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# Chapter 5 Elasticity - PowerPoint PPT Presentation

Chapter 5 Elasticity. You are responsible for reading Chapter 4!!!. What have we done?. Chapter 3 gave us downward sloping demand curves Law of demand Now want to see how Q d changes when price changes. Elasticity. Response of one variable to a change in another variable

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Chapter 5Elasticity

You are responsible for reading Chapter 4!!!

• Chapter 3 gave us downward sloping demand curves

• Law of demand

• Now want to see how Qd changes when price changes

• Response of one variable to a change in another variable

• Price elasticity of demand

• Measure of the responsiveness of Qd of a product to a change in the price of that product

• What if Ed = 3?

• If price was increased from the prevailing point the % change in Qd would be 3 times the change in price

• Shouldn’t it be negative?

• So price increases and Qd decreases?

• Yes!!

• For ease we look at the absolute value, but know that the law of demand holds

• Measures the change between two observed points.

• P1 = 10

• P2 = 12

• Q1 = 100

• Q2 = 50

• Elasticity??

• Which is Point A???

• Big Problem!!!

• Answers vary depending on where you start

• Becomes more important the larger the change

• To avoid the endpoint problem take elasticity at the midpoint (average) of the two points

• With arc elasticity it is clear which points are used

• P1 is the first price

• P2 is the second price

• Qd1 and Qd2 are the first and second quantity demanded respectively

• Numerator > Denominator

• Numerator < Denominator

• Numerator = Denominator

• Numerator = 0

• Denominator = 0

• Each has a specific name and result

• Ed > 1

• % change in quantity demanded > % change in price

• FLATTER CURVE

• What are some examples of an elastic good???

• Ed<1

• % change in the price > percent change in quantity demanded

• STEEPER CURVE

• What are some examples of an inelastic good?

• Ed=1

• % change in price = % change in quantity demanded

• Change in price brings a proportionate change in quantity demanded

• CURVE

• Ed = (denominator = 0)

• % change in quantity demanded is A LOT in response to a change in price

• Price increases and quantity demanded goes to 0

• Totally flat --- horizontal

• Extreme

• Examples???

• Ed = 0

• % change in quantity demanded DOESN’T CHANGE in response to a change in price

• Totally steep --- vertical

• Extreme

• Examples???

• Because the extremes (perfectly inelastic and perfectly elastic) are not.

• Use as points of reference only

• Revenue depends on elasticity

• Michael Jordan and Nike shoes

• No substitutes -- inelastic demand

• What happens to Qd if price increases?

• Substitutes – elastic demand

• What happens to Qd if price increases?

• Total revenue = price*quantity

• Firm uses to decide if to produce more or less

• Elastic demand

• Price increase

• Price decrease

• Inelastic demand

• Price increase

• Price decrease

• Unit elastic demand

• Price increase

• Price decrease

• Elasticity of the demand determines if with a price increase…

• Total revenue increases

• Total revenue decreases

• Total revenue remains the same

• Demand is downward sloping

• Along the line elasticity varies from highly elastic to highly inelastic

• But…remember SLOPE is constant

A

B

C

D

E

F

G

Q

Find Total Revenue and Elasticity of Demand

• Upper end of Demand Curve

• Qd is low and price is high

• Freak out more when price is high

• Lower end of Demand Curve

• Qd is high and price is low

• Freak out less when price is low

• As move down the demand curve from higher prices to lower the price elasticity of demand goes from elastic to inelastic

• Number of substitutes available

• Increase substitutes increases elasticity

• More narrowly defined goods have more substitutes (compared to broadly defined)

• Example: Fords vs all cars

• Percentage of one’s budget that is spent on the good

• More expensive??? More elastic

• More affected by price (even small changes)

• Amount of time that passed since price change

• Increase time passed gives more opportunity to change behavior or react to price change

• Overtime can look for substitutes

• Increase time increases elasticity

• More elastic in long term than short

• Measures the responsiveness of quantity demanded to a change in price of ANOTHER good

• To determine if goods are substitutes or compliments

• Ec>0 – substitutes

• % change in quantity demanded and price move in same direction

• Ec<0 – compliments

• % change in quantity demanded and price move in opposite directions

• Ec=0 – goods unrelated

• Measures the responsiveness of quantity demanded to the change in income

• Use to determine if a good is normal or inferior

• Ey>0 – normal good

• As income increases Qd increases

• Ey<0 – inferior good

• As income increases Qd decreases

• If |Ey| > 1

• % change in Qd > % change in Y

• Income elastic

• If |Ey| < 1

• % change in Qd < % change in Y

• Income inelastic

• If |Ey| = 1

• % change in Qd = % change in Y

• Income unit elastic

• If invest in the stock market do you want to invest in a normal or inferior good?

• Normal

• Why

• Increase income would increase quantity bought and increase stock prices

• Measures the responsiveness of quantity supplied of a good to the change in the price of that good

• Es > 1

• Elastic

• Es < 1

• Inelastic

• Es = 1

• Unit elastic

• Each of these will result in a “normal” upward sloped supply curve

• Yes!!

• Es =

• Perfectly elastic or horizontal

• Es = 0

• Perfectly inelastic or vertical

• Yes!!

• Overtime producers are able to adjust their behavior and production patterns

• Supply becomes more elastic as time passes

• If government levies a tax on a product who pays the tax??

• Producers?? Consumers?? Share??

• Depends on the elasticity of demand and supply

• Find equilibrium price

• Supply shifts left in the amount of the tax

• Find new equilibrium

• Find point of second equilibrium on ORGINAL supply curve

• Shows the actual price realized by firm or equilibrium price – tax = point in question

• Difference between points determines how much of tax you pay

• Perfectly inelastic demand

• Perfectly elastic demand

• Demand more elastic than supply

• Supply more elastic than demand

• Ed > Es producer bears most of the tax burden

• Ed < Es consumer bears most of the tax burden

• Ed = Es equally share the tax burden

Numbers 5, 6, and 8Working with Graphs and Numbers1, 2, and 4