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C hapter 4

C hapter 4. Elasticity. Economic Principles. Demand sensitivity Determinants of demand Sensitivity to price changes Price elasticity of demand Cross elasticity. Economic Principles. Substitute and complementary goods Normal and inferior goods Supply elasticity

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C hapter 4

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  1. Chapter 4 Elasticity

  2. Economic Principles • Demand sensitivity • Determinants of demand Sensitivity to price changes • Price elasticity of demand • Cross elasticity Gottheil - Principles of Economics, 4e

  3. Economic Principles • Substitute and complementarygoods • Normal and inferior goods • Supply elasticity • Relationship between price Elasticity of supply and tax revenues Gottheil - Principles of Economics, 4e

  4. EXHIBIT 1A DEMAND RESPONSE TO PRICE CHANGE

  5. EXHIBIT 1B DEMAND RESPONSE TO PRICE CHANGE

  6. EXHIBIT 1C DEMAND RESPONSE TO PRICE CHANGE

  7. Exhibit 1: Demand Response to Price Change 1. The demand curve in panel a can be described as: • Vertical Gottheil - Principles of Economics, 4e

  8. Exhibit 1: Demand Response to Price Change The demand curve is vertical in panel a because: • The demand for penicillin doesn’t change –regardless of what price is charged. Gottheil - Principles of Economics, 4e

  9. Exhibit 1: Demand Response to Price Change The demand curve in panel b can be described as: • Fairly steep Gottheil - Principles of Economics, 4e

  10. Exhibit 1: Demand Response to Price Change The demand curve in panel b compares to the demand curve in panel c: • The demand curve in panel b is steeper than in panel c. Gottheil - Principles of Economics, 4e

  11. Exhibit 1: Demand Response to Price Change This tells us that the demand response for spark plugs versus Coca-Cola: • When price is cut, the demand response for Coca-Cola is greater than the demand response for spark plugs. Gottheil - Principles of Economics, 4e

  12. Demand Sensitivity Demand Sensitivity • Demand sensitivity describes how consumer demand reacts to changes in price. • High sensitivity: a given change in price will result in a large change in quantity demanded. • Low sensitivity, or insensitivity: a given change in price will result in little or no change in quantity demanded. Gottheil - Principles of Economics, 4e

  13. EXHIBIT 2 MARKET DEMAND FOR COCA-COLA AND SPARK PLUGS Gottheil - Principles of Economics, 4e

  14. Exhibit 2: Market Demand for Coca-Cola and Spark Plugs In Exhibit 2, which demand curve, Panel a or b, has a steeper slope? • Panel a, the demand for Coca-Cola, has a steeper slope. Gottheil - Principles of Economics, 4e

  15. Exhibit 2: Market Demand for Coca-Cola and Spark Plugs Which panel depicts high demand sensitivity? • Panel a depicts high demand sensitivity. • A decrease in the price of Coca-Cola results in a large increase in quantity demanded. • The slope of the demand curve is steep. Gottheil - Principles of Economics, 4e

  16. What Factors Influence Demand Sensitivity? All else equal, the demand for low-priced goods is less elastic than high-priced goods. • When something is inexpensive people are less price sensitive. Gottheil - Principles of Economics, 4e

  17. What Factors Influence Demand Sensitivity? The elasticity of demand for poor people is larger than for rich people. • Poor people are more sensitive to price changes than rich people. Gottheil - Principles of Economics, 4e

  18. What Factors Influence Demand Sensitivity? The price elasticity of demand for basic goods (necessities) is not larger than for less essential goods. • There are fewer substitutes for basic goods (such as bread, electricity, or gasoline) than for less essential goods (such as slices of pizza or specific brands of running shoes). Gottheil - Principles of Economics, 4e

  19. What Factors Influence Demand Sensitivity? A product used as a compliment with an essential good will have the elasticity characteristics of the essential good. • If something is used in conjunction with an essential good, then consumption will not decline very much if price rises. Gottheil - Principles of Economics, 4e

  20. What Factors Influence Demand Sensitivity? In which of the following situations will the price elasticity of demand be largest: • When people have a brief period of time to adjust • When people have a long time period to adjust. Gottheil - Principles of Economics, 4e

