Lecture on Price Elasticity www.AssignmentPoint.com www.assignmentpoint.com

Elasticity Price Elasticity of Demand Price elasticity of demand measures the responsiveness of buyers’ purchasing habits to a price change. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Price Elasticity of Demand Definition: Ep = the percentage change in a product’s quantity demanded divided by the percentage change in its price. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Price Elasticity of Demand Formula: Microeconomics www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Price Elasticity of Demand Example 1 Let’s say that a grocery store observes that at $2.00 per gallon of milk, buyers purchase 800 gallons per day. The next week, the grocery store increases its price to $3.00 per gallon and buyers purchase 700 gallons per day. What is the price elasticity of demand for milk? www.assignmentpoint.com Microeconomics

Elasticity Price Elasticity of Demand Example 1 answer the change in quantity demanded = 100 the average quantity demanded = 750 the change in price = $1 the average price = $2.50 100/750 .133 $1/$2.50 .4 Ep = = .3325 Microeconomics www.assignmentpoint.com

Unit 3 - Elasticity Price Elasticity of Demand Example 1 answer Officially, the answer is - . 3325, because the quantity demanded decreased (change of -100). However, because price elasticity of demand is always negative, we ignore the negative sign. Microeconomics www.assignmentpoint.com

Unit 3 - Elasticity Price Elasticity of Demand If a product’s elasticity is less than 1, then we say that it is inelastic. If a product’s elasticity is greater than 1, then we say that it is elastic. If a product’s elasticity is equal to 1, then we say that it is unit elastic. www.assignmentpoint.com Microeconomics

A product with a price elasticity of demand equal to 3.5 is: Inelastic Unit elastic Elastic None of the above 10 0 of 30

A product with a price elasticity of demand equal to 3.5 is: Inelastic Unit elastic Elastic None of the above 0 of 30

Unit 3 - Elasticity Price Elasticity of Demand Example 2 A movie theatre sells 1,800 tickets when it charges a price of $11. After it lowers its price to $9, it sells 2,600 tickets. What is the price elasticity of demand for tickets for this movie theatre? www.assignmentpoint.com Microeconomics

In the previous example (1,800 and 2,600 tickets, and price of $11 and $9), what is the price elasticity of demand? .55 1.818 1.55 2.83 5.151 0 of 30

Unit 3 - Elasticity Price Elasticity of Demand Example 2 answer 800/2200 .3636 2/10 .2 Because the value is greater than 1, movie tickets at this theatre are price elastic. = 1.818 Ep = www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Price Elasticity of Demand Determinants of price elasticity of demand are: The availability of close substitutes. The more substitutes, the greater the elasticity. The product’s expense to the consumer relative to her/his income or wealth. The higher the expense, the greater the elasticity. The period of time under consideration. The longer the time period, the greater the elasticity. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Price Elasticity of Demand Price elasticity determinants of gasoline The availability of close substitutes. Gasoline does not have many substitutes. This makes gasoline inelastic. The product’s expense to the consumer relative to her/his income or wealth. For many people gasoline is a considerable expense. This makes gasoline elastic. The period of time under consideration. Within a short period of time, people cannot change their driving behavior much. This makes gasoline inelastic when looking at a short-run demand curve. Overall, especially in the short run, gasoline is probably inelastic. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Price Elasticity of Demand Elasticity and Revenue Revenue = quantity demanded x price If quantity demanded increases by 10%, and price decreases by 5% (this means that the product is elastic), then revenue increases. www.assignmentpoint.com Microeconomics

If a product is elastic and its price decreases, then the supplier’s total revenue: Increases Stays the same None of the above 0 of 30

If a product is inelastic and its price decreases, then the supplier’s total revenue: Increases Stays the same None of the above 0 of 30

If a product is unit elastic and its price decreases, then the supplier’s total revenue: Increases Stays the same None of the above 0 of 30

Unit 3 - Elasticity Price Elasticity of Demand Elasticity and Revenue Summary If a product is elastic and price increases, then revenue decreases. If a product is inelastic and price increases, then revenue increases. If a product is elastic and price decreases, then revenue increases. If a product is inelastic and price decreases, then revenue decreases. If a product is unit elastic and price changes, then revenue stays the same. www.assignmentpoint.com Microeconomics

Higher price elasticity of demand Lower price elasticity of demand When you graph a demand curve, you notice that a flatter (closer to horizontal) demand curve is associated with a: Higher price elasticity of demand Lower price elasticity of demand Perfectly inelastic demand situation None of the above 0 of 30

D1 (inelastic demand curve) D2 (elastic demand curve) Unit 3 - Elasticity Price D1 (inelastic demand curve) $9.00 D2 (elastic demand curve) $8.00 60 68 100 Quantity www.assignmentpoint.com

Unit 3 - Elasticity Elasticity and Competition A perfectly competitive firm faces a demand curve which is perfectly elastic (horizontal). The more elastic the product, the flatter the curve. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Price $9.00 60 Quantity D1 (Perfectly Elastic Demand Curve) $9.00 D2 (Perfectly Inelastic Demand Curve) 60 Quantity www.assignmentpoint.com

Unit 3 - Elasticity Income Elasticity of Demand Income elasticity of measures the responsiveness of buyers’ purchasing habits in response to an income change. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Income Elasticity of Demand Definition: Ei = the percentage change in a product’s quantity demanded divided by the percentage change in buyers’ incomes. The value can be positive (normal good) or negative (inferior good). www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Income Elasticity of Demand Formula: Where Qd = quantity demanded, and Y = income. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Cross Price Elasticity of Demand The price change of a substitute or complementary product affects the quantity demanded of the other substitute or complementary product. Substitutes have a positive cross price elasticity of demand. Complements have a negative cross price elasticity of demand. www.assignmentpoint.com Microeconomics

