Price Elasticities of Demand. Definition: Price elasticity of demand is a measure of the...

Price Price ElasticitiesElasticities of of DemandDemand

Definition:Definition:• Price elasticity of demand is a measure Price elasticity of demand is a measure

of the responsiveness of the quantity of the responsiveness of the quantity demanded of a good to a change in its demanded of a good to a change in its price when all other influences on price when all other influences on buyers’ plans remain the samebuyers’ plans remain the same

• To determine price elasticity of demand: To determine price elasticity of demand: compare the % change in the quantity compare the % change in the quantity demanded with the percentage change demanded with the percentage change in pricein price

Percentage Price in ChangePercentage Price in Change

• Starbucks raised the price of a latte Starbucks raised the price of a latte from $3 to $5 a cup. What is the from $3 to $5 a cup. What is the percentage change in price?percentage change in price?

Percent change in price =New price – Initial price

Initial Pricex 100

Percentage Change in PricePercentage Change in Price

• Starbucks cuts the price of a latte from Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the $5 to $3 a cup. What now is the percentage change in price?percentage change in price?

Percent change in price =New price – Initial price

Initial Pricex 100

Percentage Change in PricePercentage Change in Price

• Elasticity compares the percentage Elasticity compares the percentage change in the quantity demanded with change in the quantity demanded with the percentage change in pricethe percentage change in price

• Midpoint Method -- To calculate the Midpoint Method -- To calculate the percentage change that does not percentage change that does not depend on the direction of the price depend on the direction of the price changechange

Percentage Price in ChangePercentage Price in Change

• Midpoint Method CalculationMidpoint Method Calculation• Starbucks Latte price changing from $5 Starbucks Latte price changing from $5

to $3. $5 for a new price and $3 for the to $3. $5 for a new price and $3 for the initial price.initial price.

x 100Percent change in price =New price – Initial price

(New Price + Initial Price) ÷ 2

Percentage Change in PricePercentage Change in Price

• Average price is the same regardless Average price is the same regardless of whether the price rises or fallsof whether the price rises or falls

Percentage Change in Quantity Percentage Change in Quantity DemandedDemanded

• Price of a Latte rises from $3 to $5 a cup, Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from the quantity demanded decreases from 15 cups to 5 cups an hour.15 cups to 5 cups an hour.

• Uses the midpoint formula againUses the midpoint formula again

x 100x 100Percent change in price =Percent change in price =New price – Initial priceNew price – Initial price

(New Price + Initial Price) ÷ 2(New Price + Initial Price) ÷ 2

Percentage Change in Quantity Percentage Change in Quantity DemandedDemanded

• When the price of a good rises, the When the price of a good rises, the quantity demanded of it decreasesquantity demanded of it decreases– A positive change in price bring a negative A positive change in price bring a negative

change in the quantity demandedchange in the quantity demanded

• When the price of a good falls, the When the price of a good falls, the quantity demanded of it increasesquantity demanded of it increases–Negative change in price brings a positive Negative change in price brings a positive

change in the quantity demandedchange in the quantity demanded

Elastic and Inelastic DemandElastic and Inelastic Demand

• Elastic Demand Elastic Demand – when the percentage – when the percentage change in the quantity demanded exceeds change in the quantity demanded exceeds the percentage change in pricethe percentage change in price

• Unit Elastic Demand Unit Elastic Demand – percentage change in – percentage change in the quantity demanded equals the the quantity demanded equals the percentage change in pricepercentage change in price

• Inelastic Demand Inelastic Demand – percentage change in the – percentage change in the quantity demanded is less than the quantity demanded is less than the percentage change in pricepercentage change in price

Elastic DemandElastic Demand

• Perfectly Elastic Demand Perfectly Elastic Demand – an almost – an almost zero percentage change in the price zero percentage change in the price brings a very large percentage change in brings a very large percentage change in the quantity demandedthe quantity demanded

• Consumers are willing to buy any Consumers are willing to buy any quantity of the good at a given price but quantity of the good at a given price but none at a higher pricenone at a higher price

Perfectly Elastic DemandPerfectly Elastic Demand

Elastic DemandElastic Demand

• A percentage A percentage change in the change in the quantity quantity demanded demanded exceeds the exceeds the percentage percentage change in pricechange in price

Unit Elastic DemandUnit Elastic Demand

• The percentage The percentage change in the change in the quantity quantity demanded demanded equals the equals the percentage percentage change in pricechange in price

Inelastic DemandInelastic Demand

• Percentage Percentage change in the change in the quantity quantity demanded is demanded is less than the less than the percentage percentage change in change in priceprice

Perfectly Inelastic DemandPerfectly Inelastic Demand

• Percentage Percentage change in the change in the quantity quantity demanded is demanded is zero for any zero for any percentage percentage change in pricechange in price

Influences on Price Elasticity of Influences on Price Elasticity of DemandDemand

• Two influences:Two influences:1.1.Availability of substitutesAvailability of substitutes

1.1.Proportion of income spentProportion of income spent

Influences on Price Elasticity of Influences on Price Elasticity of DemandDemand

• Demand for good is elastic if a substitute is Demand for good is elastic if a substitute is easy to findeasy to find– Soft drink containersSoft drink containers

• Demand for good is inelastic if a substitute is Demand for good is inelastic if a substitute is hard to findhard to find– Oil substitutes?Oil substitutes?