  21. What Factors Influence Demand Sensitivity? In which of the following situations will the price elasticity of demand be largest: • When people have a brief period of time to adjust • When people have a long time period to adjust. Gottheil - Principles of Economics, 4e

  22. From Sensitivity to Elasticity The price elasticity of demand is not the same thing as the slope of the demand curve. • The slope of the demand curve will differ based on the units used to measure price and quantity. Gottheil - Principles of Economics, 4e

  23. From Sensitivity to Elasticity The price elasticity of demand is not the same thing as the slope of the demand curve. • We want a measure of sensitivity that will be the same regardless of the units used to measure price and quantity. Gottheil - Principles of Economics, 4e

  24. From Sensitivity to Elasticity The price elasticity of demand is not the same thing as the slope of the demand curve. • Price elasticity of demand is the percent change in quantity demanded divided by the percentage change in price. Gottheil - Principles of Economics, 4e

  25. From Sensitivity to Elasticity Formula for computing the price elasticity of demand: • ed = (Q2 - Q1)/[(Q2 + Q1)/2] divided by(P2 - P1)/[(P2 + P1)/2] Gottheil - Principles of Economics, 4e

  26. EXHIBIT 3A PRICE ELASTICITIES OF DEMAND FOR FOOTBALL TICKETS AND MILK 26 © 2005 Thomson

  27. EXHIBIT 3B PRICE ELASTICITIES OF DEMAND FOR FOOTBALL TICKETS AND MILK 27 © 2005 Thomson

  28. Exhibit 3: Price Elasticities of Demand for Football Tickets and Milk In Exhibit 3, elasticity of demand for football tickets within the $4 to $3 price range is 3.5. This means: • A price elasticity of 3.5 means that a 1 percent change in price generates a 3.5 percent change in quantity demanded. Gottheil - Principles of Economics, 4e

  29. Exhibit 3: Price Elasticities of Demand for Football Tickets and Milk In Exhibit 3, elasticity of demand for football tickets within the $4 to $3 price range is 3.5. This means: • Elasticities greater than 1.0 are price elastic. Gottheil - Principles of Economics, 4e

  30. Exhibit 3: Price Elasticities of Demand for Football Tickets and Milk In the $2 to $1 price range, elasticity of demand for football tickets falls to 0.5. This means: • A 0.5 price elasticity means that a 1 percent change in price generates a 0.5 percent change in quantity demanded. Gottheil - Principles of Economics, 4e

  31. Exhibit 3: Price Elasticities of Demand for Football Tickets and Milk In the $2 to $1 price range, elasticity of demand for football tickets falls to 0.5. This means: • Elasticities less than 1.0 are price inelastic. Gottheil - Principles of Economics, 4e

  32. Exhibit 3: Price Elasticities of Demand for Football Tickets and Milk When the price of football tickets rises from $1 to $2, quantity demanded falls from 700 to 500. The price elasticity of demand is: • (Q2 - Q1)/[(Q2 + Q1)/2] = (700 - 500)/[(700 + 500)/2] = 1/3. Gottheil - Principles of Economics, 4e

  33. Exhibit 3: Price Elasticities of Demand for Football Tickets and Milk When the price of football tickets rises from $1 to $2, quantity demanded falls from 700 to 500. The price elasticity of demand is: • (P2 - P1)/[(P2 + P1)/2] = (2 - 1)/[(2 + 1)/2] = 2/3 Gottheil - Principles of Economics, 4e

  34. Exhibit 3: Price Elasticities of Demand for Football Tickets and Milk When the price of football tickets rises from $1 to $2, quantity demanded falls from 700 to 500. The price elasticity of demand is: • ed = (1/3)/(2/3) = 1/2. Gottheil - Principles of Economics, 4e

  35. EXHIBIT 4 ELASTICITIES, PRICE, AND REVENUE CHANGES Gottheil - Principles of Economics, 4e

  36. Exhibit 4: Elasticities, Price, and Revenue Changes If demand is price inelastic and price goes down, total revenue decreases. • When demand is price inelastic, the increase in quantity is less than proportionate to the decrease in price. • Price falls more than quantity increases and total revenue decreases. Gottheil - Principles of Economics, 4e

  37. Cross Elasticity Cross elasticity of demand • It is the ratio of a percentage change in quantity demand of one good to a percentage change in the price of another good. Gottheil - Principles of Economics, 4e

