Elasticity SFLS

Elasticity

Elasticity

DEMAND (shifts)

= Less Demand at the same price

= More Demand at the same priceElasticityby how much??=

Changes in Demand without the price changing

Shift Left

Shift Right

2

Decrease Price

So if you own a store, sell coke and lower your price

3

Decrease Price

A little more Customers

Do you get

4

Decrease Price

Or a lot more Customers?

Or

5

Increase Price

6

A little Customers

Increase Price

7

Or a lot more Customers?

Increase Price

8

Example Question:You own a tea shop and sell your own specially made tea. You sell about 5000kg of tea each month at about 70rmb for 1kg.

Your costs of producing this tea is rising, (as well as the opportunity cost of your time) so you are considering raising your price to 90rmb per kg.

The law of demand says if you raise your price you will sell less tea, but the next question is by how much? - Also how will this effect your actual revenue ? - Will you make less profit or more profit?

Elasticity Textbook Definition:Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants.

Easier Definition:

Elasticity measures how much one variable responds to changes in another variable.It shows how much things will change due to a change it the price.Even Easier Definition:

Elasticity 4 Types of Elasticity:

1.) (PED) Price Elasticity of Demand2.) (PES) Price Elasticity of Supply

3.) (XED)Cross Elasticity of Demand4.) (YED)Income Elasticity of Demand

Drop the negative sign ( - ) Do NOT drop the negative sign ( -)





1.) (PED) Price Elasticity of Demandis the measurement of how demand for a good responds to a change in price. ****easy way to remember equation:

Q before you Pay

Equation:

________%Q

________Percent change in QuantityPercent change in PriceP%

Queuing Pidu Remember in English not Chinese

1.) (PED) Price Elasticity of Demandis the measurement of how demand for a good responds to a change in price. *easy way to remember equation:

Q before you Pay

________%Q

________Percent change in QuantityPercent change in PriceP%We will only deal with absolute values here, so when doing the equation always drop the negative sign (-)Equation:

You own a tea shop and sell your own specially made tea. You sell about 5000kg of tea each month at about 70rmb for 1 kg.

So if

P = 70rmb and the Q = 5000kg

What is the Price Elasticity of Demand if after you change your price, these are your shops new numbers

P = 90rmb and the Q = 3000kgExample Question:

% change in Q(3000 5000)/5000 = I -40% I% change in P(90 70)/70 = 29%The (PED) price elasticity of demand equals40%29%

= 1.381.) P = 70rmb and the Q = 5000kg2.) P = 90rmb and the Q = 3000kgExample Question:________

%Q

P%________

Starbucks raising the price of its coffee from 30rmb to 50rmb and its sales decrease from 12 to 8 cups an hour.

so if

P = 30rmb and Q = 12 cups

What is the Price Elasticity of Demand if Starbucks new numbers are

P = 50rmb and Q = 8 cupsAnother Example Question:

Another Example Question:1.) P = 30rmb and the Q = 12 cups2.) P = 50rmb and the Q = 8 cups% change in Q(8 12)/12 = I -33% I% change in P(50 30)/30 = 67%The (PED) price elasticity of demand equals33%67%

= .5

%Q

P%

________

Ok so the answer for the tea shop question is 1.38Ok so the answer for the starbucks question is .5 So what do these numbers mean?

Demand is Elastic if it is greater than 1. ( > 1)- a small change in price causes a relatively large change in quantity demanded.Demand is Inelastic if it is less than 1. ( < 1)- a relatively larger change in price causes a small change in quantity demanded.Demand is Unit-Elastic if it is exactly 1. ( = 1) - a change in price causes a proportional change in quantity demanded.Elasticity ElasticInelasticUnit-Elastic

1.38 is Elastic so a price change has a large effect on the quantity.5 is Inelastic which means the price change doesnt effect the quantity very much

1 RMB per canNow only 0.9 RMBAfter small price changeBefore price change= large number of more buyers

Demand is Elastic if it is greater than 1. ( > 1)

= normal amount of buyers Elastic

D

PQ

Small % changeLarge % changeDemand is Elastic if it is greater than 1. ( > 1)

