Chapter 6 Elasticity Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

6-2 Price Elasticity of Demand Measures buyers’ responsiveness to price changes Elastic demand Sensitive to price changes Large change in quantity Inelastic demand Insensitive to price changes Small change in quantity LO1

6-3 Ed =Ed = Price Elasticity of Demand Formula Formula for price elasticity of demand percentage change in quantity demanded of product X percentage change in price of product X LO1

6-4 Price Elasticity of Demand Formula Use the midpoint formula Ensures consistent results Ed =Ed = ÷ Change in quantity Sum of quantities/2 Change in price Sum of prices/2 LO1

6-5 Price Elasticity of Demand Formula Use percentages Unit free measure Compare elasticities across products Eliminate the minus sign Easier to compare elasticities LO1

6-6 Interpretation of Elasticity of Demand E d > 1 demand is elastic E d = 1 demand is unit elastic E d < 1 demand is inelastic Extreme cases E d = 0 demand is perfectly inelastic E d = ∞ demand is perfectly elastic LO1

6-7 Extreme Cases D1D1 P Perfectly inelastic demand (Ed = 0) 0 LO1

6-8 Extreme Cases Perfectly elastic demand P D2D2 Perfectly elastic demand (Ed = ∞) 0 LO1

6-9 Total Revenue Test Total Revenue = Price X Quantity Total Revenue Test Inelastic demand P and TR move in the same direction Elastic demand P and TR move in opposite directions LO2

6-10 Total Revenue Test Lower price and elastic demand Blue gain exceeds orange loss $ Q P a b D1D1 LO2

6-11 Total Revenue Test Lower price and inelastic demand Orange loss exceeds blue gain $ Q P c d D2D2 LO2

6-12 Total Revenue Test Lower price and unit elastic demand Blue gain equals orange loss $ Q P e f D3D3 LO2

6-13 Total Revenue Test (1) Total Quantity of Tickets Demanded per Week, Thousand s (2) Price per Ticket (3) Elasticity Coefficient (E d ) (4) Total Revenue (1) X (2) (5) Total-Revenue Test $ $ 8,000 14,000 18,000 20,000 18,000 14,000 8,000 Elastic Unit-elastic Inelastic ] ] ] ] ] ] ] ] ] ] ] ] ] ] Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total Revenue Test LO2

6-14 Elasticity and Total Revenue Quantity demanded Price Total revenue (Thousands of dollars) $ $ a b c d e f g h Elastic E d > 1 Unit elastic E d = 1 Inelastic E d < 1 D TR LO2

6-15 Summary of Price Elasticity of Demand Price Elasticity of Demand: A Summary Absolute Value of Elasticity CoefficientDemand Is:Description Impact on Total Revenue of a: Price IncreasePrice Decrease Greater than 1 (E d > 1) Elastic or relatively elastic Q d changes by a larger percentage than does price Total Revenue decreases Total Revenue increases Equal to 1 (E d = 1) Unit or unitary elastic Q d changes by the same percentage as does price Total revenue is unchanged Total revenue is unchanged Less than 1 (E d < 1) Inelastic or relatively inelastic Q d changes by a smaller percentage than does price Total revenue increases Total revenue decreases

6-16 Determinants of Price Elasticity of Demand Substitutability More substitutes, demand is more elastic Proportion of income Higher proportion of income, demand is more elastic LO3

6-17 Determinants of Price Elasticity of Demand Luxuries versus necessities Luxury goods, demand is more elastic Time More time available, demand is more elastic LO3

6-18 Price Elasticity of Demand Selected Price Elasticities of Demand Product or Service Price Elasticity of Demand (E d )Product or Service Price Elasticity of Demand (E d ) Newspapers.10Milk.63 Electricity (household).13Household appliances.63 Bread.15Liquor.70 MLB Tickets.23Movies.87 Telephone Service.26Beer.90 Cigarettes.25Shoes.91 Sugar.30Motor vehicles1.14 Medical Care.31Beef1.27 Eggs.32China, glassware1.54 Legal Services.37Residential land1.60 Automobile repair.40Restaurant meals2.27 Clothing.49Lamb and mutton2.65 Gasoline.60Fresh peas2.83

6-19 Applications of Price Elasticity of Demand Large crop yields Inelastic demand, lower total revenue Excise taxes Inelastic demand, more total revenue Decriminalization of illegal drugs Inelastic demand, more total revenue LO3

6-20 Price Elasticity of Supply Measures sellers’ responsiveness to price changes Elastic supply, producers are responsive to price changes Inelastic supply, producers are not as responsive to price changes LO4

6-21 Price Elasticity of Supply Formula for price elasticity of supply LO4 percentage change in quantity supplied of Product X percentage change in price of product X Es =Es =

6-22 Price Elasticity of Supply E s > 1 supply is elastic E s = 1 supply is unit elastic E s < 1 supply is inelastic Additionally, E s = 0 supply is perfectly inelastic LO4

6-23 Price Elasticity of Supply Time is primary determinant of elasticity of supply Time periods considered Immediate market period Short run Long run LO4

6-24 E s : The Immediate Market Period Perfectly inelastic supply P Q D1D1 D2D2 SmSm Q0Q0 PmPm P0P0 LO4

6-25 The Short Run Short run supply is more elastic than in the immediate market period P Q D1D1 D2D2 SsSs Q0Q0 PsPs P0P0 QsQs LO4

6-26 The Long Run Long run supply is even more elastic than in the short run LO4 P Q D1D1 D2D2 SLSL Q0Q0 PlPl P0P0 QlQl

6-27 Applications of Elasticity of Supply Antiques Inelastic supply Reproductions More elastic supply Volatile gold prices Inelastic supply LO4

6-28 Cross Elasticity of Demand Formula for cross elasticity of demand E x,y = percentage change in quantity demanded of product X percentage change in price of product Y LO5

6-29 Cross Elasticity of Demand Measures responsiveness of purchases of one good to change in the price of another good Substitute goods if elasticity is positive Complement goods if elasticity is negative Independent goods if elasticity is 0 LO5

6-30 Cross Elasticity of Demand Applications of cross elasticity of demand Should a company change a price? Should the government allow a merger? LO5

6-31 Income Elasticity of Demand Formula for income elasticity of demand LO5 EiEi = percentage change in quantity demanded percentage change in income

6-32 Income Elasticity of Demand Measures responsiveness of buyers to changes in their income Normal goods if elasticity is positive Inferior goods if elasticity is negative LO5

6-33 Income Elasticity Insights High income elasticities Most affected by a recession Low or negative income elasticity Not affected that much by a recession LO5

6-34 Cross and Income Elasticities Cross and Income Elasticities of Demand Value of CoefficientDescriptionType of Good(s) Cross elasticity: Positive (E wz > 0) Negative (E xy < 0) Quantity demanded of W changes in same direction as change in price of Z Quantity demanded of X changes in opposite direction from change in price of Y Substitutes Complements Income elasticity: Positive (E i >0) Negative (E i <0) Quantity demanded of the product changes in same direction as change in income Quantity demanded of the product changes in opposite direction from change in income Normal or superior Inferior LO5

6-35 Elasticity and Pricing Power Charge different prices to different buyers based on price elasticities Business air travelers Children discounts College tuition