  38. EXHIBIT 5 PRICE ELASTICITIES OF DEMAND FOR SELECTED GOODS Source: Edward Mansfield, Microeconomics (New York: W. W. Norton, 1997); Robert Hall and Mark Lieberman, Economics (Cincinnati: South-Western College Publishing, 1998); Gary Brester and Michael Wohlgenant, “Estimating Interrelated Demands for Meat Using New Measures for Ground and Table Cut Beef,” American Journal of Agricultural Economics (November 1991); and Heinz Kohler, Intermediate Economics:Theory and Applications (new York: Scott, Foresman, 1986). Gottheil - Principles of Economics, 4e

  39. Exhibit 5: Price Elasticities of Demand for Selected Goods Which of the following has the largest price elasticity of demand? • Corn • Cigarettes • Movies Gottheil - Principles of Economics, 4e

  40. Exhibit 5: Price Elasticities of Demand for Selected Goods Which of the following has the largest price elasticity of demand? • Corn • Cigarettes • Movies Gottheil - Principles of Economics, 4e

  41. EXHIBIT 6 PRICE ELASTICITIES OF DEMAND IN THE SHORT RUN AND LONG RUN Source: H. S. Houthakker and Lester Taylor, Consumer Demand in the United States, 1929–1970 (Cambridge, Mass.: Harvard University Press, 1970); Richard Voith, “The Long-Run Elasticity of Demand for Commuter Rail Transportation,” Journal of Urban Economics (November 1991); and James Griffen and Henry Steele, Energy Economics and Policy (New York: Academic Press, 1980). Gottheil - Principles of Economics, 4e

  42. Exhibit 6: Price Elasticities of Demand in the Short Run and Long Run Which of the following has the smallest price elasticity of demand in the long run? • Gasoline • Jewelry and watches • Hospital care Gottheil - Principles of Economics, 4e

  43. Exhibit 6: Price Elasticities of Demand in the Short Run and Long Run Which of the following has the smallest price elasticity of demand in the long run? • Gasoline • Jewelry and watches • Hospital care Gottheil - Principles of Economics, 4e

  44. EXHIBIT 7 CROSS ELASTICITIES BETWEEN SUBSTITUTES Gottheil - Principles of Economics, 4e

  45. Exhibit 7: Cross Elasticities Between Substitutes In Exhibit 7, the demand for Tums increase when the price of Rolaids increased because: • Tums and Rolaids are substitute goods— goods that can replace each other. • When the price of Rolaids increases, some consumers are willing to switch to a cheaper substitute—Tums. Gottheil - Principles of Economics, 4e

  46. Exhibit 7: Cross Elasticities Between Substitutes In Exhibit 7, the demand for Tums increase when the price of Rolaids increased because: • Cross elasticities for substitute goods are positive. • A decrease (or increase) in the price of one good generates a corresponding decrease (or a corresponding increase) in the quantity demanded of the other.

  47. EXHIBIT 8 CROSS ELASTICITIES OF DEMAND FOR SUBSTITUTE GOODS Source: Edwin Mansfield, Microeconomics (New York: W. W. Norton, 1997); F. Gasmi, J. J. Laffont, and Q. Vuong, “Econometric Analysis of Collusive Behavior in a Soft Drink Market,” Journal of Economics and Management Strategy (Summer 1992); and Gary Brester and Michael Wohlgenant, “Estimating Interrelated Demands for Meats Using New Measures for Ground and Table Cut Beef,” American Journal of Agricultural Economics (November 1991). Gottheil - Principles of Economics, 4e

  48. Exhibit 8: Cross Elasticities of Demand for Substitute Goods Which of the following are the closest substitutes, according to Exhibit 8: • Butter and margarine • Poultry and ground beef • Natural gas and electricity Gottheil - Principles of Economics, 4e

  49. Exhibit 8: Cross Elasticities of Demand for Substitute Goods Which of the following are the closest substitutes, according to Exhibit 8: • Butter and margarine • Poultry and ground beef • Natural gas and electricity Gottheil - Principles of Economics, 4e

  50. Exhibit 8: Cross Elasticities of Demand for Substitute Goods Butter and margarine the closest substitutes because: • They have the largest cross elasticity of demand. Gottheil - Principles of Economics, 4e

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