Influences on Price Elasticity of Influences on Price Elasticity of DemandDemand

• Three factors that influence the ability Three factors that influence the ability to find a substitute for a good:to find a substitute for a good:

1.1.Whether good is a luxury or a necessityWhether good is a luxury or a necessity2.2.How narrowly it is definedHow narrowly it is defined3.3.Amount of time available to find a Amount of time available to find a

substitute for itsubstitute for it

Price Elasticity of DemandPrice Elasticity of Demand

• The greater the proportion of income spend The greater the proportion of income spend on a good, the greater is the impact of a rise on a good, the greater is the impact of a rise in its price on the quantity of that good that in its price on the quantity of that good that people can afford to buy and the more elastic people can afford to buy and the more elastic it is the demand for that goodit is the demand for that good

• Toothpaste?Toothpaste?

Computing Price Elasticity of DemandComputing Price Elasticity of Demand

• If the price elasticity of a demand is greater If the price elasticity of a demand is greater than 1, the demand is elasticthan 1, the demand is elastic

• If the price elasticity of demand equals 1, If the price elasticity of demand equals 1, demand is unit elasticdemand is unit elastic

• If the price elasticity of demand is less than 1, If the price elasticity of demand is less than 1, demand is inelasticdemand is inelastic

Price elasticity Price elasticity of demandof demand

Percentage change in quantity demandedPercentage change in quantity demanded

Percentage change in the pricePercentage change in the price=

Computing Price Elasticity of DemandComputing Price Elasticity of Demand

Elasticity Along a Linear Demand CurveElasticity Along a Linear Demand Curve

•Slope measures responsiveness. But slope and Slope measures responsiveness. But slope and elasticity are not the same thing!elasticity are not the same thing!•Along a linear (straight-line) demand curve, Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies.the slope is constant but the elasticity varies.

•Along a linear demand curve, demand is:Along a linear demand curve, demand is:– Unit elastic at the midpoint of the curve. Unit elastic at the midpoint of the curve. – Elastic above the midpoint of the curve.Elastic above the midpoint of the curve.– Inelastic below the midpoint of the curve.Inelastic below the midpoint of the curve.

Elasticity Along a Linear Demand CurveElasticity Along a Linear Demand Curve

Total Revenue and the Price Elasticity of DemandTotal Revenue and the Price Elasticity of Demand

• Total revenue is the amount spent on a good Total revenue is the amount spent on a good and received by its sellers and equals the and received by its sellers and equals the price of the good multiplied by the quantity price of the good multiplied by the quantity soldsold– Starbucks Latte -- $3Starbucks Latte -- $3– Demand is 15 cups an hourDemand is 15 cups an hour– Total Revenue is $45 an hourTotal Revenue is $45 an hour

• Total Revenue Test is a method of estimating Total Revenue Test is a method of estimating the price elasticity of demand by observing the price elasticity of demand by observing the change in total revenue that results from the change in total revenue that results from a price changea price change

Total Revenue and the Price Elasticity Total Revenue and the Price Elasticity of Demandof Demand

• If demand is elastic: If demand is elastic: • A given percentage rise in price brings a A given percentage rise in price brings a

larger percentage decrease in the quantity larger percentage decrease in the quantity demanded.demanded.

• And total revenue decreases. And total revenue decreases. • If demand is inelastic: If demand is inelastic:

• A given percentage rise in price brings a A given percentage rise in price brings a smaller percentage decrease in the quantity smaller percentage decrease in the quantity demanded.demanded.

• And total revenue increases.And total revenue increases.

Total Revenue TestTotal Revenue Test

Total revenue test:Total revenue test:– If price and total revenue change in the If price and total revenue change in the

opposite directions, demand is elastic.opposite directions, demand is elastic.

– If a price change leaves total revenue If a price change leaves total revenue unchanged, demand is unit elastic.unchanged, demand is unit elastic.

– If price and total revenue change in the If price and total revenue change in the same direction, demand is inelastic.same direction, demand is inelastic.

Total Revenue TestTotal Revenue Test• At $3 a cup, the quantity At $3 a cup, the quantity

demanded is 15 cups an demanded is 15 cups an hour.hour.

