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  1. Chapter 4 Elasticity Gottheil — Principles of Economics, 7e

  2. Economic Principles • Demand sensitivity • Determinants of demand sensitivity to price changes • Price elasticity of demand • Cross elasticity Gottheil — Principles of Economics, 7e

  3. Economic Principles • Substitute and complementary goods • Normal and inferior goods • Supply elasticity • Relationship between price elasticity of supply and tax revenues Gottheil — Principles of Economics, 7e

  4. EXHIBIT 1A DEMAND RESPONSE TO PRICE CHANGE Gottheil — Principles of Economics, 7e

  5. EXHIBIT 1B DEMAND RESPONSE TO PRICE CHANGE Gottheil — Principles of Economics, 7e

  6. EXHIBIT 1C DEMAND RESPONSE TO PRICE CHANGE Gottheil — Principles of Economics, 7e

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

  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, 7e

  9. Exhibit 1: Demand Response to Price Change The demand curve in panel b can be described as: • Fairly steep Gottheil — Principles of Economics, 7e

  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, 7e

  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, 7e

  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, 7e

  13. EXHIBIT 2 MARKET DEMAND FOR COCA-COLA AND SPARK PLUGS Gottheil — Principles of Economics, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  26. EXHIBIT 3A PRICE ELASTICITIES OF DEMAND FOR FOOTBALL TICKETS AND MILK Gottheil — Principles of Economics, 7e

  27. EXHIBIT 3B PRICE ELASTICITIES OF DEMAND FOR FOOTBALL TICKETS AND MILK Gottheil — Principles of Economics, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  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, 7e

  35. EXHIBIT 4 ELASTICITIES, PRICE, AND REVENUE CHANGES Gottheil — Principles of Economics, 7e

  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, 7e

  37. Elasticity and the relevant price range • The price elasticity of demand for a good changes from highly elastic to increasingly inelastic as its price continuously falls. • The price elasticity of demand for a good is described as elastic or inelastic depending on the elasticity within a price range that is relevant to our experience. Gottheil — Principles of Economics, 7e

  38. 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, 7e

  39. 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, 7e

  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, 7e

  41. 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, 7e

  42. 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, 7e

  43. Exhibit 6: Price Elasticities of Demand in the Short Run andLong 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, 7e

  44. 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, 7e

  45. EXHIBIT 7 CROSS ELASTICITIES BETWEEN SUBSTITUTES Gottheil — Principles of Economics, 7e

  46. 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, 7e

  47. 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. Gottheil — Principles of Economics, 7e

  48. 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, 7e

  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, 7e

  50. 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, 7e