What is something that you won’t “live without”? What is something that you could “take or leave”?

18 Extensions of Demand and Supply Analysis

Price Elasticity of Demand Measuring Responsiveness to Price Changes Relatively Elastic or Inelastic Price-Elasticity Coefficient and Formula Percentage Change in Quantity Demanded of Product X Ed = Percentage Change in Price of Product X

Price Elasticity of Demand Formula Restated Change in Quantity Demanded of X Ed = Original Quantity Demanded of X Change in Price of X ÷ Original Price of X Using Averages Midpoint Formula W 6.1 Change in Quantity Ed = Sum of Quantities/2 ÷ Change in Price Sum of Prices/2

Price Elasticity of Demand Why Use Percentages? Elimination of the Minus Sign Interpretations of Ed Elastic Demand Ed = .04 .02 = 2 Inelastic Demand Ed = .01 .02 = .5 Unit Elasticity Ed = .02 = 1

Price Elasticity of Demand Extreme Cases Perfectly Inelastic Demand P Q D1 Perfectly Inelastic Demand (Ed = 0) Perfectly Elastic Demand P Q D2 Perfectly Elastic Demand (Ed = ∞)

The Total Revenue Test Total Revenue (TR) TR = P x Q Elastic Demand P W 6.2 $3 2 1 0 10 20 30 40 Q P a b D1

The Total Revenue Test Total Revenue (TR) TR = P x Q Inelastic Demand W 6.2 $4 3 2 1 0 10 20 Q P c d D2

The Total Revenue Test Total Revenue (TR) TR = P x Q Unit-Elastic P e W 6.2 $3 2 1 0 10 20 30 Q P e f D3

Elasticity on a Linear Demand Curve G 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test (1) Total Quantity of Tickets Demanded Per Week, Thousands (3) Elasticity Coefficient (Ed) (4) Total Revenue (1) X (2) (5) Total-Revenue Test (2) Price Per Ticket 1 2 3 4 5 6 7 8 8 7 6 5 4 3 2 1 $8,000 14,000 18,000 20,000 8,000 ] 5.00 2.60 1.57 1.00 0.64 0.38 0.20 ] Elastic Unit Elastic Inelastic Graphically…

Price Elasticity and the Total-Revenue Curve 1 2 3 4 5 6 7 8 Quantity Demanded Price (Thousands of Dollars) Total Revenue $20 18 16 14 12 10 $8 Elastic Ed > 1 a b c d e f g h Unit Elastic Ed = 1 Inelastic Ed < 1 D Elastic Ed > 1 Unit Elastic Ed = 1 TR Inelastic Ed < 1

Determinants of Price Elasticity of Demand Substitutability Proportion of Income Luxuries versus Necessities Time Applications: Large Crop Yields Excise Taxes Decriminalization of Illegal Drugs

Do you supply more labor/day when the price for that labor goes up? Can you increase that amount just within a day? (or would you have to reshuffle your schedule?) Can you increase it in a month? What about over 2 years? … you become more elastic in your supply over time See farmer example on page 348

Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X See page 348, example at bottom of page.

Price Elasticity of Supply Unit Elastic Supply Es = 1 Market Period: Not Enough Time to Shift Resources P Q Sm Greatest Price Impact Pm P0 D1 D2 Q0

Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Inelastic Supply Es < 1 Short Run: Resources Not Easily Shifted to Alternative Uses P Q Ss Lower Price Impact Ps P0 D1 D2 Q0 Qs

Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Elastic Supply Es > 1 Long Run: Resources Easily Shifted to Alternative Uses P Q Sl Least Price Impact Pl P0 D1 D2 Q0 Ql

Price Elasticity of Supply Applications Antiques and Reproductions Volatile Gold Prices

Cross elasticity Will a price decrease on Sprite cannibalize demand from Coke? (Same company) Depends on the cross elasticity of demand Coca-Cola Inc. would need to know what the percentage change in quantity demanded of coke versus the percentage change in price of Sprite Equation looks like …

Cross Elasticity of Demand Percentage Change in Quantity Demanded of Product X Exy = Percentage Change in Price of Product Y Substitute Goods – Positive Sign Complementary Goods- Negative Sign Independent Goods – Zero or Near-Zero Value

Do you buy more Gatorade when your income increases? It does if Gatorade is a normal good. But how much more? That’s where Income Elasticity of Demand comes in.

Income Elasticity of Demand Percentage Change in Quantity Demanded Ei = Percentage Change in Income Normal Goods – Positive Sign Inferior Goods- Negative Sign Insights into the Economy …

Income has grown 2 to 3 % … agriculture has had an Ei = +.2 … housing has had an Ei = +1.4 They’re both normal goods, they both a positive Ei What might have a negative Ei?

On your income, what’s the max that you’d pay for a gallon of gas in any given week? What do you actually pay? The difference is your “consumer surplus” What do you suppose is the lowest price for a gallon that would cause a station to supply a gallon? The difference between that and the going price is the “producer surplus”

Consumer and Producer Surplus Consumer Surplus O 6.3 Consumer Surplus Equilibrium Price = $8 Price (Per Bag) P1 D Q1 Quantity (Bags)

Consumer and Producer Surplus Equilibrium Price = $8 Price (Per Bag) P1 Producer Surplus Q1 Quantity (Bags)

Consumer and Producer Surplus Efficiency Revisited S W 6.3 Consumer Surplus Equilibrium Price = $8 Price (Per Bag) P1 Producer Surplus D Q1 Quantity (Bags)

Consumer and Producer Surplus Efficiency Revisited Efficiency Losses (Deadweight Losses) S Efficiency Losses Price (Per Bag) P1 D Q2 Q1 Q3 Quantity (Bags)

Elasticity and Pricing Power: Word Why Different Consumers Pay Different Prices All Buyers in a Highly Competitive Market Pay the Same Price Regardless of Their Elasticities Difficulty in Applying Different Prices Observe Differences in Group Elasticities Business Travelers Leisure Travelers Discounting for Children Different Net Prices for College Tuition