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Price Elasticity Coefficient Formula

- Ed = % change in quantity demanded of product X

% change in price of product X

Calculating % change

% Change in quantity = nqd – iqd

initial quantity demanded

Example: % Change in quantity

100,000 nqd - 110,000 iqd = - 10,000

-10,000 = .10 or 10%

100,000

Price Elasticity Coefficient Formula

- Ed = % change in quantity demanded of product X

% change in price of product X

- Change in price = New Price – Initial Price

Initial price

New Price = $4

Initial Price = $3

$4 np - $3 ip = $1 = .33 or 33%

$3 ip $3

Price Elasticity Coefficient Formula

- Ed = % change in quantity demanded of product X

% change in price of product X

10% = .30 or 30%

33%

Elasticity

- It is all about how things respond to changes in prices
- Responsive or not responsive

Supply and Demand Review

- Define the Law of Demand
- Define the Law of Supply
- What is the difference between a change in demand and a change in quantity demanded?
- What happens if price is above equilibrium?
- What happens if price is below equilibrium?
- Define Consumer’s and Producer’s Surplus
- Identify the rule for double shifts in S&D
- Explain the results of an excise tax

Consumers will buy more when prices go down and less when prices go up

HOW MUCH MORE OR LESS?

DOES IT MATTER?

Elasticity

Elasticity shows how sensitive quantity is to a change in price.

Summary of the Chapter

- Paul Salmon Video - Elasticity

Goals Of This Chapter

- By the end of this chapter you should be able to do the
- Elasticity Slide

4 Types of Elasticity

- Elasticity of Demand
- Elasticity of Supply
- Cross-Price Elasticity (Subs or Comp)
- Income Elasticity (Norm or Inferior)

Total Revenue

- Total revenue = total amount the seller receives from the sale of a product or service
- In a particular time period
- Formula

TR = P * Q

- TR = total revenue
- P = Price
- Q = quantity

Total Revenue

- Formula

TR = P X Q

- TR = total revenue
- P = Price
- Q = quantity
- Example
- Price is $3.50 per gallon
- Quantity = 10 gallons
- $3.5 * 10 = $35 Total Revenue

What Happens If---

- What happens to total revenue if
- Prices go up?
- Prices go down?
- We know about the Supply and Demand Curve
- Does not tell us what happens if---
- Brings us to elasticity

Elasticity

- Measure of the responsiveness of the quantity demanded to a good or service
- To change in price
- When all other factors remain the same

1. Elasticity of Demand

- Elasticity of Demand-
- Measurement of consumers responsiveness to a change in price.
- What will happen if price increase? How much will it affect Quantity Demanded
- Who cares?
- Used by firms to help determine prices and sales
- Used by the government to decide how to tax

Elasticity of Demand

- In the previous section, supply and demand curves were drawn as straight lines.
- This is a simplification,
- we assume rate of change of demand or supply is the same for all prices in the market.
- At some prices, a small change in price may
- cause a large change in the quantity demanded.

Name---

- In the short run, name
- Products whose price change will not change demand much
- Products whose price change will change demand significantly

This shown in the diagram as the movement from Pe to Pe1; a small change in price which causes an even larger percentage decrease in quantity demanded (from Qe to Qe1.

At other prices, a large increase in price may see a much smaller decrease in demand. This shown in the diagram as the movement from Pe2 to Pe3; a large change in price which causes a smaller percentage decrease in quantity demanded (from Qe2 to Qe3.

Inelastic Demand

INelastic = Quantity is INsensitive to a change in price.

- If price increases, quantity demanded will fall a little
- If price decreases, quantity demanded increases a little.
- In other words, people will continue to buy it.

20%

5%

A INELASTIC demand curve is steep! (looks like an “I”)

- Examples:
- Gasoline
- Milk
- Diapers

- Chewing Gum
- Medical Care
- Toilet paper

Inelastic Demand

If percentage change in price produces a smaller percentage change in quantity demanded

Inelastic Demand

- General Characteristics of INelastic Goods:
- Few Substitutes
- Necessities
- Small portion of income
- Required now, rather than later
- Elasticity coefficient less than 1

20%

5%

Elastic Demand

Elastic = Quantity is sensitive to a change in price.

- If price increases, quantity demanded will fall a lot
- If price decreases, quantity demanded increases a lot.
- In other words, the amount people buy is sensitive to price.

An ELASTIC demand curve is flat!