Elastic

1 RMB per canAfter small price changeBefore price change

Now only 0.9 RMB

D

PQ

Small % changeLarge % change

1 RMB per canNow 1.1 RMB per canDemand is Elastic if it is greater than 1. ( > 1)

Elastic

2.5 RMBNow only . 2 RMBAfter larger price changeBefore price change= much few more buyers

= normal amount of buyers

Demand is Inelastic if it is less than 1. ( < 1)Inelastic

D

PQ

Large % changesmall % change

2.5 RMBNow only . 2 RMBAfter larger price changeBefore price change

Demand is Inelastic if it is less than 1. ( < 1)Inelastic

D

PQ

Large % changesmall % change

2.5 RMBAfter larger price changeBefore price change

Demand is Inelastic if it is less than 1. ( < 1)InelasticNow cost 3 RMB


PQ

PQ

PQ

PQ

PQ

PerfectlyElasticDemandElasticDemandUnit-ElasticDemandInelasticDemandPerfectlyInelasticDemandElastic if it is greater than 1 ( > 1)Inelastic if it is less than 1 ( < 1)Unit -Elastic if it is equal to 1 ( = 1)

Slope and Elasticity is NOT the same thing!

Elasticity of a Linear Demand Curve0The slope of a linear demand curve is constant, but its elasticity is not.

PQ$302010$00204060

200%40%

= 5.0E =67%67%

= 1.0E =40%200%

= 0.2E =

3232The material on this slide is not used anywhere else in the textbook. Therefore, if you are pressed for time and looking for things to cut, you might consider cutting this slide. (Note that this is my personal recommendation and is not necessarily the official position of Greg Mankiw or Cengage/South-Western.)

Due to space limitations, this slide uses E as an abbreviation for elasticity, or more specifically, the price elasticity of demand, and the slide omits the analysis of revenue along the demand curve.

Calculations of percentage changes use the midpoint method. (This is why the increase from Q=0 to Q=20 is 200% rather than infinity.)

As you move down a linear demand curve, the slope (the ratio of the absolute change in P to that in Q) remains constant:

From the point (0, $30) to the point (20, $20), the rise equals -$10, the run equals +20, so the slope equals -1/2 or -0.5.

From the point (40, $10) to the point (60, $0), the rise again equals -$10, the run equals +20, and the slope again equals -0.5.

However, the percentage changes in these variables do not remain constant, as shown by the different colored elasticity calculations that appear on the slide.

The lesson here is that elasticity falls as you move downward & rightward along a linear demand curve.

Elasticity of a Linear Demand Curve0The slope of a linear demand curve is constant, but its elasticity is not.

PQ$302010$00204060

Top part of a curve is elastic > 1 Middle part is as close to unit elastic as possible = 1 Bottom part of a curve is Inelastic < 1

3333The material on this slide is not used anywhere else in the textbook. Therefore, if you are pressed for time and looking for things to cut, you might consider cutting this slide. (Note that this is my personal recommendation and is not necessarily the official position of Greg Mankiw or Cengage/South-Western.)

Due to space limitations, this slide uses E as an abbreviation for elasticity, or more specifically, the price elasticity of demand, and the slide omits the analysis of revenue along the demand curve.

Calculations of percentage changes use the midpoint method. (This is why the increase from Q=0 to Q=20 is 200% rather than infinity.)

As you move down a linear demand curve, the slope (the ratio of the absolute change in P to that in Q) remains constant:

From the point (0, $30) to the point (20, $20), the rise equals -$10, the run equals +20, so the slope equals -1/2 or -0.5.

From the point (40, $10) to the point (60, $0), the rise again equals -$10, the run equals +20, and the slope again equals -0.5.

However, the percentage changes in these variables do not remain constant, as shown by the different colored elasticity calculations that appear on the slide.

The lesson here is that elasticity falls as you move downward & rightward along a linear demand curve.

Reasons or Influences of the (PED) Price Elasticity of Demand 1.) Availability of Substitutes2.) Good vs Luxury 3.) How narrow it is defined4.) Time4 reasons for Elasticity:

Reasons or Influences of the (PED) Price Elasticity of Demand 1.) Availability of Substitutes2.) Good vs Luxury 3.) How narrow it is defined4.) Time4 reasons for Elasticity:To understand the determinants of price elasticity, I will give you an examples for each one. Each compares two common goods.

In each example:Suppose the prices of both goods rise by 20%.Note the difference in Quantities.

Reasons or Influences of the (PED)1.) Availability of Substitutes- Price elasticity is higher when close substitutes are available. Sunscreen vs. Breakfast cereal The prices of both rise by 20%. Example:

Sunscreen has no close substitutes, so consumers would probably not buy much less if its price rises.

Breakfast cereal has close substitutes so buyers can easily switch if the price rises.

So its Elastic > 1 So its Inelastic < 1

Insulin vs. Vacation Cruises

To millions of diabetics , insulin is a necessity. A rise in its price would cause little or no decrease in demand.

