9/4/20151 ElasticityElasticity Claudia Garcia-Szekely

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ElasticityElasticityElasticityElasticity

Claudia Garcia-SzekelyClaudia Garcia-Szekely

04/19/23 2

2010

120

150

0 6 24 30

D0

30

100

50

A movem

ent Along

A change in quantity

demanded

A change in price

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100

110

100 130

Big change in Q100

110

100105

Smal

l cha

nge

in Q

Consumers Overreact

Consumers barely notice

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100

110

100 130

Big change in Q100

110

100105

Smal

l cha

nge

in Q

Consumers Overreact

Consumers barely notice

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The Price Elasticity of Demand

Compares

Can you avoid an increase in price of prescription drugs? Can consumers avoid an increase in price of strawberries?

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epd =

epd

=

epriced =

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Elasticity Between two points

Price Quantity Demanded Point

0 25 A

0.5 22 B

1 19 C

1.5 16 D

2 13 E

2.36 11 F

2.5 10 G

3 7 H

3.5 4 I

4 1 J

4.5 0 K

Measures the response to a $0.50 change in the price (up or down )

Price Elasticity1. Calculate the

difference between the two quantities: 22-19 = 3

2. Calculate the average of the two quantities: (22+19)/2 = 20.53. %Quantity demanded:3/20.5 = 0.146

4. Calculate the difference between the two prices: 1-0.5= 0.5

5. Calculate the average of the two prices: (1+0.5)/2 = 0.75

6. %Price: 0.5/0.75 =0.667.

Price Elasticity of Demand between B and C.

0.146 /0.667 = -0.21

Always Negative

9

Elasticity of Demand Between PointsA and E

Elasticity of Demand Between PointsA and E

E

Midpoint formula gives you the elasticity at

the Midpoint

Midpoint formula gives you the elasticity at

the Midpoint10

A

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Make A the MidpointMake A the Midpoint

Elasticity of Demand at Point AElasticity of Demand at Point A

Use a point above A and a point

below A

10

7

8

1812

6

24

A

> 1

% Change in

Quantity

% Change in Price

>Consumers Over-react: Demand is

Elastic

< 1

% Change in

Quantity

% Change in Price

<Consumers Under-react: Demand is

Inelastic

= 1

% Change in

Quantity

% Change in Price

=Demand is UNIT Elastic

The steeper Demand is, the more InelasticThe flatter Demand is, the more Elastic

epd =

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Example

It has been observed that a 20% decrease in the price, caused a 5% increase in quantity demanded.

Elasticity of Demand is less than one: Inelastic

epd = 5% / -20% = - 0.25

Elasticity has no units!

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ExampleIt has been observed that a 5% increase in price, caused a 10% reduction in quantity demanded.

Elasticity of Demand is greater than one: Elastic

epd = -10% / 5% = - 2

The price elasticity of demand is -0.5.

What is the change in price necessary to induce a 10% reduction in consumption?

14

edp= % Q / % P

-0.5= -10%/ % P-10 /-0.5 =+% P

20 =+% P% P =% Q /ed

p

Calculate price elasticityPRICE QUANTITY

3 4

1 12

e = -1

In order to induce a 5% increase in consumption, the price would have to (rise/fall) ________ by _____%

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Price Elasticity of DemandPRICE QUANTITY

5 4

1 12

e = - 0.75

If we want to increase quantity demanded by 10% what is the necessary change in price?

Price must _________________ by _______%(Increase/decrease)



If we increase the price by 10% how would the quantity demanded change?

Quantity demanded_______________ by _______% (Increase/decrease)



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Calculate price elasticityPRICE QUANTITY

3 3

1 12e = -1.2









Q P e100 10.25 120 9.90 -5.23140 9.55 -4.27160 9.20 -3.57180 8.85 -3.03200 8.50 -2.61220 8.15 -2.27240 7.80 -1.98260 7.45 -1.74280 7.10 -1.54300 6.75 -1.36320 6.40 -1.21340 6.05 -1.08343 6.00 -1.01360 5.70 -0.96380 5.35 -0.85400 5.00 -0.76420 4.65 -0.67440 4.30 -0.59460 3.95 -0.52480 3.60 -0.46500 3.25 -0.40520 2.90 -0.34540 2.55 -0.29560 2.20 -0.25580 1.85 -0.20600 1.50 -0.16620 1.15 -0.12640 0.80 -0.09660 0.45 -0.05680 0.10 -0.02686 0.00 0.00

The Elasticity Changes Along the Demand Curve

For low prices (at the bottom of the demand curve) demand is relatively inelastic