- Examples:
- Soda
- Boats
- Beef

- Real Estate
- Pizza
- Gold

Elastic Demand

- General Characteristics of Elastic Goods:
- Many Substitutes
- Luxuries
- Large portion of income
- Plenty of time to decide
- Elasticity coefficient greater than 1

Price Elasticity Coefficient Formula

- Ed = % change in quantity demanded of product X

% change in price of product X

Calculating % change

% Change in quantity = nqd – iqd

initial quantity demanded

Example: % Change in quantity

100,000 nqd - 110,000 iqd = - 10,000

-10,000 = .10 or 10%

100,000

Price Elasticity Coefficient Formula

- Ed = % change in quantity demanded of product X

% change in price of product X

- Change in price = New Price – Initial Price

Initial price

New Price = $4

Initial Price = $3

$4 np - $3 ip = $1 = .33 or 33%

$3 ip $3

Price Elasticity Coefficient Formula

- Ed = % change in quantity demanded of product X

% change in price of product X

10% = .30 or 30%

33%

Graph

- Graph the previous example
- Is it elastic or inelastic? WHY?
- Inelastic because change in % change in quantity demanded is less than % change in price
- Or a 33% change in price created a 10% drop in quantity demanded
- Calculated price elastic is < 1 therefore price is inelastic

You Solve

- Decide the price elasticity of demand for a slice of pizza at $2.00 by examining a price decrease from $2.00 to $1.50 per slice. In this case, the demand pizza would increase from 7 million slices to 10 million slices. You can use these figures to calculate the price elasticity of demand

Ed= % change in quantity demanded of product X

% change in price of product X

- Ed = (10M – 7M) ÷ 7M (DN-O÷O)

($1.50 - $2.00) ÷ $2.00 (PN-O÷O)

- Ed = .43 = -1.72

- 0.25

Drop the negative: Ed is > 1 therefore the demand for pizza slices is elastic

Negative Numbers

- If price increases by 10% and consumers respond by decreasing purchases by 20%
- the equation computes the elasticity coefficient as -2.
- The result is negative because an increase in price (a positive number)
- leads to a decrease in purchases (a negative number).
- Because the law of demand says it will always be negative, many economists ignore the negative sign

Elastic or Inelastic?

Beef- 1.27

Gasoline- .20

Real Estate- 1.6

Medical Care- .31

Electricity- .13

Gold- 2.6

Elastic

INelastic

Elastic

INelastic

INelastic

Elastic

What about the demand for insulin for diabetics?

What if % change in quantity demanded equals % change in price?

Perfectly INELASTIC

(Coefficient = 0)

Unit Elastic (Coefficient =1)

2. Price Elasticity of Supply

- Elasticity of Supply-
- Elasticity of supply shows how sensitiveproducers are to a change in price.
- Elasticity of supply is based on time limitations.
- Producers need time to produce more.

- INelastic = Insensitive to a change in price (Steep curve)
- Most goods have INelastic supply in the short-run
- Elastic = Sensitive to a change in price (Flat curve)
- Most goods have elastic supply in the long-run
- Perfectly Inelastic = Q doesn’t change (Vertical line)
- Set quantity supplied

Elasticity of supply is influenced by a number of factors. These include :

- the length of the production period. In the late 1990\'s, demand for Australia wines overseas has reached all time records. Vines take three years to grow to a point where they yield adequate amounts of fruit. Increases in demand for Australian wine has seen prices rise (from Po to P1), and returns to existing grape growers are excellent. Those who wish to buy grapes face a market where supply can only increase marginally (from Qo to Q1), in the short term.
- However, many new stands of vines are being planted, and in a few years, returns to growers may stabilise, as supply increases. Prices will fall from P1 to P2 as the supply of grapes increases from Q1 to Q2.

Price Elasticity of Supply Over Time

- How would you graph the supply elasticity of Gas over time?
- Lets see

3. Cross-Price Elasticity of Demand

Cross-Price elasticity shows how sensitive a product is to a change in price of another good

It shows if two goods are substitutes or complements

% change in quantity of product “b”

% change in price of product “a”

P increases 20%

Q decreases 15%

- (test) If coefficient is negative (shows inverse relationship) then the goods are complements
- If coefficient is positive (shows direct relationship) then the goods are substitutes

Think

- Pizza and Burgers are elastic and substitutes of each other
- If the price of pizza declines
- 1. What happens to the sale of pizza?
- 2. What happens to the sale of burgers?
- 2. Soda is a compliment to pizza. What happens to the sale of soda?
- Lets Graph

Income elasticity shows how sensitive a product is to a change in INCOME

It shows if goods are normal or inferior

4. Income-Elasticity of Demand% change in quantity

% change in income

Income increases 20%, and quantity decreases 15% then the good is a…

INFERIOR GOOD

- (test) If coefficient is negative (shows inverse relationship) then the good is inferior
- If coefficient is positive (shows direct relationship) then the good is normal
- Ex: If income falls 10% and quantity falls 20%…

Total Revenue Test

- Uses elasticity to show how changes in price will affect total revenue (TR).
- (TR = Price x Quantity)
- Elastic Demand-
- Price increase causes TR to decrease
- Price decrease causes TR to increase
- Inelastic Demand-
- Price increase causes TR to increase
- Price decrease causes TR to decrease
- Unit Elastic-
- Price changes and TR remains unchanged
- Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases?

Is the range between A and B, elastic, inelastic, or unit elastic?

