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Econ 2610: Principles of Microeconomics

Econ 2610: Principles of Microeconomics. Yogesh Uppal Email: yuppal@ysu.edu. Chapter 4. Elasticity. Drug Enforcement and Local Theft. Hypothesis Drug users steal to buy drugs Increase drug enforcement will decrease theft Analysis Increased enforcement reduces supply of drugs

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Econ 2610: Principles of Microeconomics

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  1. Econ 2610: Principles of Microeconomics Yogesh Uppal Email: yuppal@ysu.edu

  2. Chapter 4 Elasticity

  3. Drug Enforcement and Local Theft • Hypothesis • Drug users steal to buy drugs • Increase drug enforcement will decrease theft • Analysis • Increased enforcement reduces supply of drugs • Price of drugs increases • Quantity demanded decreases • Theft goes down ONLY IF total expenditures on drugs decreases • How responsive is quantity demanded to price?

  4. Price Elasticity of Demand P Q • Price elasticity of demand • Percentage change in quantity demanded from 1% change in price • Measure of responsiveness of quantity demanded to changes in price • Example • Price of beef decreases 1% • Quantity of beef demanded increases 2% • Price elasticity of demand is – 2

  5. Calculate Price Elasticity Percentage change in quantity demanded ε = Percentage change in price • Price elasticity of demand is always negative • Ignore the sign • For small percentage changes in price

  6. Elastic Demand Price Elasticity of Demand Unit elastic Elastic Inelastic 0 1 2 3 • If price elasticity is greater than 1, demand is elastic • Percentage change in quantity is greater than percentage change in price • Demand is responsive to price

  7. Inelastic Demand Price Elasticity of Demand Unit elastic Elastic Inelastic 0 1 2 3 • If price elasticity is less than 1, demand is inelastic • Percentage change in quantity is less than percentage change in price • Quantity demanded is not very responsive to price

  8. Unit Elastic Demand Price Elasticity of Demand Unit elastic Elastic Inelastic 0 1 2 3 • If price elasticity is 1, demand is unit elastic • Price and quantity change by the same percentage

  9. Example: Demand for Pizza Percentage change in quantity demanded ε = Percentage change in price 1% ε = = 0.33 Demand is inelastic 3%

  10. Determinants of Price Elasticity of Demand

  11. Examples of Elasticities

  12. Price Elasticity Notation Percentage change in quantity demanded ΔQ / Q ε = ε = ΔP / P Percentage change in price • ΔQ is the change in quantity • ΔQ / Q is percentage change in quantity • ΔP is change in price • ΔP / P is percentage change in price

  13. Price Elasticity on a Straight-Line Demand Curve P 1 x ε = Q slope • Price elasticity is different at each point • Slope is the same for the demand curve • P/Q decreases as price goes down and quantity goes up

  14. Price Elasticity Pattern a Price a/2 b/2 b Quantity • Price elasticity changes systematically as price goes down • At high P and low Q, P / Q is large • Demand is elastic • At the midpoint, demand is unit elastic • At low P and high Q, P / Q is small • Demand is inelastic

  15. Two Special Cases Price Price D D Quantity Quantity Perfectly Elastic Demand Infinite price elasticity of demand Perfectly Inelastic Demand Zero price elasticity of demand

  16. Elasticity and Total Expenditure Price Expenditures = 8 2 D 4 Quantity • When price increases, expenditures can increase, decrease or remain the same • The change in expenditures depends on elasticity • Terminology: total expenditures = total revenue • Calculate as P x Q • Graphing idea: total expenditures is the area of a rectangle with height P and width Q • Example: P = 2 and Q = 4

  17. Price Elasticity and Total Expenditure D D 12 12 Expenditure = $1,000/day Expenditure = $1,600/day Price ($/ticket) Price ($/ticket) B 4 A 2 4 6 5 6 Quantity (00s of tickets/day) Quantity (00s of tickets/day) • Movie ticket price increases from $2 to $4 • A and B are both below the midpoint of the curve • Inelastic portion of the demand curve • Total revenue increases when price increases

  18. Price Elasticity and Total Expenditure 12 12 Z Expenditure = $1,600/day 10 Expenditure = $1,000/day Y 8 Price ($/ticket) Price ($/ticket) D D 2 6 1 6 Quantity (00s of tickets/day) Quantity (00s of tickets/day) • Movie ticket price increases from $8 to $10 • Prices are both above the midpoint of the curve • Elastic portion of the demand curve • Total revenue decreases

  19. Price Changes and Total Expenditure Changes 12 1,800 1,600 10 8 Total expenditure ($/day) 1,000 6 Price ($/ticket) 4 2 2 6 10 1 2 3 4 5 6 Price ($/ticket) Quantity (00s of tickets/day)

  20. Elasticity, Price Change, and Expenditures

  21. Cross-Price Elasticity of Demand • Substitutes and complements affect demand • Cross-price elasticity of demand • Percentage change in quantity demanded of A from a 1 percent change in the price of B • Sign of cross-price elasticity shows relationship between the goods • Complements have negative cross-price elasticity • Substitutes have positive cross-price elasticity

  22. Income Elasticity of Demand • Income elasticity of demand • Percentage change in quantity demanded from a 1 percent change in income • Income elasticity of demand can be positive or negative • Positive income elasticity is a normal good • Negative income elasticity is an inferior good

  23. Price Elasticity of Supply ΔQ / Q Price elasticity of supply = ΔP / P P 1 x Price elasticity of supply = Q slope • Price elasticity of supply • Percentage change in quantity supplied from a 1 percent change in price

  24. Price Elasticity of Supply S B 10 A 8 Price 4 2 3 Quantity • If supply curve has a positive intercept • Price elasticity of supply decreases as Q increases • Graph shows • Slope = 2 • At A, P = 8 and Q = 2 • Price elasticity of supply = (8 / 2) (1 / 2) = 2.00 • At B, P = 10 and Q = 3 • Price elasticity of supply = (10 / 3) (1 / 2) = 1.67

  25. Perfectly Inelastic Supply Price S Quantity • Zero price elasticity of supply • No response to change in price • Example: land on Manhattan • Supply is completely fixed • Any one-of-a-kind item has perfectly inelastic supply • Work of art (Mona Lisa) • Hope Diamond

  26. Perfectly Elastic Supply Price S Quantity • Infinite price elasticity of supply • Sell all you can at a fixed price • Inputs purchased at a constant price • No volume discounts • Constant proportions of production • Lemonade example • Cost of production is 14¢ at all levels of Q • Marginal cost P = 14¢

  27. Determinants of Price Elasticity of Supply

  28. Supply Bottleneck: Unique Inputs • Over time, most producers develop alternative production methods and a variety of input choices • The more flexible the production process, the more elastic supply • When production relies on a single input, supply is highly inelastic • No alternatives to singular talent • Sports stars • Actors and musicians • Bill Gates, Warren Buffet, George Soros, Carl Icahn

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