CHAPTER 20 ELASTICITY

Elasticity Sensitivity of one thing to a change in something else

Law of Demand There is an inverse relationship between changes in price and changes in quantity demanded.

Price Elasticity of Demand The sensitivity of quantity demanded to a change in price. If quantity demanded is sensitive to a change in price, we say demand is relatively elastic. If quantity demanded is not very sensitive to a change in price, we say demand is relatively inelastic

A Tale of Two Businesses (selling different products) Q T.R. 10 100 11 95 P Q T.R. 10 100 11 50

Determinants of Price Elasticity of Demand Number of Substitutes Time Period Importance to Budget Necessity vs. luxury

Basic Formula

Types of PE of D PE of D > 1 = Elastic PE of D < 1 = Inelastic PE of D = 1 = Unit Elastic Perfectly Inelastic Perfectly Elastic

Complications?? PE of D changes in ranges along a downward sloping demand curve. The direction of the calculation changes the PE of D coefficient.

Using PE of D to Predict Total Revenue Changes Where Demand is Inelastic When Demand is Elastic Increase in P …. Increase in TR Decrease in P …..Decrease in TR Increase in P ….. Decrease in TR Decrease in P ……. Increase in TR

Price Discrimination Charging different groups of customers different prices based upon the group's price elasticity of demand Must be able to separate the groups Must be able to prevent them from reselling amongst each other

Income Elasticity of Demand Formula Positive = Normal Good Negative = Inferior Good Example Income Widget Consumption $50,000 100,000 $60,000 60,000

Cross Price Elasticity Formula Positive = Substitutes Negative = Complements Example: Price of Peanut Butter Ave. Consumption of Jelly $4.00 per Jar 10 $5.00 per Jar 6

Price Elasticity of Supply Formula Determinants Example: Calculate the price elasticity of supply using the midpoint Price of Peanut Butter Quantity Supplied $5.00 per Jar 100 $10.00 per Jar 110