Unit 3 - Elasticity Cross Price Elasticity of Demand The formula for cross price elasticity of demand is: the % change in the quantity demanded of product A the % change in the price of related product B Ecp = www.assignmentpoint.com Microeconomics

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Practice problem . A 10% increase in the price of movie ticket in Westridge 8 leads to a 15% decrease in the number of tickets sold, indicating the demand for movie ticket in Westridge 8 is: a) elastic. b) inelastic. c) unit elastic. d) Can not tell from the information given. www.assignmentpoint.com

2. Anna owns the Sweet Alps Chocolate store 2.  Anna owns the Sweet Alps Chocolate store. She charges $10 per pound for her hand made chocolate. You, the economist, have calculated the elasticity of demand for chocolate in her town to be 2.5. If she wants to increase her total revenue, what advice will you give her and why?  Be able to explain your answer. www.assignmentpoint.com

Anna should lower her price  Anna should lower her price.  Her price elasticity of demand for chocolate is elastic (greater than one) and therefore, when she lowers her price she will sell a lot more chocolate.  The greater quantity sold will make up for her lower price, increasing her total revenue.  In other words, she is selling at a lower price but making up for it in volume of sales. www.assignmentpoint.com

3.  A 10 percent increase in income brings about a 15 percent decrease in the demand for a good. What is the income elasticity of demand and is the good a normal good or an inferior good?  Be able to explain your answer. www.assignmentpoint.com

3.  -15%/10% = -.15/.10 = -1.5.  Remember the elasticity is always read as the absolute value or a positive number, so it is 1.5 (elastic, or greater than one).  The good is an inferior good because the sign is negative, indicating that an increase in income will bring a decrease in the demand for the good. www.assignmentpoint.com

4.  If the price of a good increases by 8% and the quantity demanded decreases by 12%, what is the price elasticity of demand?  Is it elastic, inelastic or unitary elastic? www.assignmentpoint.com

.  -12%/8% = -.12/.08 = -1.5.  Again, drop the negative sign, so the elasticity is 1.5.  This means it is elastic (greater than one). www.assignmentpoint.com

Yesterday, the price of envelopes was $3 a box, and Julie was willing to buy 10 boxes. Today, the price has gone up to $3.75 a box, and Julie is now willing to buy 8 boxes. Is Julie's demand for envelopes elastic or inelastic? What is Julie's elasticity of demand? To find Julie's elasticity of demand, we need to divide the percent change in quantity by the percent change in price.  % Change in Quantity = (8 - 10)/(10) = -0.20 = -20%  % Change in Price = (3.75 - 3.00)/(3.00) = 0.25 = 25%  Elasticity = |(-20%)/(25%)| = |-0.8| = 0.8  www.assignmentpoint.com

Problem : If Neil's elasticity of demand for hot dogs is constantly 0 Problem : If Neil's elasticity of demand for hot dogs is constantly 0.9, and he buys 4 hot dogs when the price is $1.50 per hot dog, how many will he buy when the price is $1.00 per hot dog? www.assignmentpoint.com

This time, we are using elasticity to find quantity, instead of the other way around. We will use the same formula, plug in what we know, and solve from there.  Elasticity =  And, in the case of John, %Change in Quantity = (X – 4)/4  Therefore :  Elasticity = 0.9 = |((X – 4)/4)/(% Change in Price)|  % Change in Price = (1.00 - 1.50)/(1.50) = -33%  0.9 = |(X – 4)/4)/(-33%)|  |((X - 4)/4)| = 0.3  0.3 = (X - 4)/4  X = 5.2  www.assignmentpoint.com

: Katherine advertises to sell cookies for $4 a dozen : Katherine advertises to sell cookies for $4 a dozen. She sells 50 dozen, and decides that she can charge more. She raises the price to $6 a dozen and sells 40 dozen. What is the elasticity of demand? Assuming that the elasticity of demand is constant, how many would she sell if the price were $10 a box? To find the elasticity of demand, we need to divide the percent change in quantity by the percent change in price.  www.assignmentpoint.com

% Change in Quantity = (40 - 50)/(50) = -0 % Change in Quantity = (40 - 50)/(50) = -0.20 = -20%  % Change in Price = (6.00 - 4.00)/(4.00) = 0.50 = 50%  Elasticity = |(-20%)/(50%)| = |-0.4| = 0.4  The elasticity of demand is 0.4 (elastic).  To find the quantity when the price is $10 a box, we use the same formula:  Elasticity = 0.4 = |(% Change in Quantity)/(% Change in Price)|  % Change in Price = (10.00 - 4.00)/(4.00) = 1.5 = 150%  Remember that before taking the absolute value, elasticity was -0.4, so use -0.4 to calculate the changes in quantity, or you will end up with a big increase in consumption, instead of a decrease!  -0.4 = |(% Change in Quantity)/(150%)|  |(%Change in Quantity)| = -60% = -0.6  -0.6 = (X - 50)/50  X = 20  The new demand at $10 a dozen will be 20 dozen cookies. www.assignmentpoint.com

The quantity of a good demanded rises from 1000 to 1500 units when the price falls from $1.50 to $1.00 per unit. The price elasticity of demand for this product is approximately:A. 1.0B. .16C. 2.5D. 4.0  www.assignmentpoint.com

If the elasticity of demand for a commodity is estimated to be 1  If the elasticity of demand for a commodity is estimated to be 1.5, then a decrease in price from $2.10 to $1.90 would be expected to increase daily sales by:A. 50%B. 1.5%C. 5%D. 15%  www.assignmentpoint.com