chapter 4 elasticity
DESCRIPTION
CHAPTER 4 Elasticity. The Responsiveness of the Quantity Demanded to Price. When price rises, quantity demanded decreases. The question is how much quantity will decrease in response to a given price increase. - PowerPoint PPT PresentationTRANSCRIPT
CHAPTER 4Elasticity
The Responsiveness of the Quantity Demanded to Price When price rises, quantity demanded
decreases. The question is how much quantity
will decrease in response to a given price increase.
We want a measure that is units free and can be compared across different commodities.
The Responsiveness of Quantity Demanded to Price
The measure we will study that meets the criteria we want is
the price elasticity of demand.
Price Elasticity of Demand Price elasticity of demand is a
measure of the responsiveness of the quantity demanded of a good to a change in its price (ceteris paribus).
Elastic Demand - means demand is sensitive to price
Inelastic Demand - means demand is insensitive to price
Elasticity: A Units-Free Measure
Price elasticity ofdemand =
Percentage change in quantity demanded
Percentage change in price
Calculating Elasticity Negative sign is ignored for
convenience. The changes in price and quantity
are expressed as percentages of the average price and average quantity between the two prices and quantities being compared.– Avoids having two values for the price
elasticity of demand
Calculating Elasticity
PQ
%%
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
Calculating Elasticity
PQ
%%
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
ave
ave
PPQQ
//
Calculating Elasticity
PQ
%%
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
ave
ave
PPQQ
//
(Q2 - Q1)/Qave(P2 - P1)/Pave
=
Calculating the Elasticity of Demand - Example
P1 = 410 P2 = 390 Q1 = 36 Q2 = 44
Calculating the Elasticity of Demand
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint (P1, Q1)
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint (P1, Q1)
Newpoint (P2, Q2)
Calculating the Elasticity of Demand
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
= 8Q
Originalpoint (P1, Q1)
Newpoint (P2, Q2)
Calculating the Elasticity of Demand
`P =$20
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint (P1, Q1)
Newpoint (P2, Q2)
Pave = $400
= $20P
= 8Q
Calculating the Elasticity of Demand
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint (P1, Q1)
Newpoint (P1, Q1)
Pave = $400
Qave = 40
= $20P
= 8Q
Calculating the Elasticity of Demand
Calculating Elasticity
PQ
%%
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
ave
ave
PPQQ
//
(Q2 - Q1)/Qave(P2 - P1)/Pave
=400/2040/8
Calculating Elasticity
PQ
%%
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
ave
ave
PPQQ
//
(Q2 - Q1)/Qave(P2 - P1)/Pave
=400/2040/8
= 4
Elasticity Using Different Bases Use P1 and Q1 as base
– E = ((44 – 36)/36)/((390 – 410)/410)– = (8/36)/(-20/410) = .222/.0488 = 4.55
Use P2 and Q2 as base– E = ((44 – 36)/44)/((390 – 410)/390)– = (8/44)/(-20/390) = .182/.051 = 3.57
Note that average of these two elasticities is about 4, which is the elasticity obtained using the average Ps and Qs
P1 = 410, Q1 = 36; P2 = 390, Q2 = 44
Inelastic and Elastic Demand
Five demand curves that cover the entire range of possible elasticities of demand:– Perfectly inelastic (Elasticity=0)– Inelastic (0<Elasticity<1)– Unit elastic (Elasticity=1)– Elastic (1<Elasticity< )– Perfectly elastic (Elasticity= )
Inelastic and Elastic Demand
6
12
Pric
e
Quantity
D1
Elasticity = 0
Perfectly Inelastic
Inelastic and Elastic Demand
Perfectly inelastic demand – Implies that quantity demanded remains
constant when price changes occur. – Price elasticity of demand = 0
Inelastic and Elastic Demand
6
12
Pric
e
Quantity
D2
0<Elasticity<1
Inelastic
Inelastic and Elastic Demand
Inelastic demand – Implies the percentage change in quantity
demanded is less than the percentage change in price.
