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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 5 elasticity
Chapter 5Elasticity

You are responsible for reading Chapter 4!!!

what have we done
What have we done?
  • Chapter 3 gave us downward sloping demand curves
    • Law of demand
  • Now want to see how Qd changes when price changes
elasticity
Elasticity
  • 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
slide5
So…
  • 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
point elasticity
Point elasticity
  • Measures the change between two observed points.
example
example
  • P1 = 10
  • P2 = 12
  • Q1 = 100
  • Q2 = 50
  • Elasticity??
  • Which is Point A???
  • Big Problem!!!
problem
Problem
  • Answers vary depending on where you start
  • Becomes more important the larger the change
arc elasticity
Arc Elasticity
  • To avoid the endpoint problem take elasticity at the midpoint (average) of the two points
differences
Differences
  • 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
price elasticity of demand can yield 5 basic results
Price elasticity of demand can yield 5 basic results
  • Numerator > Denominator
  • Numerator < Denominator
  • Numerator = Denominator
  • Numerator = 0
  • Denominator = 0
  • Each has a specific name and result
elastic demand
Elastic Demand
  • Ed > 1
  • % change in quantity demanded > % change in price
  • FLATTER CURVE
  • What are some examples of an elastic good???
inelastic demand
Inelastic Demand
  • Ed<1
  • % change in the price > percent change in quantity demanded
  • STEEPER CURVE
  • What are some examples of an inelastic good?
unit elastic demand
Unit Elastic Demand
  • Ed=1
  • % change in price = % change in quantity demanded
  • Change in price brings a proportionate change in quantity demanded
  • CURVE
perfectly elastic demand
Perfectly Elastic Demand
  • 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???
perfectly inelastic demand
Perfectly inelastic demand
  • Ed = 0
  • % change in quantity demanded DOESN’T CHANGE in response to a change in price
  • Totally steep --- vertical
  • Extreme
  • Examples???
aren t demand curve downward sloping
Aren’t demand curve downward sloping?
  • Because the extremes (perfectly inelastic and perfectly elastic) are not.
  • Use as points of reference only
how does a change in price affect total revenue of a firm
How does a change in price affect Total Revenue of a Firm?
  • 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?
what is total revenue
What is total revenue??
  • Total revenue = price*quantity
  • Firm uses to decide if to produce more or less
examples
examples
  • Elastic demand
    • Price increase
    • Price decrease
  • Inelastic demand
    • Price increase
    • Price decrease
  • Unit elastic demand
    • Price increase
    • Price decrease
important to look at because
Important to look at because…
  • Elasticity of the demand determines if with a price increase…
    • Total revenue increases
    • Total revenue decreases
    • Total revenue remains the same
price elasticity of demand and a straight line
Price elasticity of demand and a straight line
  • Demand is downward sloping
  • Along the line elasticity varies from highly elastic to highly inelastic
  • But…remember SLOPE is constant
slide27
P

A

B

C

D

E

F

G

Q

Find Total Revenue and Elasticity of Demand

summary
Summary
  • 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
slide30
So…
  • As move down the demand curve from higher prices to lower the price elasticity of demand goes from elastic to inelastic
determinates of price elasticity of demand
Determinates of price elasticity of demand
  • Number of substitutes available
    • Increase substitutes increases elasticity
    • More narrowly defined goods have more substitutes (compared to broadly defined)
      • Example: Fords vs all cars
more determinates
More determinates
  • Percentage of one’s budget that is spent on the good
    • More expensive??? More elastic
    • More affected by price (even small changes)
final determinate
Final determinate
  • 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
cross elasticity of demand
Cross Elasticity of Demand
  • Measures the responsiveness of quantity demanded to a change in price of ANOTHER good
when would you use cross price elasticity
When would you use Cross Price Elasticity?
  • 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
income elasticity of demand
Income elasticity of demand
  • Measures the responsiveness of quantity demanded to the change in income
why use income elasticity of demand
Why use income elasticity of demand?
  • 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
can also say
Can also say…
  • 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
can we use income elasticity in the real world
Can we use income elasticity in the real world??
  • 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
price elasticity of supply
Price Elasticity of Supply
  • Measures the responsiveness of quantity supplied of a good to the change in the price of that good
classification is like demand
Classification is like demand
  • Es > 1
    • Elastic
  • Es < 1
    • Inelastic
  • Es = 1
    • Unit elastic
  • Each of these will result in a “normal” upward sloped supply curve
any extreme elasticities
Any extreme elasticities???
  • Yes!!
  • Es =
    • Perfectly elastic or horizontal
  • Es = 0
    • Perfectly inelastic or vertical
does time play a role in elasticity of supply
Does time play a role in elasticity of supply?
  • Yes!!
  • Overtime producers are able to adjust their behavior and production patterns
  • Supply becomes more elastic as time passes
elasticity and taxes
Elasticity and taxes
  • If government levies a tax on a product who pays the tax??
  • Producers?? Consumers?? Share??
  • Depends on the elasticity of demand and supply
how find
How find??
  • 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
who pays more of the tax
Who pays more of the tax??
  • Perfectly inelastic demand
  • Perfectly elastic demand
  • Demand more elastic than supply
  • Supply more elastic than demand
summary53
Summary
  • 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
homework
Homework

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

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