• Total revenue is $45 an Total revenue is $45 an hour.hour.

• When the price rises to When the price rises to $5 a cup, the quantity $5 a cup, the quantity demanded decreases to demanded decreases to 5 cups an hour.5 cups an hour.

• Total revenue decreases Total revenue decreases to $25 an hour. to $25 an hour.

• Demand is elastic.Demand is elastic.

Total Revenue TestTotal Revenue Test• At $50 a book, the At $50 a book, the

quantity demanded is 5 quantity demanded is 5 million books. million books.

• Total revenue is $250 Total revenue is $250 million.million.

• When the price rises to When the price rises to $75 a book, the quantity $75 a book, the quantity demanded decreases to 4 demanded decreases to 4 million books.million books.

• Total revenue increases Total revenue increases to $300 million.to $300 million.

• Demand is inelastic.Demand is inelastic.

Addiction and ElasticityAddiction and Elasticity

•Nonusers’ demand for addictive substances is Nonusers’ demand for addictive substances is elastic. elastic. •So a moderately higher price leads to a So a moderately higher price leads to a substantially smaller number of people trying a substantially smaller number of people trying a drug. drug.•Existing users’ demand for addictive Existing users’ demand for addictive substances is inelastic.substances is inelastic.• So even a substantial price rise brings only a So even a substantial price rise brings only a modest decrease in the quantity demanded.modest decrease in the quantity demanded.

Price Price ElasticitiesElasticities of of Demand Demand NotesNotes

Definition:Definition:• Price elasticity of demand isPrice elasticity of demand is

• To determine price elasticity of demand: To determine price elasticity of demand: compare the % change in the quantity compare the % change in the quantity demanded with the percentage change demanded with the percentage change in pricein price

Percentage Price in ChangePercentage Price in Change

• Starbucks raised the price of a latte Starbucks raised the price of a latte from $3 to $5 a cup. What is the from $3 to $5 a cup. What is the percentage change in price?percentage change in price?

=–

x

Percentage Change in PricePercentage Change in Price

• Starbucks cuts the price of a latte from Starbucks cuts the price of a latte from $5 to $3 a cup. What now is the $5 to $3 a cup. What now is the percentage change in price?percentage change in price?

=–

x

Percentage Change in PricePercentage Change in Price

• Elasticity compares the percentage Elasticity compares the percentage change in the quantity demanded with change in the quantity demanded with the percentage change in pricethe percentage change in price

• Midpoint Method --Midpoint Method --

Percentage Price in ChangePercentage Price in Change

• Midpoint Method CalculationMidpoint Method Calculation• Starbucks Latte price changing from $5 Starbucks Latte price changing from $5

to $3. $5 for a new price and $3 for the to $3. $5 for a new price and $3 for the initial price.initial price.

x=–

( + ) ÷ 2

Percentage Change in PricePercentage Change in Price

Percentage Change in Quantity Percentage Change in Quantity DemandedDemanded

• Price of a Latte rises from $3 to $5 a cup, Price of a Latte rises from $3 to $5 a cup, the quantity demanded decreases from the quantity demanded decreases from 15 cups to 5 cups an hour.15 cups to 5 cups an hour.

• Uses the midpoint formula againUses the midpoint formula again

x 100x 100Percent change in price =Percent change in price =New price – Initial priceNew price – Initial price

(New Price + Initial Price) ÷ 2(New Price + Initial Price) ÷ 2

Percentage Change in Quantity Percentage Change in Quantity DemandedDemanded

• When the price of a good rises, the When the price of a good rises, the quantity demanded of it decreasesquantity demanded of it decreases

• When the price of a good falls, the When the price of a good falls, the quantity demanded of it increasesquantity demanded of it increases

Elastic and Inelastic DemandElastic and Inelastic Demand

• Elastic Demand Elastic Demand – –

• Unit Elastic Demand Unit Elastic Demand – –

• Inelastic Demand Inelastic Demand – –

Elastic DemandElastic Demand

• Perfectly Elastic Demand Perfectly Elastic Demand – –

• Consumers are willing to buy any Consumers are willing to buy any quantity of the good at a given price but quantity of the good at a given price but none at a higher pricenone at a higher price

Perfectly Elastic DemandPerfectly Elastic Demand

Elastic DemandElastic Demand

Unit Elastic DemandUnit Elastic Demand

Inelastic DemandInelastic Demand

Perfectly Inelastic DemandPerfectly Inelastic Demand

Influences on Price Elasticity of Influences on Price Elasticity of DemandDemand

• Two influences:Two influences:1.1.Availability of ________________Availability of ________________

