ECON 100 Lecture 13 Monday, November 3

Announcements MIDTERM #1: Wednesday November 19, starts at 7 P.M. Only material covered in lectures will be on the midterm. Sample midterm exams are posted on webpage ( Spring 2014, 2013, and 2012) are posted. The solutions will be posted later. Announcements section. Answers to PS #5 are posted on webpage. PS#6 is on its way. Webpage : https://ais.ku.edu.tr/course/25089/Default.html

Problem Session / KOLT tutors PS1: FRIDAY B4 (at 13:00) in room SOS B21 PS2: FRIDAY B5 (at 14:30) in room SOS B08 No attendance is taken at the PSs. Econ 100 KOLT tutors: Sonkurt, Jülide, and Ilgaz

Please turn off your phones. Class participation You must attend the section where you are registered. Your in-class exercise is your participation record. I collect them at the end of the lecture. Please turn off your phones.

Remember the last lecture (It was almost a week ago!)

Elasticity is a general concept we use to quantify the response in one variable (A) when another variable (B) changes.

The Price Elasticity of Demand, EP The measure of responsiveness of quantity demanded to a change in price. EP is computed as follows:

How price elastic is demand for water? In the United States, a 10% increase in the price of water reduces demand in the urban residential sector (that means peoples’ homes) by 3.5%. Please compute the price elasticity of demand for water. EP is defined as % change in QD divided by % change in P So, EP = 3.5/10 = 0.35 Demand for water is price inelastic.

Demand Elasticity, EP Unit elastic: │EP│ = 1 Inelastic: │EP│ < 1 1 2 3 4 5 6 Unit elastic Inelastic Elastic │EP│

What makes the demand more elastic? Demand tends to be more elastic if, … there are close substitutes. the market is more narrowly defined: food (inelastic) versus milk (more elastic). more time is allowed after the price change. the good is a luxury. (Necessities have inelastic demand.)

Let’s see some price elasticity numbers

More computations! Learning activity #1

The table shows the prices of good X and good Y, the annual income of the consumer, and the quantities of good X consumed during a six year period. Year PX QX PY Income 2007 100 80 50 20,000 2008 110 90 40 18,000 2009 2010 2011 2012 25,000 Which pair of years will you use to calculate the price elasticity of demand for good X? Why? What is the price elasticity of demand for X? Is demand for good X elastic or inelastic?

Solution Choose 2008 and 2009 Why? Because Py and Income are constant in those two years. In 2008 : P = 110, Q = 90 In 2009 : P = 90, Q = 100

Solution In 2008 : P = 110, Q = 90 In 2009 : P = 90, Q = 100 The percentage change in Q is +11.1% (100–90)/90 The percentage change in P is –18.2% (90–110)/110 EP = % change in Q divided by % change in P EP = –11.1/18.2 = -0.61 (inelastic) EP = – 0.61 is the value of the price elasticity of demand at P = 110.

Solution In 2008 : P = 110, Q = 90 In 2009 : P = 90, Q = 100 We can also ask: What is the price elasticity of demand at P = 90? The percentage change in Q is -10% (90–100)/100 The percentage change in P is +22.2% (110–90)/90 EP = % change in Q divided by % change in P EP = –10/22.2 = -0.45 (inelastic) EP = – 0.45 is the value of the price elasticity of demand at P = 90.

Why are we getting different results for EP?

Price elasticity and the linear demand curve The price elasticity is NOT constant along a linear demand curve.

A Linear Demand Curve Is this demand curve elastic or inelastic? A B 7 Price Is this demand curve elastic or inelastic? 7 A B 6 5 4 3 2 1 2 4 6 8 10 12 14 Quantity

A Linear Demand Curve Price Is this demand curve elastic or inelastic at P = 6? Is this demand curve elastic or inelastic at P = 2? 7 A B 6 5 4 3 2 1 2 4 6 8 10 12 14 Quantity

A little bit of mathematics

Price decreases from P1 to P2. Quantity demanded increases from Q1 to Q2. ΔQ = Q2–Q1 is the change in quantity demanded. Let ΔQ = Q2–Q1 P2–P1 is the change in price. Let ΔP = P2–P1 Price Quantity Demand P1 P2 DP Q1 Q2 DQ

Price elasticity formula: % change in Q divided by % change in P (Q2–Q1)/Q1 : this is % change in quantity (P2–P1)/P1 : this is % change in price ΔQ = Q2–Q1 and ΔP = P2–P1 EP = ΔQ/Q1 divided by ΔP/P1.

Elasticity EP = (1/slope)x(P/Q) Price Quantity Demand P1 P2 DP Q1 Q2 DQ

A Linear Demand Curve Price 7 Elasticity is larger than 1. 6 5 4 Elasticity is smaller than 1. 3 2 1 2 4 6 8 10 12 14 Quantity

which we also write as EP = [1/slope]x(P/Q) Slope = ‒½ 1/slope = ‒2 EP at P = 6 is ‒2x(6/2) = ‒6 EP at P = 3.5 is ‒2x(3.5/7) = ‒1 EP at P = 1 is ‒2x(1/12) = ‒1/6

The “midpoint formula” for price elasticity of demand I need to teach them this formula. Sorry.

Midpoint formula means computing EP at point C A Linear Demand Curve Price 7 A B Midpoint formula means computing EP at point C 6 5 4 3 2 1 2 4 6 8 10 12 14 Quantity

Revenue and price elasticity

Elasticity of Demand and Total Revenue A firm’s revenues are equal to price per unit times quantity sold. Revenue = Price x Quantity The elasticity of demand directly influences revenues when the price of the good changes. Instructor Notes:

Total Revenue and the Price Elasticity of Demand Total revenue is the amount paid by the buyers and received by the sellers of a good. Computed as the price times quantity sold. TR = P x Q

Total Revenue Price Demand $4.00 P x Q = $400 (revenue) 100 Quantity

Elasticity and Total Revenue If demand is elastic at P = Po, a small increase in price will cause a decrease in total revenue. Raise P by 10%  QD will decline by 20%  TR = PxQ will decline. If demand is inelastic at P = Po, a small increase in price will cause an increase in total revenue. Raise P by 10%  QD will decline by 5%  TR = PxQ will rise.

Relationship Between Elasticity and Total Revenue Price Rise Price Decline Elastic (EP > 1) TR decreases TR increases Unit Elastic (EP = 1) TR constant Inelastic (EP < 1) 35

Your turn now

Bridge Toll Example Current toll for the George Washington Bridge is $2.00/trip. Suppose the quantity demanded is 100,000 trips/hour. If the price elasticity of demand for bridge trips is EP = -- 0.5, what is the effect of a 10% toll increase on revenues/hour? Your example. As of 2013, the George Washington Bridge carries approximately 102 million vehicles per year. It is the world's busiest motor vehicle bridge.

FSM and Boğaziçi Price AKS ARALIĞI 3.20 m’DEN KÜÇÜK İKİ AKSLI ARAÇLAR otomobiller, motosiklet Aks aralığı 3.20 m.’den küçük kamyon, kamyonet, ve minibüsler dahil TL4.25! Quantity … Aralık ayında (2011), Boğaziçi ve Fatih Sultan Mehmet köprülerinden 13.3 milyon araç geçiş yaparken,…

Bridge Toll increase with EP = -0.5 inelastic demand Price elasticity of demand = -0.5 Toll increase of 10% implies a 5% decline in the quantity demanded. Trips fall to 95,000/hour. Total revenue rises to $209,000/hour (= 95,000 x $2.20). ditto

End of the lecture