elasticity of demand chapter 6 114-122 mr. henry ap economics
TRANSCRIPT
Elasticity of DemandChapter 6 114-122
Mr. HenryAP Economics
Understanding Definitions:Which stretches or changes, more – something that is elastic or inelastic?
• Something that is elastic…
Law of Demand:other things equal, consumers will buy more of a product when its price declines and less
when its price increases.
But the big question is:How much more or less will they buy?
Demand Elasticity&
Elastic Demand
• Demand Elasticity is a measure that shows how a change in quantity demanded responds to a change in price
• Economists say that demand is elastic when a given change in prices causes a relatively larger change in quantity demanded
• Elastic goods and services generally have plenty of substitutes.Can you think of examples of demand elasticity?
Inelastic Demand
• For some products, demand may be inelastic, which means that a given change in prices causes a relatively smaller change in the quantity demanded.
• Inelastic goods have fewer substitutes and price change doesn't affect quantity demanded as much.
• Examples of inelastic goods?• Gas, electricity, water, drinks, clothing, tobacco,
food, and oil
According to the Federal Highway Administration, the number of motor vehicles has been rising by an estimated 3.69 million each year since 1960 with the largest annual growth between 1998 and 1999 as well as between 2000 and 2001. Today there are over 254.4 million vehicles in America.
Unit Elastic
• If PEoD = 1 then Demand is Unit Elastic• Unit Elastic is a type of elasticity where a change in
price causes a proportional change in quantity demanded
• It is hard to cite examples of Unit Elastic items, but the demand for movies, tires, and private education is estimated to be nearly unit-elastic
The Midpoint Method has three formulas
Doing the math…Price Elasticity of Demand
Doing the math…Price Elasticity of Demand• Elasticity = (% change in quantity demanded / % change in price)
Calculating the Percentage Change in Quantity Demanded
* We always ignore the negative sign when analyzing price elasticity and present the absolute value, so PEoD is always positive.
900-1100-------------
1100+900/2
1.10-.90-------------.90+1.10/2
-200-------------
1000
.20-------------
.20
-.20
.20=1
Sample Problem
Sample Problem 2
Consumers see a price change in a product from $4 to $5 and demand goes from 20 units to 10 units. Calculate & type of elasticity. 20-10 ÷ (20+10)/2- - - - - - - - - - - - - - - - 4-5 ÷ (4+5) / 2
= 10/15 ÷ -1/4.50= 67% ÷ 22%= 3.04 (elastic)
Question: Hollister.com wants to increase its total revenue. One strategy is to offer a 10% discount on every shirt it sells. Hollister.com knows that its customers can be divided into two distinct groups according to their likely responses to the discount. The accompanying table shows how the two groups respond to the discount.
Sample Problem 3
a. Using the midpoint method, calculate the price elasticities of demand for group A and group Bb. Explain how the discount will affect total revenue from each groupc. Suppose Hollister.com knows which group each customer belongs to when he/she logs on and
can choose whether or not to offer the 10% discount. If Hollister.com wants to increase its total revenue, should discounts be offered to group B, to neither group, or to both groups?
a. Using the midpoint method, calculate the price elasticities of demand for group A and group Bb. Explain how the discount will affect total revenue from each groupc. Suppose Hollister.com knows which group each customer belongs to when he/she logs on and
can choose whether or not to offer the 10% discount. If Hollister.com wants to increase its total revenue, should discounts be offered to group B, to neither group, or to both groups?
b. For group A, since the price elasticity of demand is .625 (6.25%) and demand is inelastic, total revenue will decrease as a result of the discount. For group B, since the price elasticity of demand is 1.25 (12.5%) and demand is elastic, total revenue will increase as a result of the discount.
In real life…have you ever bought more of something because of a discount that you normally don’t buy? And for something you
typically buy when there is a discount you don’t act on it??Ie my mother gets better Giant Eagle discounts compared to me
and I shop there more!! ~ Things that make me mad
c. If Hollister.com wants to increase total revenue, it should definitely not offer the discount to group A and it should definitely offer the discount to group B.
–Tomorrow we will continue to look at Demand Elasticity
Elasticity
Summary Review from Yesterday• Elastic
– Increased price implies decreased total revenue.– Decreased price implies increased total revenue.– Given the law of demand, increased quantity (decreased price)
implies increased total revenue.– Marginal revenue is positive.
• Inelastic– Increased price implies increased total revenue.– Decreased price implies decreased total revenue.– Given the law of demand, increased quantity (decreased price)
implies decreased total revenue.– Marginal revenue is negative.
• Unit elastic is neither elastic nor inelastic so MR = 0.