– Price elasticity of demand > 0 and < 1
Inelastic and Elastic Demand
6
12
Pric
e
Quantity
D3
1 2 3
Elasticity = 1
Unit Elasticity
Inelastic and Elastic Demand
Unit elastic demand– Implies that the percentage change in quantity
demanded equals the percentage change in price.
– Price elasticity of demand = 1
Inelastic and Elastic Demand
6
12
Pric
e
Quantity
D4
1<Elasticity< ∞
Elastic
Inelastic and Elastic Demand
Elastic demand –Implies the percentage change in quantity
demanded is greater than the percentage change in price.
–Price elasticity of demand > 1 and <
Inelastic and Elastic Demand
6
12
Pric
e
Quantity
D5
Elasticity =
Perfectly Elastic
Inelastic and Elastic Demand
Perfectly elastic demand– Implies that if price changes by any percentage
quantity demanded will fall to 0.– Price elasticity of demand =
Examples of Elasticity Calculation
(1) Q1 = 10, P1 = 50, Q2 = 8, P2 = 60 Elasticity = ((8-10)/9)/(60-50)/55) = (-2/9)/(10/55)=-1.22 Therefore demand over this range is
elastic
Examples of Elasticity Calculation
(2) Q1 = 30, P1 = 20, Q2 = 28, P2 = 26 Elasticity = ((28-30)/29)/(26-20)/23) = (-2/29)/(6/23)=-.264 Therefore demand over this range is
inelastic
Examples of Elasticity Calculation
(3) Q1 = 55, P1 = 9, Q2 = 45, P2 = 11 Elasticity = ((45-55)/50)/(11-9)/10) = (-10/50)/(2/10)=-1.00 Therefore demand over this range is
unitary elastic
The Factors that Influence the Elasticity of Demand
The closer the substitutes for a good, the more elastic is demand.
The higher the proportion of income spent on a good, the more elastic is demand.
The greater the time elapsed since a price change, the more elastic is demand.
Total Revenue Test The 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 (all other things remaining the same).
Unitary Elastic Demand and Total Revenue
If demand is unitary elastic, an increase in price results in an equal percentage decrease in the quantity demanded and total revenue remains constant.
Elastic Demand andTotal Revenue
If demand is elastic, an increase in price results in a larger percentage decrease in the quantity demanded and total revenue decreases.
Inelastic Demand andTotal Revenue
If demand is inelastic, an increase in price results in a smaller percentage decrease in the quantity demanded and total revenue increases.
Exampleof Total Revenue Test
Elasticity Calculation (1) Q1 = 10, P1 = 50, Q2 = 8, P2 = 60 Elasticity = ((8-10)/9)/(60-50)/55) = (-2/9)/(10/55)=-1.22 (elastic) TR1 = P1xQ1 = 50x10 = 500 TR2 = P2xQ2 = 60x8 = 480 TR falls as P increases Therefore demand is elastic
Exampleof Total Revenue Test
Elasticity Calculation (2) Q1 = 30, P1 = 20, Q2 = 28, P2 = 26 Elasticity = ((28-30)/29)/(26-20)/23) = (-2/29)/(6/23)=-.264 (inelastic) TR1 = P1xQ1 = 20x30 = 600 TR2 = P2xQ2 = 26x28 = 728 TR rises as P increases Therefore demand is inelastic
Exampleof Total Revenue Test
Elasticity Calculation (3) Q1 = 55, P1 = 9, Q2 = 45, P2 = 11 Elasticity = ((45-55)/50)/(11-9)/10) = (-10/50)/(2/10)=-1.00 (unitary elastic) TR1 = P1xQ1 = 9x55 = 495 TR2 = P2xQ2 = 11x45 = 495 TR doesn’t change as P increases Therefore demand is unitary elastic
Elasticity Along a Straight-Line Demand Curve
Elasticity is not the same as slope, but the two are related.
As the price increases, demand becomes more elastic.
Elasticity will equal 1.0 at the midpoint of any linear demand curve.
Other Commonly UsedElasticities
Income Elasticity of Demand Cross Price Elasticity of Demand Price Elasticity of Supply