AP Economics Elasticity Review Summary Elasticity is a general measure of responsiveness that can be used to answer various questions. The price elasticity of demand — the percent change in the quantity demanded divided by the percent change in the price (dropping the minus sign) — is a measure of the responsiveness of the quantity demanded to changes in the price. AP Economics Elasticity

AP Economics Elasticity Review Summary The responsiveness of the quantity demanded to price can range from perfectly inelastic demand, where the quantity demanded is unaffected by the price, to perfectly elastic demand, where there is a unique price at which consumers will buy as much or as little as they are offered. When demand is perfectly inelastic, the demand curve is vertical; when it is perfectly elastic, the demand curve is horizontal. The price elasticity of demand is classified according to whether it is more or less than 1. If it is greater than 1, demand is elastic; if it is exactly 1, demand is unit-elastic; if it is less than 1, demand is inelastic. This classification determines how total revenue, the total value of sales, changes when the price changes. AP Economics Elasticity

AP Economics Elasticity Review Summary The price elasticity of demand depends on whether there are close substitutes for the good, whether the good is a necessity or a luxury, the share of income spent on the good, and the length of time that has elapsed since the price change. AP Economics Elasticity

AP Economics Elasticity Price Elasticity of Demand Some Estimated Price Elasticities of Demand Good Price elasticity Inelastic demand Eggs -0.1 Beef -0.4 Stationery -0.5 Gasoline -0.5 Elastic demand Housing -1.2 Restaurant meals -2.3 Airline travel -2.4 Foreign travel -4.1 |Price elasticity of demand| < 1 |Price elasticity of demand| > 1 AP Economics Elasticity

AP Economics Cross-Price Elasticity of Demand Intro to Cross-Price EoD Intro: The cross-price elasticity of demand measures the effect of a change in one good’s price on the quantity of another good demanded. AP Economics Cross-Price Elasticity of Demand

AP Economics Cross-Price Elasticity Cross Price Elasticity of Demand If EQX,PY > 0, then X and Y are gross substitutes because as the price of good Y increases, the demand for good X increases. This can happen from either of two effects. Good X substitutes for Good Y. For example, as the price of Y = apples increases, the demand for X = oranges increases because consumers substitute oranges for apples. Good X is needed because it is affordable. For example, as the price of Y = College education increases, freshmen students must economize and consume more affordable goods, like X = Ramen Noodles. Since there are two effects, their sum is called the gross effect. AP Economics Cross-Price Elasticity

AP Economics Cross-Price Elasticity Cross Price Elasticity of Demand If EQX,PY < 0, then X and Y are gross complements because as the price of good Y increases, the demand for good X decreases. This can happen from either of two effects. Good Y complements Good X. For example, as the price of Y = bread increases, the demand for X = butter decreases because consumers need less butter when there is less bread. Good X is not wanted because it is unaffordable. For example, as the price of Y = college education increases, freshmen students must economize and consume fewer unaffordable goods, like X = Chix Fillet. Since there are two effects, their sum is called the gross effect. AP Economics Cross-Price Elasticity

AP Economics Income Elasticity Intro to Income Elasticity EoD Intro: The income elasticity of demand is the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in income. If the income elasticity is greater than 1, a good is income elastic; if it is positive and less than 1, the good is income-inelastic. % change in demand divided by the % change in income AP Economics Income Elasticity

Income Elasticity Income Elasticity If EQX,M > 0, then X is a normal good. Higher income M implies higher demand. If EQX,M < 0, then X is a inferior good. Higher income M implies lower demand. BA 210 Lesson I.7 Elasticity

AP Economics Income Elasticity Normal goods have a positive income elasticity of demand so as consumers’ income rises more is demanded at each price i.e. there is an outward shift of the demand curve Normal necessities have an income elasticity of demand of between 0 and +1 for example, if income increases by 10% and the demand for fresh fruit increases by 4% then the income elasticity is +0.4. Demand is rising less than proportionately to income. Luxury goods and services have an income elasticity of demand > +1 i.e. demand rises more than proportionate to a change in income – for example a 8% increase in income might lead to a 10% rise in the demand for new kitchens. The income elasticity of demand in this example is +1.25. Inferior Goods Inferior goods have a negative income elasticity of demand meaning that demand falls as income rises. Typically inferior goods or services exist where superior goods are available if the consumer has the money to be able to buy it. Examples include the demand for cigarettes and low-priced own label foods in supermarkets. AP Economics Income Elasticity

AP Economics Income Elasticity Elasticity Applications Business Applications of Elasticity Pricing and managing cash flows. Effect of changes in competitors’ prices. The income elasticity of demand is usually strongly positive for Fine wines and spirits, high quality chocolates and luxury holidays overseas. Sports cars Consumer durables - audio visual equipment, smart-phones Sports and leisure facilities (including gym membership and exclusive sports clubs). In contrast, income elasticity of demand is lower for Staple food products such as bread, vegetables and frozen foods. Mass transport (bus and rail). Beer and takeaway pizza! Income elasticity of demand is negative (inferior) for cigarettes and urban bus services. AP Economics Income Elasticity

AP Economics Review Questions Cross elasticity of demand measures how sensitive purchases of a specific product are to changes in: The price of some other product The price of that same product Income The general price level If it is a normal or inferior good a. The price of some other product AP Economics Review Questions

Example 1: Pricing and Cash Flows Elasticity Applications Example 1: Pricing and Cash Flows According to an FTC Report by Michael Ward, AT&T’s own price elasticity of demand for long distance services is -8.64. AT&T needs to boost revenues in order to meet it’s marketing goals. If AT&T lowered price by 3 percent, what would happen to the volume (Hint quantity) of long distance telephone calls routed through AT&T? Economics Review

Calls would increase by 25.92 percent. Elasticity Applications Answer Calls would increase by 25.92 percent. Economics Review

Controversy: Gambling AP Economics

Controversy: Gambling A lottery is a form of gambling which involves the drawing of lots for a prize. Some governments outlaw it, while others endorse it to the extent of organizing a national or state lottery. At the beginning of the 20th century, most forms of gambling, including lotteries and sweepstakes, were illegal in many countries, including the U.S.A. and most of Europe. This remained so until after World War II. In the 1960s casinos and lotteries began to appear throughout the world as a means to raise revenue in addition to taxes. AP Economics

Controversy: Gambling Lotteries and gambling are an effective way to raise revenue because there are few substitutes. As the government taxes any good, it raises the price, and so consumers lower demand, which lowers tax revenue. But with few substitutes, the demand for gambling is very inelastic, and so consumers’ demand is only slightly lower, which means tax revenue is only slightly lower. Lotteries and gambling are controversial, however, if you believe most gamblers are irrational. If irrational, a gambler could hurt themselves by saying yes to gambling when they should have said no. AP Economics