AP Microeconomics Rixie Unit 2, Days 1 & 2 Elasticity of Demand AP Microeconomics Rixie Unit 2, Days 1 & 2

The Law of Demand tells us that we will buy less of a product if the price increases, but how much less?

Price Elasticity of Demand A way to measure the responsiveness or sensitivity of consumers to a price change Ed = (% in quantity demanded of good X) / (% in price of good X) Note: when calculating elasticity of demand (Ed), you should use the absolute value of your final answer.

The greater this ratio, the more responsive consumers are to a change in price of good X. Price elastic – the consumer is generally responsive to a change in price Price inelastic – the consumer is generally unresponsive to a change in price

Range of Price Elasticity

The slope of a demand curve and elasticity of demand are NOT equivalent measures. However, the steepness of a demand curve can indicate whether a product is perfectly inelastic, relatively inelastic, relatively elastic, or perfectly elastic. (see next slide)

Graphical Representation of Elasticity of Demand Ed = 0 Ed < 1 Ed = 1 Ed > 1 Ed = infinity

Practice If the price of corn rises 5 percent and the quantity demanded for corn falls 1 percent, then Ed = 5 and demand is price elastic Ed= 1/5 and demand is price elastic Ed= 5 and demand is price inelastic Ed= 1/5 and demand is price inelastic Ed = 5 and corn is unit elastic The answer is D!

Practice problems for your notes: The price of a laptop computer increases by 10%, and we observe a 20% decrease in quantity demanded. The price of a pack of gum increases by 10%, and we observe a 5% decrease in quantity demanded. The price of oranges increases by 5%, and the quantity demanded decreases by 5%.

Midpoint Formula (used when moving point to point along a curve) Allows us to calculate the same thing (elasticity of demand) as the previous formula, but is more precise when given numerical data to work with rather than percentages. https://www.youtube.com/watch?v=lrGiZ7aTlQo&t=446s

Midpoint Formula Practice Problem At the initial price of $10, the quantity demanded of Good X is 100. When the price rises to $20, the quantity demanded falls to 90. What is the elasticity? (note – you should still use the absolute value of your final answer) Ed = (90-100) (20-10) (90+100)/2 (20+10)/2 ÷

Total Revenue Total Revenue (TR) is equal to price times quantity: TR = P x Q

How does TR relate to elasticity? The Total Revenue Test If you know that the demand for good X is elastic, TR and P (price) will change in opposite directions. (Ex: price increases, so total revenue decreases) If you know that the demand for good X is inelastic, TR and P will change in the same direction. If you know that the demand for good X is unit elastic, TR will not change with the change in price.

Determinants of Price Elasticity of Demand Substitutability The larger the number of substitute goods that are available, the greater the price elasticity of demand. Ex: Nike shoes (lots of substitutes) vs. Beyoncé concert tickets (one-of-a-kind)

Determinants of Price Elasticity of Demand 2. Proportion of Income The higher the price of a good relative to consumers’ incomes, the greater the price elasticity of demand. Ex: A car (huge chunk of income) vs. a pack of gum (small piece of income)

Determinants of Price Elasticity of Demand 3. Luxuries versus Necessities The more that a good is considered to be a “luxury” rather than a “necessity,” the greater is the price elasticity of demand. Ex: Jewelry (not needed) vs. bread (needed)

Determinants of Price Elasticity of Demand 4. Time The longer the time period, the more elastic is product demand. Ex: Rising gas prices - you still have to get gas to go places but in the long run you could switch to a hybrid car to use less

Cross elasticity of demand Measures how sensitive consumer purchases of one product (X) are to a change in price of another product (Y)

If cross elasticity of demand is: Positive: X & Y are substitutes Sales of X move in the same direction as a change in price of Y Ex: Coke & Pepsi Negative: X & Y are complements An increase in price of one good decreases the demand for the other. Ex: Cameras and film Near-zero: X & Y are independent The goods are unrelated and the price change of one has no effect on the purchase of the other

Income elasticity of demand Measures the degree to which consumers respond to a change in their incomes by buying more or less of a good

If Income elasticity of demand is: Positive: normal (or superior) goods Quantity demanded of the product changes in the same direction as change in income Ex: Televisions, cars, new name-brand clothing Negative: inferior goods Quantity demanded of the product changes in the opposite direction from change in income Ex: Used clothing, Ramen noodles, bus tickets

Price elasticity of Supply Measures producer sensitivity to a change in price

How elastic is supply? (use same ranges as elasticity of demand) Supply is Elastic Es = 1 Supply is Unit Elastic Es < 1 Supply is Inelastic

Producers being able to modify supply is highly dependent on the time available… Market Period: Occurs when the time immediately after a change in market price is too short for producers to respond with a change in quantity supplied Supply curve could be perfectly inelastic (vertical), because quantity supplied cannot change Regardless of a change in demand or a change in price, the quantity supplied remains constant. Ex: tomato farmer brings a truckload of tomatoes to market (the entire season’s output)

Short run Short Run: Too short a time period to change plant capacity, but long enough to use more labor and/or resources to increase quantity supplied Supply is somewhat more elastic Can change quantity supplied (within limits) as response to a predicted increase in demand Ex: tomato farmer could predict change in demand and increase labor, fertilizer, and pesticides

Long run Long Run: A time period long enough for firms to adjust their plant sizes and for firms to enter or leave the industry Supply is very elastic. Time to acquire larger facilities, buy land, buy more or better machinery Can greatly increase quantity supplied Ex: Tomato farmer can buy more land, machinery, equipment, and therefore employ more workers

Graphical representations

Classwork – p. 370 #2, 4, 6, 7, 12, 13, 14 (to be finished for homework)