 % Δ Quantity x x “B” “A” Mid-Point Formula for Elasticity Q2 – Q1/(Q2 + Q1/2) ÷ P2 – P1/(P2 – P1/2) Calculate the midpoint between A and B

Elasticity : Elasticity The LAST way to Determine Elasticity of Demand is the TOTAL REVENUE TEST . To Determine TOTAL REVENUE (TR): Price X Quantity = TR

PowerPoint Presentation : Total Revenue Test: When a fall in price leads to an increase in a firm's total revenue, demand is elastic. Logic: Consumers are highly responsive to changes in price. A small decrease will in price leads to a large increase in quantity demanded, meaning more revenue for firms. When a fall in price leads to a decrease in a firm's total revenue, demand is inelastic Logic: Consumers are unresponsive to changes in price. A fall in price will lead to only a small increase in quantity demanded, so firms' total revenue declines. When a change in price leads to no change in a firm's total revenue, demand is unit elastic . Logic: Consumers respond to a 10% fall in price with a 10% increase in quantity demanded, therefore firms's total revenue remains the same.

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 X “A” TR= \$9 x 1 = \$9 X “B” X “C” TR= \$5 X 5 = \$25 X “D” TR= \$3 X 7 = \$21 X “E” TR= \$2 X 8= \$16 TR= \$7 X 3 = \$21 As Price Decreases from “A” to “B” Total Revenue I NCREASES As price Decreases from “B” to “C” Total Revenue I NCREASES As price Decreases from “C” to “D” Total Revenue DECREASES As price Decreases from “D” to “E” Total Revenue DECREASES PRICE DECREASES WHAT HAPPENS TO TOTAL REVENUE TOTAL REVENUE TEST E d=9.09 E d=2.39 E d=1.00 E d=.42

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 X “A” TR= \$9 x 1 = \$9 X “B” X “C” TR= \$5 X 5 = \$25 X “D” TR= \$3 X 7 = \$21 X “E” TR= \$2 X 8= \$16 TR= \$7 X 3 = \$21 As Price Increases from “B” to “A” Total Revenue DECREASES (note the mistake on your PPT!!) As price Increases from “C” to “B” Total Revenue DEC REASES As price Increases from “D” to “C” Total Revenue INCREASES . As price Increases from “E” to “D” Total Revenue IN CREASES PRICE INCREASES WHAT HAPPENS TO TOTAL REVENUE TOTAL REVENUE TEST E d=2.39 E d=1.00 E d=.42 E d=.11

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 X “A X “B” X “C” X “D” X “E” ELASTIC RANGE INELASTIC RANGE UNIT ELASTIC RANGE

Elasticity of Supply : Elasticity of Supply Price Elasticity of Supply: The responsiveness of producers to a change in price . Formulas are the same as Demand!!

PowerPoint Presentation : Price Elasticity of Supply (PES) = Δ Qs of good X ÷ original Qs of X Δ P of good X original P of X % Δ Q PES = ÷ % Δ P Or more Simply Δ Q s of good X Δ P of good X ÷ average Q s average P MIDPOINT FORMULA = Price ELASTICITY OF SUPPLY

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 “A”X “B” X” “C” X “” “D”X “ ”E” X “”

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 “A”X “B” X” S* Calculate Es going from Point A to Point B THEN Calculate Es going from Point B to Point A. Are the Elasticities different? Is Supply Elastic, Inelastic, Or Unit Elastic?

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 “A”X “B” X” S* Calculate Es going from Point A to Point B THEN Calculate Es going from Point B to Point A. Are the Elasticities different? Is Supply Elastic, Inelastic, Or Unit Elastic?

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 “A”X “B” X” S* Calculate Es going from Point A to Point B THEN Calculate Es going from Point B to Point A. Are the Elasticities different? Is Supply Elastic, Inelastic, Or Unit Elastic?

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 “A”X “B” X” S* Mid-Point Formula for Elasticity Q2 – Q1/(Q2 + Q1/2) ÷ P2 – P1/(P2 – P1/2) Calculate the midpoint between A and B

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 “A”X “B” X” S* Mid-Point Formula for Elasticity Q2 – Q1/(Q2 + Q1/2) ÷ P2 – P1/(P2 – P1/2) Calculate the midpoint between A and B

PowerPoint Presentation : \$10 \$9 \$8 \$7 \$6 \$5 \$4 \$3 \$2 \$1 1 2 3 4 5 6 7 8 9 10 Quantity of _____________ Price of _____ 0 “A”X “B” X” S* Mid-Point Formula for Elasticity Q2 – Q1/(Q2 + Q1/2) ÷ P2 – P1/(P2 – P1/2) Calculate the midpoint between A and B

Cross-Price Elasticity of Demand : Cross-Price Elasticity of Demand A measure of the responsiveness of the quantity demanded of one good or service to a change in price of another good. Deals with substitutes and compliments only! Formula to Calculate Cross Price Elasticity (XED) %Δ Q D of good A %Δ P of good B

Cross-Price Elasticity of Demand : Cross-Price Elasticity of Demand Examples: -- If the price of beef fell and Qd of chicken fell there is a direct relationship , so the items must be substitutes. Cross-elasticity coefficient will show the degree to which quantity D of chicken falls as the P of beef falls. XED will be positive . --If the price of heating oil falls it may induce some to install oil generated central heating in houses. A fall in the price of oil means an increase in Qd of generators. Inverse relationship , the goods are compliments . XED will be negative.

Cross-Price Elasticity of Demand : Cross-Price Elasticity of Demand EXAMPLES: XED for substitutes: Oil and Ethanol Price of oil = \$100 Qd ethanol = 1m New price of oil = \$130 New Qd ethanol = 1.1m XED for compliments: tennis balls and tennis racquets Price of balls = \$10 Qd of racquets = 80 New price of balls = \$8 New Qd of racquets = 110

Income Elasticity of Demand : Income Elasticity of Demand a measure of the responsiveness of consumers' demand for a good or service to a change in income Formula to Calculate Income Elasticity of Demand (IED) %Δ Q d % Δ in income

Income Elasticity of Demand : Income Elasticity of Demand If a good is INFERIOR , there is an inverse relationship b/w income and demand, so IED is NEGATIVE! If a good is NORMAL , there is a direct relationship between income and demand, so IED is POSITIVE -- Income elastic: a given change in income leads to a greater than proportionate increase in demand for the good or service. Examples: foreign travel, good wines, eating in restaurants, fashionable brands. -- Income inelastic: a given change in income leads to a less than proportionate increase in demand for the good or service. Examples: bread, staple foods, cheap restaurants, --Negative IED (inferior goods): knock-off brands, Wal-Mart clothes.

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