Copyright © 2004 South-Western Warm Up: Let’s have on final practice problem… Spring Break gets extended by one week this year!!! At the same time, United Airlines’ pilots go on strike. What impact will these events have on the equilibrium price and equilibrium quantity for airline tickets to Cancun? 1. Equilibrium Price 2. Equilibrium Quantity Hint: Draw two graphs

Copyright © 2004 South-Western Question: You own a thriving sandwich shop in downtown Crystal Lake. You want to increase your revenue (make more $) Should you raise the prices or lower them? That depends on the market’s price elasticity of demand for your product.

Copyright © 2004 South-Western 5 Elasticity and Its Application

Copyright © 2004 South-Western Price Elasticity of Demand Where would you buy gas at the “old 5-Way”? SHELL or MOBILE? Shell - $2.39Mobil - $2.61

Copyright © 2004 South-Western Price Elasticity of Demand Remember the LAW OF DEMAND?? Price Elasticity of Demand : Describes the sensitivity of quantity demanded to movements in price. Price elasticity of demand describes the SLOPE of the demand curve

Copyright © 2004 South-Western Figure 1b The Price Elasticity of Demand

Copyright © 2004 South-Western Figure 1c The Price Elasticity of Demand

Copyright © 2004 South-Western Figure 1d The Price Elasticity of Demand

Copyright © 2004 South-Western Figure 1a The Price Elasticity of Demand Can you name any products that would have a demand curve that looks like this? Perhaps … Chemotherapy drugs

Copyright © 2004 South-Western Figure 1e The Price Elasticity of Demand

Copyright © 2004 South-Western Price Elasticity of Demand Price Elasticity of Demand : Describes the sensitivity of quantity demanded to movements in price. **Or, how likely will consumers buy something else if you raise price. What determines the sensitivity (elasticity)? 1.Availability of Substitutes Many substitutes More Elastic (more sensitive to movements in price) Few substitutes More Inelastic (less sensitive) 2.Luxury vs. Necessity Luxury goods Elastic Necessity goods Inelastic

Copyright © 2004 South-Western 3. Definition of the Market (ie. Gas vs. Thornton’s Gas) Gas (Broad Definition of the Market) Inelastic Thornton’s Gas (Specific Definition of the Market) Elastic 4. Time Horizon (Short Time Horizon vs. Long ) Short Time horizon More Inelastic Long Time horizon More Elastic Determinants of Elasticity of Demand Cont’d….

Copyright © 2004 South-Western 5 Elasticity and Its Application Practice Problems- wkst Elasticity and Its Application Practice Problems- wkst

Copyright © 2004 South-Western How sensitive is the demand for these products to changes in price? Elastic Demand or Inelastic Demand 1. Salt Inelasticnecessity 2. New Cars Elasticluxury, has substitutes 3. Pork Chops Elastichas substitutes 4. European vacation trip Elasticluxury, has substitutes 5. Insulin Inelastic-necessity 6. Insulin at one of four drugstores in a shopping mall Elastic -narrow market

Copyright © 2004 South-Western Question: You own a thriving sandwich shop in downtown Crystal Lake. You want to increase your revenue (make more $) Should you raise the prices or lower them? That depends on the market’s price elasticity of demand for your product.

Copyright © 2004 South-Western Figure 2 Total Revenue- The total revenue is the price of the product times the quantity sold.

Copyright © 2004 South-Western Figure 3 How Total Revenue Changes When Price Changes: Inelastic Demand The two graphs show the difference in total revenue for the same product priced at $1 and 3$. Notice the slope of the demand curve!! Because the price elasticity of demand is inelastic, raising the price results in greater total revenues, since the quantity sold only goes down by a small percentage, relative to the price change.

Copyright © 2004 South-Western Figure 4 How Total Revenue Changes when Price Changes: Elastic Demand Look what happens to total revenue if price is raised and price elasticity of demand is elastic. Price is raised from $4 to $5 and total revenue goes down by $100.

Copyright © 2004 South-Western Figure 10a Policies to Reduce the Use of Illegal Drugs

Copyright © 2004 South-Western Figure 10b Policies to Reduce the Use of Illegal Drugs

Copyright © 2004 South-Western Figure 5 Elasticity of a Linear Demand Curve

Copyright © 2004 South-Western Figure 5 Elasticity of a Linear Demand Curve Question: How does Wallmart see the Price Elasticity of Demand for their products? Elastic or Inelastic

Copyright © 2004 South-Western Income Elasticity of Demand ●Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. Assuming Portillo’s is a Normal Good: If you earn more money, you’ll buy more Portillo’s, but how much? Income Elasticity

Copyright © 2004 South-Western Income Elasticity of Demand ●Will the income elasticity of demand for Inferior goods be positive or negative? ■Negative ●Will the income elasticity of demand for Inferior goods be positive or negative? ■Negative

Copyright © 2004 South-Western Cross-Price Elasticity of Demand ●Compares the change in quantity demanded of one good, versus a change in price of another good. ●Cross Price = % chg. in quantity Good A % chg. in price of Good B ie. How much will the demand of Coke change if the price of Pepsi changes. ●Compares the change in quantity demanded of one good, versus a change in price of another good. ●Cross Price = % chg. in quantity Good A % chg. in price of Good B ie. How much will the demand of Coke change if the price of Pepsi changes.

Copyright © 2004 South-Western How sensitive are SUPPLIERS to changes in Price? Price Elasticity of Supply What is the price elasticity of Supply of beachfront hotel space in Cancun?

Copyright © 2004 South-Western Figure 6b The Price Elasticity of Supply

Copyright © 2004 South-Western Figure 6c The Price Elasticity of Supply Suppliers also have a price elasticity to supply. Suppliers respond to price changes by supplying more or less, but how much more or less varies according which product.

Copyright © 2004 South-Western Figure 6d The Price Elasticity of Supply The production of some products respond easier to price changes, than others. Suppliers can supply much more if price increases. Think: Cell Phone shops, or Cash for Gold stores.

Copyright © 2004 South-Western Determinants of Elasticity of Supply ●Ability of sellers to change the amount of the good they produce. ■Beach-front land is inelastic. ■Books, cars, or manufactured goods are elastic. ●Time period. ■Supply is more elastic in the long run. ●Ability of sellers to change the amount of the good they produce. ■Beach-front land is inelastic. ■Books, cars, or manufactured goods are elastic. ●Time period. ■Supply is more elastic in the long run.

Copyright © 2004 South-Western Elastic or Inelastic Supply Curves? ●Nuclear Power Suppliers ■inelastic ●Aircraft Carriers ■inelastic ●Farmland ■inelastic ●Nuclear Power Suppliers ■inelastic ●Aircraft Carriers ■inelastic ●Farmland ■inelastic Youtube info-mercials ●elastic ●Blogs ●elastic ●Cash for Gold Stores ●elastic Youtube info-mercials ●elastic ●Blogs ●elastic ●Cash for Gold Stores ●elastic

Copyright © 2004 South-Western Figure 7 How the Price Elasticity of Supply Can Vary For many products it’s easier to expand production at first, but gets more difficult after initial efficiencies are exhausted.

Copyright © 2004 South-Western Figure 8 An Increase in Supply in the Market for Wheat

Copyright © 2004 South-Western Figure 9a A Reduction in Supply in the World Market for Oil

Copyright © 2004 South-Western Figure 9b A Reduction in Supply in the World Market for Oil