Principles of Economics 2nd edition by Fred M Gottheil PowerPoint Slides prepared by Ken Long ©1999 South-Western College Publishing

Chapter 4 Elasticity 8/28/20188/28/2018 ©1999 South-Western College Publishing

This chapter discusses principles associated with Determinants of Demand Sensitivity to Price Changes Normal & Inferior Goods Substitute and Complementary Goods Price Elasticity of Demand Cross Elasticity Supply Elasticity Elasticity and Taxes Demand Sensitivity ©1999 South-Western College Publishing

How would you respond to a cut in the price of a Coke? That all depends on the price sensitivity of demand for Coke ©1999 South-Western College Publishing

A B D D Which demand curve is for spark plugs and which for Coca-Cola? ©1999 South-Western College Publishing

When consumers are very sensitive to a price change what does the demand curve look like? Relatively flat ©1999 South-Western College Publishing

When consumers are less sensitive to a price change what does the demand curve look like? Relatively steep ©1999 South-Western College Publishing

What factors influence Demand Sensitivity? Low price goods Income levels Substitute goods Basic goods Linked goods Time to adjust ©1999 South-Western College Publishing

What do low priced goods have to do with sensitivity? The lower the price of a good the less sensitive consumers are to a price change ©1999 South-Western College Publishing

How do income levels effect demand? Poor people are more sensitive to price changes than rich people ©1999 South-Western College Publishing

What do substitutes have to do with sensitivity? The more substitutes a good has, the more sensitive consumers are to a price change ©1999 South-Western College Publishing

What do basic goods have to do with sensitivity? The greater the need of a good to the consumer, the less sensitive the consumer is to a price change ©1999 South-Western College Publishing

What do linked goods have to do with sensitivity? When two goods have a complementary relationship, demand sensitivities are linked to one another ©1999 South-Western College Publishing

What are some examples of Complementary Goods? computers and software cars and gasoline tapes and tape players ©1999 South-Western College Publishing

What does time have to do with sensitivity? The more time to adjust, the more sensitive consumers are to a price change ©1999 South-Western College Publishing

What is Elasticity? A term economists use to measure sensitivity ©1999 South-Western College Publishing

How do we measure the Price Elasticity of Demand? The percentage change in quantity demanded divided by the percentage change in price ©1999 South-Western College Publishing

If there is an increase from 3 units to 5, what is the percentage increase? 2/3 = 66% ©1999 South-Western College Publishing

If there is a decrease from 5 units to 3, what is the percentage decrease? 2/5 = 40% ©1999 South-Western College Publishing

P A 2 B 3 D Q ©1999 South-Western College Publishing 2020

Problem - When we move along a demand curve between two points, we get different answers to elasticity depending if we are moving up or down the demand curve ©1999 South-Western College Publishing

If we go from 3 to 5, the percentage change is 2/3 , but if we go from 5 to 3, the percentage change is 2/5 , so the elasticities are different ©1999 South-Western College Publishing

The answer to this problem is to work with averages ... ©1999 South-Western College Publishing

divided by Price elasticity equals the change in quantity demanded sum of quantities/2 divided by change in price sum of prices/2 24 ©1999 South-Western College Publishing

Quantity Price Bananas 200 $20 $18 240 Oranges 400 $40 280 $70 2525 ©1999 South-Western College Publishing

What is the Price Elasticity of Demand for bananas? 2 40 = 220 19 19 40 760 = X 2 220 440 ©1999 South-Western College Publishing

What is the Price Elasticity of Demand for oranges? 120 30 = 340 55 55 120 6,600 = X 30 340 10,200 ©1999 South-Western College Publishing

If a college raises tuition, what happens to revenue? If demand is elastic - revenue goes down If demand is inelastic - revenue goes up ©1999 South-Western College Publishing

If price increases and the revenue increases, the demand curve within the price range is price inelastic, < 1 ©1999 South-Western College Publishing

If price increases and the revenue decreases, the demand curve within the price range is price elastic, > 1 ©1999 South-Western College Publishing

If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1 ©1999 South-Western College Publishing

What strategies do Coca-Cola and Pepsi use to make the demand for their products less elastic? http://www.cocacola.com http://www.pepsi.com ©1999 South-Western College Publishing

What is Cross Elasticity of Demand? The percentage change in the quantity demanded of one commodity resulting from a 1 percent change in price of another commodity ©1999 South-Western College Publishing

If negative - complements (steak & steak sauce) If positive - substitutes (butter & margarine) ©1999 South-Western College Publishing

What is Income Elasticity of Demand? The ratio of the percentage change in quantity demanded to the percentage change in income ©1999 South-Western College Publishing

When is a demand curve income elastic? When a 1% change in income generates a greater than 1% change quantity demanded ©1999 South-Western College Publishing

When ia demand curve income inelastic? When a 1% change in income generates a less than 1% change quantity demanded ©1999 South-Western College Publishing

A good that people buy less of as their incomes increase What is an Inferior Good? A good that people buy less of as their incomes increase ©1999 South-Western College Publishing

A good that people buy more of as their incomes increase What is a Normal Good? A good that people buy more of as their incomes increase ©1999 South-Western College Publishing

What is Price Elasticity of Supply? The ratio of the percentage change in quantity supplied to the percentage change in price ©1999 South-Western College Publishing

Does time effect Supply Elasticities? Yes! The more time, the more elastic the supply curve ©1999 South-Western College Publishing

Which type of good would be best to tax to raise the most revenue? Goods with inelastic demand curves ©1999 South-Western College Publishing

What does the Tobacco Resource Center do to increase the elasticity of demand for cigarettes? http://www.tobacco.neu.edu/ ©1999 South-Western College Publishing

What factors influence Demand Sensitivity? What is Elasticity? How do we measure the Price Elasticity of Demand? What is Cross Elasticity of Demand? What is Income Elasticity of Demand?

END ©1999 South-Western College Publishing