Unit 3 Elasticity/Taxes

Chapter 6 Elasticity

I. Elasticity

a) Shows how sensitive quantity is to a change in price.

1. Elasticity of Demand2. Elasticity of Supply3. Cross-Price Elasticity4. Income Elasticity

II. Elasticity of Demand

a) Measure CONSUMERS responsiveness to a change in price.

b) Who cares?1. Used by firms to help determine prices and sales2. Used by government to decide how to tax.

III. Inelastic Demand

a) Quantity if Insensitive to a change in price1. Price Rises = quantity demanded falls very little.2. Price Falls = quantity demanded increases very little.

b) People continue to buy no matter whatc) Inelastic demand curve is steep.d) Examples

1. Gasoline2. Milk3. Diapers

IV. Inelastic Characteristics

a) Few Substitutesb) Necessitiesc) Small portion of incomed) Required now rather than latere) Elasticity coefficient less than 1.

Inelastic Demand

V. Elastic Demand

a) Quantity demanded is sensitive to a change in price.

1. If price rises = quantity demanded falls a lot.2. If price falls = quantity demanded rises a lot.

b) Amount people buy is sensitive to price.c) Examples:

1. Soda2. Boats3. Beef

VI. Elastic Characteristics

a) Many Substitutesb) Luxuriesc) Large portion of incomed) Plenty of time to decidee) Elasticity coefficient greater than 1

Elastic Demand

Elastic or Inelastic?Beef-

Gasoline- Real Estate-

Medical Care- Electricity-

Gold-

Elastic- 1.27INelastic - .20Elastic- 1.60INelastic - .31INelastic - .13Elastic - 2.6

What about the demand for insulin for diabetics?

Perfectly INELASTIC(Coefficient = 0)

What if % change in quantity demanded equals

% change in price?

Unit Elastic (Coefficient =1)45 Degrees

VII. Total Revenue Test

a) Uses elasticity to show how changes in price will affect total revenue (TR). (TR=Price x Quantity)

b) Elastic Demand1. Price increase causes TR to decrease2. Price decrease causes TR to increase

c) Inelastic Demand1. Price increase causes TR to increase2. Price decrease causes TR to decrease

d) Unit Elastic1. Price changes and TR remains unchanged

VIII. Midpoint Method

a) Technique for calculating the percent change for calculating elasticities.

IX. Price Elasticity of Supply

a) Show how sensitive PRODUCERS are to change in price.b) Mostly based on time limitations, producers need time

to produce more.

c) Inelastic: insensitive to a change in price (steep curve)1. Most goods have inelastic supply in the short-run

d) Elastic: Sensitive to change in price (flat curve)1. Most goods have elastic supply in the long-run

e) Perfectly inelastic: Q doesn’t change (vertical line) 1. Set Quantity

X. Cross-Price Elasticity of Demand

a) Shows how sensitive a product is to a change in price of ANOTHER good

b) Shows if two goods are substitutes or complements

c) If coefficient is negative then goods are complementsd) If coefficient is positive then the goods are substitutes

% change in quantity of product “b”% change in price of product “a”

P increases 20% Q decreases 15%

XI. Income-Elasticity of Demand

a) Shows how sensitive a product is to a change in INCOME

b) Shows if two goods are normal or inferior

c) If coefficient is negative then the good is inferiord) If coefficient is positive then the good is normal.

% change in income% change in quantity

Income increases 20%, and quantity decreases 15% then the good is a…

An Elasticity Menagerie

An Elasticity Menagerie

1996 Micro FRQ #2

The Toledo arena holds a maximum of 40,000 people. Each year the circus performs in front of a sold out crowd. (a) Analyze the effect on each of the following of the addition of a fantastic new death-defying trapeze act that increases the demand for tickets.

(i)The price of tickets(ii)The quantity of tickets sold

(b) The city of Toledo institutes an effective price ceiling on tickets. Explain where the price ceiling would be set. Explain the impact of the ceiling on each of the following.

(i) The quantity of tickets demanded(ii) The quantity of tickets supplied

(c) Will everyone who attends the circus pay the ceiling price set by the city of Toledo. Why or why not? 18