10 x 100 =$1000 Total Revenue

5 x 225 =$1125 Total Revenue

A

Price decreased and TR increased, so…

Demand is ELASTIC

50%

B

125%

You Should Now Get This

- Elastic and Inelastic Demand Baby
- Winner 2013 Econ video contest

Graph the following chart

- Calculate the Ed using the top set of numbers and prices rising

Answers -Graph

- This is what your graph should look like

Answers - Ed

- Ed = % change in quantity demanded of product X

% change in price of product X

% Change in quantity = nqd – iqd

initial quantity demanded

% Change in price = New Price – Initial Price

Initial price

Ed = (90 – 100) ÷ 100

($2 - $1.00) ÷ $1.00

- Ed = -.10 = -.1

1

Drop the negative: Ed is < 1 therefore the demand for is INelastic

Calculate the TR and determine if Total Revenue increased or decreased with a price increase

- What is gain or loss on

price move?

Answers

- $3 * 70 = $210
- $2 * 90 = $180
- Total Revenue increased $30

What Happens If ---

- Graph the following chart
- Calculate the Ed using the bottom two numbers and prices rising

Answers - Ed

- Ed = % change in quantity demanded of product X

% change in price of product X

% Change in quantity = nqd – iqd

initial quantity demanded

% Change in price = New Price – Initial Price

Initial price

Ed = (40 – 70) ÷ 70

($4 - $3.00) ÷ $3.00

- Ed = -.4285 or 42.85% = 1.28

.3333 or 33.33%

Drop the negative: Ed is > 1 therefore the demand for is elastic

Practice Problem

- See handout

Consumer and Producer Surplus

- Consumer Surplus
- Difference between maximum price willing to pay and the actual price producers charge
- Think of it as a “willing to pay” curve

Marginal Benefit & Surplusses

- Marginal Benefit
- What you gain when you get one more unit
- Measured by what you are willing to give up
- Everyday life we say “getting value for our money”
- There is a difference between value and price

Value vs. Price

- Value is what we get
- Price is what we pay
- Everyday idea of value is marginal benefit

OR

- The measure of the maximum price what consumers are willing to pay for another unit of a good or service

Pizza Sales Per Slice

2

1.5

$1

.5

Consumer Surplus

Consumer surplus from 10th slice of pizza

P

Willing to pay

Market Price

Amount Paid

D

10

20 30 40

In the free-market, buyers and sellers voluntarily come together to seek mutual benefits.

In the free-market, buyers and sellers voluntarily come together to seek mutual benefits.

In the free-market, buyers and sellers voluntarily come together to seek mutual benefits.

In the free-market, buyers and sellers voluntarily come together to seek mutual benefits.

Example of Voluntary Exchange

Ex: You want to buy a truck so you go to the local dealership. You are willing to spend up to $20,000 for a new 4x4. The seller is willing to sell this truck for no less than $15,000. After some negotiation you buy the truck for $18,000.

Analysis:

Buyer’ Maximum-

Sellers Minimum-

Price-

Consumer’s Surplus-

Producer’s Surplus-

$20,000

$15,000

$18,000

$2,000

$3,000

Consumer Surplus is the difference between what you are willing to pay and what you actually pay.

CS = Buyer’s Maximum – Price

Producer’s Surplus is the difference between the price the seller received and how much they were willing to sell it for.

PS = Price – Seller’s Minimum

Consumer and Producer’s Surplus

P

- Calculate the :
- Consumer Surplus
- Producer Surplus
- Total Surplus

$10

8

6

$5

4

2

1

S

CS

PS

D

2 4 6 8

10

Q

Surpluses

- Could be calculated in Quantity

Practice Problem

Q. If dinner sells for $10, what is the value of Dons’ consumer surplus?

Practice Problem

Q. If dinner sells for $10, what is the value of Dons’ consumer surplus?

A. Willing to pay is $15. Market price is $10. Willing to pay ($15) – Actual Price ($10) = $5

Practice Problem

Q. If dinner sells for $11, what is the TOTAL value of consumer surplus?

Practice Problem

Q. If dinner sells for $11, what is the TOTAL value of consumer surplus?

- 20 – 11 = 9, 15 – 11 = 4, 12 – 11 = 1
- 9 + 4 + 1 = $14 consumer surplus

For a given linier demand curve, the value of consumer surplus does what as market price increases?

For a given linier demand curve, the value of consumer surplus does what as market price increases?

- Decreases as market price increases

15. A marketing firm has done a study of market demand for DVDs of three different movies. Calculate the total revenue for each movie in columns 3, 5, and 7.

Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue?

Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue?

Applying the total revenue test, we see that total revenues remain approximately constant for movie A, meaning that demand is unit-elastic. Total revenues for movie B are increasing as price decreases, meaning that demand for movie B is elastic. Total revenues for movie C are decreasing as price decreases, meaning the demand for movie C is inelastic. [text: E pp. 77-80; MA pp. 77-80; MI pp. 77-80]

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