A cruise is a luxury. If the price rises, some people will decide not to do it.

2.) Good vs Luxury - Price elasticity is higher for luxuries than for necessities. So its Elastic > 1 So its Inelastic < 1 Reasons or Influences of the (PED)The prices of both rise by 20%. Example:

Blue Jeans vs. Clothing

For a narrowly defined good such as blue jeans, there are many substitutes (khakis, shorts, Speedos).

There are fewer substitutes available for broadly defined goods.

3.) How narrow the market is defined- Price elasticity is higher for narrowly defined goodsSo its Elastic > 1 So its Inelastic < 1 Reasons or Influences of the (PED)The prices of both rise by 20%. Example:

Gasoline in Short Run vs. Gasoline in Long Run

Theres not much people can do in the short run, other than ride the bus or carpool.

In the long run, people can buy smaller cars or live closer to where they work.

4.) Time-Price elasticity is higher in the long run than the short run. So its Inelastic > 1 So its Elastic < 1 Reasons or Influences of the (PED)The prices of both rise by 20%. Example:

Total Revenue and (PED) Price Elasticity of Demand


Total Revenue - The total amount spent on the of sales of a good or service.Total revenue testDo the equation above before the changes and after the changes are made to compare if the outcome is welcomed or not.

Equation:Price Quantity Sold( P ) ( Q )

Starbucks raising the price of its coffee from 30rmb to 50rmb and its sales decrease from 12 to 8 cups an hour.

so if

P = 30rmb and Q = 12 cups

What is the Price Elasticity of Demand if Starbucks new numbers are

P = 50rmb and Q = 8 cupsAnother Example Question:

0

PQ

D508

B

3012

A

Demand for coffee Point A 30 x 12 = 360Example Total Revenue Test

43

0

PQ

D508

B

3012

A

Demand for coffee Point A 30 x 12 = 360Point B50 x 8 = 400The total revenue is increased from 360 to 400. So an increase in price led to more revenue since the demand is inelastic, you can raise your price and make more money, though less people buy it.Example Total Revenue Test

44

0

PQ

D808

B

6020

A

Demand for teaPoint B 80 x 8 = 640

Example Total Revenue Test

45

0

PQ

D808

B

6020

A

Demand for teaPoint B 80 x 8 = 640Point A60 x 20 = 1200The total revenue is increased from 640 to 1200. So an decrease in price led to more revenue since this demand is elastic, you can lower your price and make more money.

Example Total Revenue Test

46

Elasticity and Total Revenue

When a seller raises the price of a good, there are two countervailing effects in action: Price Effect: - After a price increase, each unit sold sells at a higher price, which tends to raise revenue.Quantity Effect: - After a price increase, fewer units are sold, which tends to lower revenue.( More Inelastic) ( More Elastic )

47

Example Question:You own a tea shop and sell your own specially made tea. You sell about 5000kg of tea each month at about 70rmb for 1kg.

Your costs of producing this tea is rising, (as well as the opportunity cost of your time) so you are considering raising your price to 90rmb per kg.

The law of demand says if you raise your price you will sell less tea, but the next question is by how much? - Also how will this effect your actual revenue ? - Will you make less profit or more profit?

Continuing our scenario, if you raise your pricefrom 70 to 90, would your revenue rise or fall?Total Revenue =

A price increase has two effects on revenue:1.) Higher P means more revenue on each unit you sell. 2.) But you sell fewer units (lower Q), due to Law of Demand.

Which of these two effects is bigger? It depends on the Price Elasticity of Demand. Example Question:

( P ) ( Q )

from 70 to 90, and quantity change from 5,000 to 3,000, would your revenue rise or fall?P = 70rmb and the Q = 5000kgP = 90rmb and the Q = 3000kg

Before change: 70 x 5000 = 350,000 RMBAfter change: 90 x 3000 = 270,000 RMB

Example Question:So you would lose money if you raise your price, the quantity effect is stronger and your demand is Elastic


= 1.381.) P = 70rmb and the Q = 5000kg2.) P = 90rmb and the Q = 3000kgExample Question:________

%Q

P%________

Increase in Price

In this case, the quantity effect is stronger than the price effect.

= Lower Total RevenueElasticity and Total Revenue Elastic

52

If the example was changed a little, a much bigger difference would be found. For example, lets say the increase of price from 70 to 90 only decreased quantity from 5,000 to 4,000P = 70rmb and the Q = 5000kgP = 90rmb and the Q = 4000kg

Before change: 70 x 5000 = 350,000 RMBAfter change: 90 x 4000 = 360,000 RMBExample Question Changed a little:

So you would gain more money if you raise your price, and the price effect is stronger and your demand is Inelastic


= .691.) P = 70rmb and the Q = 5000kg2.) P = 90rmb and the Q = 4000kgExample Question:________

%Q

P%________

Increase in Price


= Lower Total RevenueElasticity and Total Revenue Elastic

Inelastic

Increase in Price

In this case, the price effect is stronger than the quantity effect.