Elasticity
Price Elasticity of Demand• %> 1 then Demand is Price Elastic (Demand is sensitive to price changes)
% change in price results in a larger % change in quantity demandedEd= .04/.02 = 2
• If PEoD = 1 then Demand is Unit Elastic% change in price and % change in quantity demanded are the same
Ed= .02/.02 = 1
• If PEoD % < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes) % change in price produces a smaller % change in quantity demanded
Ed= .01/.02 = .5
Alfred Marshall1842-1924
His book, Principles of Economics (1890), was the dominant economic textbook in England for many years. It brings the ideas of supply and demand, marginal utility, and costs of production into a coherent whole. He is known as one of the founders of economics and is credited with defining PED.
Determinants of Demand Elasticity• Three questions can be asked about a product to give
us a good idea about the product’s demand elasticity• Can the purchase be delayed? Cannot postpone the
purchase of a product = usually inelastic• Are Adequate Substitutes Available? Can consumers
switch back and forth between the product and its substitute = elastic
• Does the purchase use a large portion of income? If amount is large = then demand tends to be elastic
• If amount of income is small = demand tends to be inelastic (ie 5% increase in candy bar vs. a car)
Determinants of Demand Elasticity• Can the purchase be delayed? Cannot postpone the purchase of a
product = usually inelastic• Are Adequate Substitutes Available? Can consumers switch back
and forth between the product and its substitute = elastic• Does the purchase use a large portion of income? If amount is
large = then demand tends to be elastic
Gas at GetGo
Total Revenue Test
• In economics, the Total Revenue Test is a means for determining whether demand is elastic or inelastic. If demand is elastic, a decrease in price will increase total revenue. Even though a lesser price is received per unit, enough additional units are sold to more than make up for the lower price. If demand is inelastic, a price decrease will reduce total revenue. The increase in sales will not fully offset the decline in revenue per unit, and total revenue will decline.
• Total Revenue is TR=P (product price) xQ (quantity sold)• Are there any items that you notice / feel never go on sale??
• Price $2; Quantity Demanded 10; TR=$20
Notice if price declines from $2 to $1, the qty. demanded becomes 40 and TR=$40, so TR has increased from $20 to $40
At $4 Qd was 10 units (TR 40)At $1 Qd was 20 units (TR 20)
Bad day at the shop
At $3 Qd was 10 units (TR 30)At $1 Qd was 30 units (TR 30)Hope you didn’t spend much
on advertising!
AP Review
• If a store raises its prices by 20 percent and its total revenue increases by 10 percent, the demand it faces in this price range must be
A. InelasticB. ElasticC. Unit ElasticD. Perfectly ElasticE. Perfectly Inelastic
A. Inelastic
AP Review
• Demand is elastic ifA. Consumers respond strongly to changes in the product’s
priceB. A large percentage change in price brings about a small
percentage change in quantity demandedC. A small percentage change in price brings about a small
percentage change in quantity demandedD. The quantity demanded is not responsive to price changesE. The demand curve is vertical
A. Consumers respond strongly to changes in the product’s price
AP Review
• When a firm raises the price of its product, what happens to total revenue?
A. If demand is elastic, total revenue decreasesB. If demand is unit elastic, total revenue increasesC. If demand is inelastic, total revenue decreasesD. If demand is elastic, total revenue increasesE. If demand is unit elastic, total revenue
decreasesA. If demand is elastic, total revenue decreases
AP Review• The basic formula for the price elasticity of demand
coefficient is:?A. Absolute decline in qty demanded/absolute increase
in priceB. % change in qty demanded / % change in priceC. Absolute decline in price / absolute increase in qty
demandedD. % change in price / % change in qty demanded
B. If demand is elastic, total revenue decreasesFYI E is the bionomial theorom – please see your math teacher on that one.
AP Review
• Suppose the price of NetFlix increased from $16.20 to $19.80 and as a result the number of NetFlix subscribers decreased from 224,000 to 176,000. Along this portion of the demand curve, price elasticity of demand is:
A. 0.8B. 1.2C. 1.6D. 8.0E. 9.3
B. 1.2(Is NetFlix elastic, inelastic, or unit elasticity in this example?)
AP Review• An antidrug policy which reduces the supply of bricks (ie heroin) might:A. Increase street crime because the addict’s demand for heroin is
highly inelasticB. Reduce street crime because the addict’s demand for heroin is highly
elasticC. Reduce street crime because the addict’s demand for heroin is highly
inelasticD. Increase street crime because the addict’s demand for heroin is
highly elasticE. Reduce street crime because the addict’s demand for heroin is unit
elasticityB. Increase street crime because the addict’s demand for heroin is highly
inelastic