For high prices (at the top of the demand curve) demand is relatively elastic

As P

rice I

ncre

ases

Ela

sti

cit

y I

ncre

ases

At the midpoint,

|e| = 1|e| < 1

|e| > 1|e| = 1

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|e| < 1

|e| > 1|e| = 1

Midpoint0 100100/2 = 50

0 10001000/2 = 500

Po At Po: Both Elastic

Demand A is (elastic/inelastic)_____

Midpoint

Demand A

Elasticity is NOT the same as slopeElasticity is NOT the same as slope

P1 At P1: Both Inelastic

Demand B is (elastic/inelastic)_____

Demand B

Elasticity changes along Demand lineElasticity changes along Demand lineSlope Remains the same along Demand lineSlope Remains the same along Demand line

50454035302520

15

10

50

2

4

6

8

10

12

14

16

18

20

17.5

5045201510 25 40

35

30

50

2

12

6

16

10

4

14

8

18

20

5045201510 25 4035

3050

2

12

6

16

10

4

14

8

18

20

17.5

D1 is more elastic than D2a.For prices below P2

b.For prices above P2

c.For prices above P3

d.For all prices

% Change in Quantity% Change in Price

e =

> 1

% Change in

Quantity

% Change in Price

>Demand is Elastic

0.60

10,000 Units

0.61

0 Units

Demand is Perfectly

Elastic

Almost no change in P

Very large change in Q


e = < 1

% Change in

Quantity

% Change in Price

<Demand is Inelastic

Demand is Perfectly Inelastic

0.60

3.61 Larg

e c

han

ge in

P

No change in

Q


e =

= 1

% Change in

Quantity

% Change in Price

=Demand is UNIT Elastic

Demand is UNIT Elastic

Everywhere

The demand curve with the smallest elasticity at point M is___

The demand curve with the largest elasticity at point M is ___Demand curve _______ is perfectly elasticDemand curve _______ is perfectly inelastic

M

90= 18x5

50454035302520151050

2

4

6

8

10

12

14

16

18

20

160=16x1

0 210=14x15

240=12x20

250=10x25

240=8x30

210=6x35

160=4x40

2x45= 90

250=10x25

Maximum Total

Revenue

90

160

210

240

250

240

210

160

90

90

160

210

240

250

240

210

160

90

32

If after an increase price…

Total Revenues Decrease

Total Revenues Increase

Total Revenues

Remain the Same

Demand

is unit

elastic

Demand

is unit

elastic

Demand

is ElasticDemand

is Elastic Demand

is

InelasticDemand

is

Inelastic

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3. Is this demand elastic or inelastic?PRICE TOTAL

REVENUEELASTICITY

1 1,950,000

1.25 2,062,500

Demand is

Inelastic

Demand is

Inelastic

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What Determines the Elasticity?

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The number of Substitutes Available.

The more substitutes, the easier it is for consumers to switch.

The more sensitive (elastic) demand would be to price changes

Definition of the market.

If price increases, consumers have

many alternatives:

Other flavors

Other brands

Other desserts

Narrowly

Narrowly

defined defined

markets have

markets have

more elastic

more elastic

demands.

demands.

39

The Definition of the market. If ALL ALL food prices

increase, consumers have NO NO alternatives:

BroadlyBroadly defined defined markets markets have have lessless

elastic elastic demandsdemands

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a) All carsb) Imported carsc) German carsd) German Red Carse) BMW red convertibles

Which product has a Which product has a more elastic demand?more elastic demand?Which product has a Which product has a more elastic demand?more elastic demand?

Which product has Which product has more substitutes?more substitutes?Which product has Which product has more substitutes?more substitutes?

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The Amount of Time to React

• The longer the time to react, the easier it is to find a substitute or modify behavior.

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When Demand is Inelastic

Loss

Gain

Q1

P1

Q0

P0

D0

S0

S1

Gain

Loss

>

TR increase

Midpoint

Inelastic

Restricting Supply increase revenue for producers

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When Demand is Elastic

Q1

P1

Q0

P0

D0

S0

S1

TR Decrease

>Gain Lo

ss

Loss Gain

Midpoint

Elastic

Restricting Supply decrease revenue for producers

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When Demand is Elastic

Q1

P1

Q0

P0

D0

S0

S1

TR Increase

>

Gain

Loss

Gain Loss

Elastic

Midpoint

Increasing Supply Increase revenue for producers

Loss

Gain

Loss

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When Demand is Inelastic

Q1

P1

Q0

P0

D0

S0

S1

TR decrease>

Gain

Midpoint

Inelastic

Increasing Supply decrease revenue for producers

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|e| < 1

|e| > 1|e| = 1

Midpoint

Decrease Price to Increase TR

Increase Price to Increase TR

An increase/decrease in price would leave TR unchanged

Table 5. Estimated Price Elasticities of Demand for Various Goods and Services

Goods Estimated Elasticity of Demand

Inelastic

Salt 0.1

Matches 0.1

Toothpicks 0.1

Airline travel, short-run 0.1

Gasoline, short-run 0.2

Gasoline, long-run 0.7

Residential natural gas, short-run 0.1

Residential natural gas, long-run 0.5

Coffee 0.25

Fish (cod) consumed at home 0.5

Tobacco products, short-run 0.45

Legal services, short-run 0.4

Physician services 0.6

Taxi, short-run 0.6

Automobiles, long-run 0.2

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Approximately Unitary Elasticity