1.1.Proportion of ___________spentProportion of ___________spent

Influences on Price Elasticity of Influences on Price Elasticity of DemandDemand

• Demand for good is elastic if a substitute is Demand for good is elastic if a substitute is easy to findeasy to find

• Demand for good is inelastic if a substitute is Demand for good is inelastic if a substitute is hard to findhard to find

Influences on Price Elasticity of Influences on Price Elasticity of DemandDemand

• Three factors that influence the ability Three factors that influence the ability to find a substitute for a good:to find a substitute for a good:

Price Elasticity of DemandPrice Elasticity of Demand

• The greater the proportion of income spend The greater the proportion of income spend on a good, the greater is the impact of a rise on a good, the greater is the impact of a rise in its price on the quantity of that good that in its price on the quantity of that good that people can afford to buy and the more elastic people can afford to buy and the more elastic it is the demand for that goodit is the demand for that good

Computing Price Elasticity of DemandComputing Price Elasticity of Demand

• If the price elasticity of a demand is greater If the price elasticity of a demand is greater than 1, the demand is ____________than 1, the demand is ____________

• If the price elasticity of demand equals 1, If the price elasticity of demand equals 1, demand is demand is ________________________

• If the price elasticity of demand is less than 1, If the price elasticity of demand is less than 1, demand is ____________demand is ____________

Price elasticity Price elasticity of demandof demand

Percentage change in quantity demandedPercentage change in quantity demanded

Percentage change in the pricePercentage change in the price=

Computing Price Elasticity of DemandComputing Price Elasticity of Demand

Elasticity Along a Linear Demand CurveElasticity Along a Linear Demand Curve

•Slope measures responsiveness. But slope and Slope measures responsiveness. But slope and elasticity are not the same thing!elasticity are not the same thing!•Along a linear (straight-line) demand curve, the Along a linear (straight-line) demand curve, the slope is constant but the elasticity varies.slope is constant but the elasticity varies.

•Along a linear demand curve, demand is:Along a linear demand curve, demand is:– ____________ ____________ at the midpoint of the curve. at the midpoint of the curve.

– ________________________ above the midpoint of the curve. above the midpoint of the curve.

– ________________________ below the midpoint of the curve. below the midpoint of the curve.

Elasticity Along a Linear Demand CurveElasticity Along a Linear Demand Curve

Total Revenue and the Price Elasticity of DemandTotal Revenue and the Price Elasticity of Demand

• Total revenue is the amount spent on a good Total revenue is the amount spent on a good and received by its sellers and equals the and received by its sellers and equals the price of the good multiplied by the quantity price of the good multiplied by the quantity soldsold– Starbucks Latte -- $3Starbucks Latte -- $3– Demand is 15 cups an hourDemand is 15 cups an hour– Total Revenue is $45 an hourTotal Revenue is $45 an hour

• Total Revenue Test is a method of estimating Total Revenue Test is a method of estimating the price elasticity of demand by observing the price elasticity of demand by observing the change in total revenue that results from the change in total revenue that results from a price changea price change

Total Revenue and the Price Elasticity Total Revenue and the Price Elasticity of Demandof Demand

• If demand is elastic: If demand is elastic:

• If demand is inelastic: If demand is inelastic:

Total Revenue TestTotal Revenue Test

Total revenue test:Total revenue test:– If price and total revenue change in the If price and total revenue change in the

opposite directions, demand is ________opposite directions, demand is ________

– If a price change leaves total revenue If a price change leaves total revenue unchanged, demand is unchanged, demand is ________________________..

– If price and total revenue change in the If price and total revenue change in the same direction, demand is ____________.same direction, demand is ____________.

Total Revenue TestTotal Revenue Test• At $3 a cup, the quantity At $3 a cup, the quantity

demanded is 15 cups an demanded is 15 cups an hour.hour.

• Total revenue is Total revenue is ________________________

• When the price rises to $5 a When the price rises to $5 a cup, the quantity demanded cup, the quantity demanded decreases to 5 cups an hour.decreases to 5 cups an hour.

• Total revenue decreases to Total revenue decreases to ____________. ____________.

• Demand is Demand is ________________________..

Total Revenue TestTotal Revenue Test• At $50 a book, the At $50 a book, the

quantity demanded is 5 quantity demanded is 5 million books. million books.

• Total revenue is Total revenue is ________________________

• When the price rises to When the price rises to $75 a book, the quantity $75 a book, the quantity demanded decreases to 4 demanded decreases to 4 million books.million books.

• Total revenue increases to Total revenue increases to ____________.____________.

• Demand is Demand is ________________________..

Addiction and ElasticityAddiction and Elasticity

•Nonusers’ demand for addictive substances is Nonusers’ demand for addictive substances is ____________. ____________.

•Existing users’ demand for addictive Existing users’ demand for addictive substances is ____________.substances is ____________.•