= Higher Total Revenue

55

Increase in Price


= Lower Total RevenueElasticity and Total Revenue ElasticInelastic

Increase in Price



Unit-Elastic

Increase in Price

In this case, they offset each other and there is no gain

= No change in Total Revenue

56



3.) (YED)Income Elasticity of Demand4.) (XED) Cross Elasticity of Demand


2.) (PES) Price Elasticity of Supply*easy way to remember equation:

Q before you Pay

________%Q

________Percent change in QuantityPercent change in PriceP%We will only deal with absolute values here, so when doing the equation always drop the negative sign (-)Equation:is the measurement of how supply for a good responds to a change in price.

PQ

PQ

PQ

PQ

PQ

Elastic if it is greater than 1 ( > 1)

Unit -Elastic if it is equal to 1 ( = 1)

InelasticSupplyPerfectlyInelasticSupplyInelastic if it is less than 1 ( < 1)

Unit-ElasticSupplyPerfectlyElasticSupplyElasticSupply

Reasons or Influences of the (PES) Price Elasticity of Supply 4 reasons for Elasticity:1.) Production Possibilities or Availability of Inputs2.) Storage Possibilities or Time

Hurrah! only two this time!

Corn vs. Beachfront Property

Corn becomes more profitableA rise in its price would cause a rise in the supply of land for corn

Even with a increase of price their isnt much more beachfront property to be had available

1.) Production possibilities - Goods that are fixed quantity are inelasticSo its Elastic > 1 So its Inelastic < 1 Reasons or Influences of the (PED)The prices of both rise by 20%. Example:

Fresh Strawberries vs. Canned Fruit Strawberries will become rotten and cannot be stored for a long time, in the short run, the price doesnt change the supply much

Canned fruit can last a long time and an increase in prices will increase the supply, particularly over the long term.

2.) Storage possibilities -Some things are almost impossible to store in the short run, but over time, plans can changeSo its Elastic > 1 So its Inelastic < 1 Reasons or Influences of the (PED)The prices of both rise by 20%. Example:





3.) (XED) Cross Elasticity of DemandIt measures responsiveness of the demand for a good to a change in the price of a substitute or complement Equation:Must keep the negative sign ( -) now! Without it you cannot know the answer!

____________%Q of A

_____________Percent change in Quantity of good APercent change in Price of good BP of B%


3.) (XED) Cross Elasticity of DemandIt measures responsiveness of the demand for a good to a change in the price of a substitute or complement (I.) If it is a positive number then it is a substitute.

- Price of A and the Quantity of B move in the same direction.

Price of this goes upi.) SubstituteIncrease Demand of this= Buy less of it but more of this =Price of this goes downDecrease Demand of this

= Buy more of this but less of this =

Example Question: If Coffee is a substitute for Tea, then if the price of tea changes how much will that effect the quantity of coffee?

3.) (XED) Cross Elasticity of DemandP of coffee falls 10 %Q of tea decrease 5%- 5%- 10%

= .5

________%Q of A

P of B%

The (XED) for a substitute is positive.Example: Coffee is a substitute for Tea.

A fall in the price of Coffee

= Lower Demand for Tea

*** Same is true for the reverse ***

3.) (XED) Cross Elasticity of Demand

3.) (XED) Cross Elasticity of DemandIt measures responsiveness of the demand for a good to a change in the price of a substitute or complement (II.) If it is a negative number then it is a complement.

- Price of A and the Quantity of B move in the opposite direction.

Price of this goes upDecrease demand of this= Buy less of it and buy less of this =Price of this goes downIncrease demand of this= Buy more of it and buy more of this =

(the price of this didnt change)

i.) Complement

Example Question: If sugar is a complement for coffee, then if the price of coffee changes how much will that effect the quantity of sugar?

3.) (XED) Cross Elasticity of DemandP of coffee falls 10 %Q of sugar increases 2%

________%Q of A

P of B%

2%- 10%

= -.2

The (XED) for a complement is negative.Example: Sugar is a complement for Coffee.