Movies 0.9

Housing, owner occupied, long-run 1.2

Shellfish, consumed at home 0.9

Oysters, consumed at home 1.1

Private education 1.1

Tires, short-run 0.9

Tires, long-run 1.2

Radio and television receivers 1.2

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Elastic

Restaurant meals 2.3

Foreign travel, long-run 4

Airline travel, long-run 2.4

Fresh green peas 2.8

Automobiles, short-run 1.2 - 1.5

Chevrolet automobiles 4

Fresh tomatoes 4.6

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Types of Elasticity•Price elasticity of demand.•Price elasticity of supply.•Income elasticity of demand.•Cross Price elasticity of demand.

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The Price Elasticity of Supply

• Measures how easy or difficult it is for producers to react to price changes.

• Since there is a direct relationship between the price and the quantity supplied

• The price elasticity of supply is always positive.

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Price Elasticity of Supply ep

s

epd =

% Change Quantity Supplied% Change in price

epd

=

Change in Qs Average Qs

Change in Price Average Price

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Extreme Cases

SPo

Constant Costs:

Production can not increaseP

Fixed Quantity

Q1Q0

D1D0

D1

S

D0

P

eps = 0

Demand increase

eps = 8

Perfectly Elastic Supply

Production increase w/o increase in prices

Perfectly Inelastic Supply

04/19/23 54



RembrandtsRembrandtsSeats in a theater or stadiumSeats in a theater or stadium

Elasticity changes along a Supply Curve

eps =

infinity

eps =

0

e dec

reas

es e = 1

S

S

S

e in

crea

ses

P

e > 1

ela

stic

e < 1

inel

astic

Note these three supply curves have

the same SLOPE yet Elasticity is different!

Note these three supply curves have

the same SLOPE yet Elasticity is different!

Cut Vertical

Axis: elastic

Cut Horizontal

Axis: inelastic

Perfectly Elastic eps = 8

Perfectly Inelastic ep

s = 0

Calculate the Elasticity at point B.Without calculating the elasticity, you know the elasticity at point B is: < 1; > 1; = 1? How do you know?

When price rises by 20%, quantity supplied rises by 20%. Which curve best demonstrates the elasticity of supply in this example?

30%When price rises by 20%, quantity supplied remains the same. Which curve best demonstrates the elasticity of supply in this example?

E

Po

P1

P2

P3

P4

04/19/23 58

Without calculating the elasticity:

a. Is the elasticity at A>B? A<B? A=B?

b. Is the demand elasticity at F>1? F<1? F=1?

c. Is the demand elasticity at B >0? <0? =0?

d. Is the supply elasticity at F>1? F<1? F=1?

e. Is the supply elasticity at C >0? <0? =0?

f. Is the elasticity at C>D? C<D? C=D?

g. Is the elasticity at E>1? E<1? E=1?

h. Is the elasticity at C>1? C<1? C =1?

E

F

Calculating the resulting change in

price

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% Price = %Demand/(Ed + Es)

P0

Q0

P1

Q1

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% Price = %Demand/(Ed + Es)

P0

Q0

P1

Q1

Suppose demand shifts out to the right by 10 percent, the elasticity of demand is 1.5 and the elasticity of supply is 0.5. By how much will price change?

% Price = 10%/(1.5 + 0.5)

% Price = 10/2

% Price = 5

Price increase by 5%

Calculating the resulting change in

price

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% Price = %Supply/(Ed + Es)P0

Q0

P1

Q1

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% Price = %Supply/(Ed + Es)P0

Q0

P1

Q1

If supply increases by 4 percent, the elasticity of demand is 0.5, and elasticity of supply is 1.5, then the price will:

% Price = 4/(0.5+ 1.5)

% Price = 4/(2)

% Price = 2%

Price decrease by 2%

63

A significant price decline with virtually no change in quantity would most likely be caused by : a. a highly elastic demand and a shift in supply to the right. b. a highly inelastic supply and a shift in demand to the right. c. a highly inelastic demand and a shift in supply to the right. d. a highly elastic supply and a shift in demand to the left.

