Warm-Up What is wrong with this statement: “We bought enough. We just ran out!” Draw what the market might look in this situation. What should happen to either price, demand or supply to reach equilibrium.
Medicare’s Costly Role in Health Care, Washington Post, January 1, 2014, A10. Medicaid Expands Role Under New Law, Washington Post, January 1, 2014, A1.
Income and Substitution Effects Chapter 10: The Rational Consumer (pages 263-265)
Law of Demand… Substitution Effect Income Effect in PA makes Good A relatively more expensive in QD Income Effect in price lowers purchasing power
What if… Burgers & chicken are normal PBurgers while Pchicken How will the change in burger price affect quantity demanded? Explain the substitution effect. Explain the income effects.
Introduction to Elasticity Chapter 6: Elasticity (pages 144-155)
Elasticity LARGE D in QD = Elastic D in P will lead to D in QD Question is how much LARGE D in QD = Elastic small D in QD = Inelastic
Price Elasticity of Demand Elasticity changes if you move up or down the curve MIDPOINT METHOD solves problem
Midpoint Method
Using Midpoint Method
Sage & Share Calculate elasticity of demand Price Quantity Demanded Situation A $1.50 100,000 Situation B $1.00 200,000 Calculate elasticity of demand Is demand for strawberries elastic or inelastic?
How elastic is elastic? PERFECTLY INELASTIC QD does not change with DP Vertical line
Perfectly Inelastic 1 Quantity of shoelaces Quantity of shoelaces (billions of pairs per year) (a) Perfectly Inelastic Demand: Price Elasticity of Demand = 0 $3 $2 Price of shoelaces (per pair) D 1 An increase in price… … leaves the quantity demanded unchanged.
How elastic is elastic? PERFECTLY INELASTIC PERFECTLY ELASTIC DP leads to no DQD Elasticity = 0 PERFECTLY ELASTIC DP leads to large DQD Elasticity = ∞
Perfectly Elastic (b) Price Elastic Demand: Price Elasticity of Demand = ∞ $5 Price of pink tennis balls (per dozen) Quantity of tennis balls (dozens per year) At exactly $5, consumers will buy any quantity At any price above $5, quantity demanded is zero D 2 At any price below $5, quantity demanded is infinite
How elastic is elastic? PERFECTLY INELASTIC PERFECTLY ELASTIC DP leads to no DQD Elasticity = 0 PERFECTLY ELASTIC DP leads to large DQD Elasticity = ∞ UNIT ELASTIC Elasticity = 1
. . . generates a 20% decrease in the quantity of crossings demanded. Unit Elastic (a) Unit-Elastic Demand: Price Elasticity of Demand = 1 900 1,100 $1.10 0.90 Price of crossing Quantity of crossings (per day) D 1 A 20% increase in the price . . . B A . . . generates a 20% decrease in the quantity of crossings demanded.
A Question... If you want to increase revenue, what should you do with the price?
So What?!? Elasticity predicts D in TOTAL REVENUE with DP TR = P * Q 1,100 $0.90 D Total revenue = price x quantity = $990
DTR Depends on … PRICE EFFECT QUANTITY EFFECT DP leads goods to either be more or less expensive P TR QUANTITY EFFECT DP leads to a either more or fewer goods demanded P QD TR
Effect of P on TR 900 1,100 $1.10 0.90 Price of crossing $1.10 0.90 Quantity of crossings (per day) Price of crossing Price effect of price increase: higher price for each unit sold D Quantity effect of price increase: fewer units sold C A B
General Rules … Changes in Price Elasticity If DP = TR then … Unit elastic If P = TR then … Elastic If P = TR then … Inelastic Changes in Price Elasticity If DP = TR then … Unit elastic If P = TR then … Elastic If P = TR then … Inelastic
Elasticity Ds Along Curve 1 2 3 4 5 6 7 10 9 8 $25 24 21 16 Quantity Total revenue $10 Price The price elasticity of demand changes along the demand curve Elastic D Unit-elastic Price QD TR $0 10 1 9 2 8 16 3 7 21 4 6 24 5 25 Inelastic Demand is elastic: a higher price reduces total revenue Demand is inelastic: a higher price increase total revenue
Real Life Example…
Eat Up Idiots… How can you remember relative elasaticities along the demand curve? Eat … Up … Idiots
Elasticity Impacted By… Substitutability Proportion of income spent on good Luxury or necessity Time