A fall in the price of Coffee

= Higher Demand for Sugar

*** Same is true for the reverse ***

3.) (XED) Cross Elasticity of Demand





4.) (YED) Income Elasticity of Demand- A measure of the extent to which the demand for a good changes when income changes measuring whether good is normal or inferior.Equation:Must keep the negative sign ( -) now! Without it you cannot know the answer!

____________%Q

____________Percent change in QuantityPercent change in IncomeIncome%

4.) (YED) Income Elasticity of Demand- A measure of the extent to which the demand for a good changes when income changes measuring whether good is normal or inferior.(I.) If increased income means more demand then it is a normal good and is positive number.

The quantity demanded of a good and income of it change in the same direction.

Income Increasei.) Normal goodDemand increasesBuy more of this at the same priceIncome DecreaseDemand decreases Buy less of this at the same price

4.) (YED) Income Elasticity of Demand- A measure of the extent to which the demand for a good changes when income changes measuring whether good is normal or inferior.(II.) If increased income means less demand then it is an inferior good and is negative number.

The quantity demanded of a good and income of it change in the opposite direction.

Income IncreaseDemand decrease Buy less of this at the same priceIncome DecreaseDemand increasesBuy more of this at the same price

ii.) Inferior good

So to Summarize all of it now

1.) (PED) Price Elasticity of Demandis the measurement of how demand for a good responds to a change in price. *easy way to remember equation:

Q before you Pay

________%Q

________Percent change in QuantityPercent change in PriceP%We will only deal with absolute values here, so when doing the equation always drop the negative sign (-)Equation:

Reasons or Influences of the (PED) Price Elasticity of Demand 1.) Availability of Substitutes2.) Good vs Luxury 3.) How narrow it is defined4.) Time4 reasons for Elasticity:

2.) (PES) Price Elasticity of Supply*easy way to remember equation:

Q before you Pay

________%Q

________Percent change in QuantityPercent change in PriceP%We will only deal with absolute values here, so when doing the equation always drop the negative sign (-)Equation:is the measurement of how supply for a good responds to a change in price.

Reasons or Influences of the (PES) Price Elasticity of Supply 4 reasons for Elasticity:1.) Production Possibilities or Availability of Inputs2.) Storage Possibilities or Time


PQ

PQ

PQ

PQ

PQ

PerfectlyElasticDemandElasticDemandUnit-ElasticDemandInelasticDemandPerfectlyInelasticDemandElastic if it is greater than 1 ( > 1)Inelastic if it is less than 1 ( < 1)Unit -Elastic if it is equal to 1 ( = 1)

PQ

PQ

PQ

PQ

PQ

Elastic if it is greater than 1 ( > 1)

Unit -Elastic if it is equal to 1 ( = 1)

InelasticSupplyPerfectlyInelasticSupplyInelastic if it is less than 1 ( < 1)

Unit-ElasticSupplyPerfectlyElasticSupplyElasticSupply


Total Revenue - The total amount spent on the of sales of a good or service.Total revenue testDo the equation above before the changes and after the changes are made to compare if the outcome is welcomed or not.

Equation:Price Quantity Sold( P ) ( Q )

Elasticity and Total Revenue

When a seller raises the price of a good, there are two countervailing effects in action: Price Effect: - After a price increase, each unit sold sells at a higher price, which tends to raise revenue.Quantity Effect: - After a price increase, fewer units are sold, which tends to lower revenue.( More Inelastic) ( More Elastic )

89

Elasticity and Total Revenue Unit-Elastic

Increase in Price

In this case, they offset each other and there is no gain

= No change in Total Revenue

Increase in Price


= Lower Total RevenueElasticInelastic

Increase in Price



90

3.) (XED) Cross Elasticity of DemandIt measures responsiveness of the demand for a good to a change in the price of a substitute or complement (I.) If it is a positive number then it is a substitute.

- Price of A and the Quantity of B move in the same direction.

3.) (XED) Cross Elasticity of DemandIt measures responsiveness of the demand for a good to a change in the price of a substitute or complement (II.) If it is a negative number then it is a complement.

- Price of A and the Quantity of B move in the opposite direction.

4.) (YED) Income Elasticity of Demand- A measure of the extent to which the demand for a good changes when income changes measuring whether good is normal or inferior.(I.) If increased income means more demand then it is a normal good and is positive number.

The quantity demanded of a good and income of it change in the same direction.

4.) (YED) Income Elasticity of Demand- A measure of the extent to which the demand for a good changes when income changes measuring whether good is normal or inferior.(II.) If increased income means less demand then it is an inferior good and is negative number.

The quantity demanded of a good and income of it change in the opposite direction.

Thats allThe End.Thanks

Education

Elasticity SFLS