Q1

P1

Q0

P0

D0

S0

S1

Q1

P1

Q0

P0

D0

S0

D1

Q1

P1

Q0

P0

D0

S0

S1

Q1

P1

Q0

P0

D0

S0

D1

a

b

c

d

|e| < 1

|e| > 1|e| = 1

Income increase

Measures the SIZE of the

shift

Normal

Inferior

Income Increase

04/19/23 65

Income Elasticity

epd =

Change in Quantity / Average Quantity

Change in Income / Average Income

epd =

Percentage Change in Demand

Percentage Change in Income

04/19/23 66

Income Elasticity

1. Find the Percentage change in quantity demanded = 100 / 350 = 0.286

I ncomeQ. DemandedEdy

1000 300

2000 400 0.43

3000 500 0.56

4000 600 0.64

5000 700 0.69

6000 800 0.73

7000 900 0.76

8000 1000 0.79

2. Find the percentage change in income = 1000/1500 = 0.6673. The Income Elasticity = 0.286/0.667 =

0.429+

04/19/23 67

Normal Goods

• The Demand for normal goods INCREASES when income INCREASES.

• There is a positive relationship between income and demand for normal goods.

• The sign of the income elasticity for normal goods is positive.

Normal Goods: Luxuries

Goods which you can consume less when your income drops.Goods which you would consume more when your income increase.

04/19/23 68

epd =

Percentage Change in Demand larger than change in income

Percentage Change in Income1

Normal Goods: Necessities

Goods which you can NOT consume less when your income drops.Goods which you would NOT consume more when your income increase.

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epd =

Percentage Change in Demand SMALLER than change in income

Percentage Change in Income1

04/19/23 70

Inferior Goods• Demand for inferior goods

DECREASES when income INCRESES.

• There is a negative relationship between income and demand for inferior goods.

• The sign of the income elasticity for inferior goods is negative.

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Inferior Good Income Elasticity

I ncome Q. Demanded Edy

1000 1000

2000 900 -0.16

3000 800 -0.29

4000 700 -0.47

5000 600 -0.69

6000 500 -1.00

7000 400 -1.44

8000 300 -2.14

|e| < 1

|e| > 1|e| = 1Price of substitute Price of substitute

increaseincrease

Price of Price of Complement Complement

IncreaseIncrease

04/19/23 73

Cross Price Elasticity Formula

% Change in Quantity demanded of X

%Change in price of Y.ep

d =Coke

Pepsi

04/19/23 74

Cross Price Elasticity for Complements

• Demand drops when the price of a complement increases.

If price of PRINTERS increases, the Demand for INK drops.

• Price and Demand move in opposite directions.

• The cross price elasticity for complements is NEGATIVE.

04/19/23 75

Cross Price Elasticity Complements

( Negative)Price X Quantity Y Cross Price

Elasticity x,y

100.00 600.00

130.00 580.00 -0.130

160.00 560.00 -0.170

190.00 540.00 -0.212

220.00 520.00 -0.258

250.00 500.00 -0.307

280.00 480.00 -0.361

310.00 460.00 -0.418

340.00 440.00 -0.481

370.00 420.00 -0.550

400.00 400.00 -0.626

All Negative!All Negative!

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Cross Price Elasticity for Substitutes

• When price INCREASES, Demand for the substitute INCREASES too.If the price of Texaco gasoline rises, the

Demand for Chevron gasoline rises too.

• Price and Demand for substitutes move in the SAME direction.

• The cross price elasticity between substitutes is POSITIVE.

04/19/23 77

Cross Price Elasticity Substitutes (Positive)Price X Quantity Y Cross Price

Elasticity x,z

100.00 600.00

130.00 620.00 0.126

160.00 640.00 0.153

190.00 660.00 0.179

220.00 680.00 0.204

250.00 700.00 0.227

280.00 720.00 0.249

310.00 740.00 0.269

340.00 760.00 0.289

370.00 780.00 0.307

400.00 800.00 0.325

All Positive!All Positive!

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Income Demand X1000 10002000 9003000 8004000 7005000 600

Income Demand Y1000 3002000 4003000 5004000 6005000 7006000 800

Calculate the Income Elasticity for an

increase in income from $3,000 to $4,000.

Is the good Normal or Inferior?

Is the elasticity positive or negative?

Use the information in table 1 above to calculate: 1. Price elasticity of demand for good X between points B and D. 2. Price elasticity of demand for good X at C.3. Price elasticity of supply between A and B.4. Cross Price elasticity between X and N between points E and F. Are X and N substitutes? Or

complements?5. Cross Price elasticity between X and R between points E and F. Are X and R substitutes? Or

complements?Your answer must have a value AND A SIGN!

Solutions

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Solutions

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Solutions

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Solutions

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Documents

9/4/20151 ElasticityElasticity Claudia Garcia-Szekely