Price Elasticity of demand % Change in quantity demanded the responsiveness of the amount purchased to a change in price. Price Elasticity of demand = % Change in quantity demanded % Change in Price = % Q % P - or put more simply - ( Q - Q ) ( P - P ) ( Q - Q ) P = 1 1 = 1 X Q P - Q ( P P ) 1 PED > 1 Elastic < 1 Inelastic = 1 Unit Elastic

Price Elasticity of demand % Change in quantity demanded Mid Points Formula Price Elasticity of demand = % Change in quantity demanded % Change in Price = % Q % P - But use average Q and average P - = =

Examples Inelastic 0.1 Salt Matches Toothpicks Airline travel (short run) 0.2 Gasoline (short run) 0.7 Gasoline (long run) Natural gas, home (short run) 0.5 Natural gas, home (long run) 0.3 Coffee Fish (cod), at home Tobacco products (short run) 0.4 Legal services (short run) 0.6 Physician services Taxi (short run) Automobiles (long run) Approximately Unitary Elasticity 0.9 Movies 1.2 Homes, owner occupied (long run) Shellfish (consumed at home) 1.1 Oysters (consumed at home) Private education Tires (short run) Tires (long run) Radio and television receivers Elastic 2.3 Restaurant meals 4.0 Foreign travel (long run) 2.4 Airline travel (long run) 2.8 Fresh green peas 1.2-1.5 Automobiles (short run) Chevrolet automobiles 4.6 Fresh tomatoes

Calculate the Price Elasticity of the following: 1. The number of cans demanded of a soft drink increases by 30 % after its price decreases by 40% 2. The number of available apartments increases by 8% following a 6 % increase in rents 3. The number of Caesar salads demanded at a restaurant increases from 60 to 80 per week when the price falls from $5.00 to $4.50 4. At a price of $200, 10,000 treadmills were supplied each month. Since the price increased to $250, 14,000 are supplied each month. 5. The number of DVDs demanded each weekend from Blockbuster falls from 500 to 400 following an increase in the rental charge from $2.00 to $2.40

Elasticity and Total Revenue ___ Quan 1 2 3 4 5 6 7 8 Price 8 7 6 5 4 X =

For Example: Quan 1 100 20 12 150 45 32 Price 1 5 8 3 12 6 24 Quan 2 120 25 16 200 45 40 Price 2 3 7 10 8 2 Ch in Q Q1 ___ P1 Ch in P ___ X ___ =

Different Elasticities Price Quantity/ time Perfectly inelastic: An increase in Price results in no change in Quantity Mythical demand curve (b) Price Quantity/ time Relatively inelastic: A percent increase in Price results in a smaller % reduction in Quantity Demand for Cigarettes

(c) Price Quantity/ time Unitary elasticity: The percent change in quantity demanded due to an increase in price is equal to the % change in price. Demand curve of unitary elasticity = 1

Elasticity of Demand (d) Price Quantity/ time Relatively elastic: A % increase in Price leads to a larger % reduction in Quantity. Demand for Granny Smith Apples (e) Price Quantity/ time Perfectly elastic: Consumers will buy all of Farmer Hollings’s wheat at the market price, but none will be sold above the market price. Demand for Farmer Hollings’s wheat

2. Necessity vs Luxury 4. Time to shop around Elasticity What affects Elasticity??? 1. Available Substitutes 2. Necessity vs Luxury 3. Proportion of Income 4. Time to shop around

a. Market Period c. Long Run Elasticity What affects Supply Elasticity??? 1. Time a. Market Period b. Short Run c. Long Run

Elastic and Inelastic Supply Curves Price Price Quantity Quantity Elastic supply – quantity supplied is sensitive to changes in price. Inelastic demand – quantity supplied is not sensitive to changes in price.

Income Elasticity of demand % Change in quantity demanded the responsiveness of a product’s demand to a change in income. Income Elasticity of demand = % Change in quantity demanded % Change in Income A normal good has a positive income elasticity of demand. As income increases, the demand for normal goods increases. Goods with a negative income elasticity are inferior goods. As income expands, the demand for inferior goods will decline.

Income Elasticity of Demand Low Income Elasticity - 0.20 0.38 Fuel 0.20 Electricity 0.46 Fish (haddock) 0.51 Food 0.64 Tobacco 0.69 Hospital care Margarine High Income Elasticity 2.46 Private education 2.45 New Cars 1.57 Recreation and amusements 1.54 Alcohol

Cross Price Elasticity the responsiveness of a product’s demand to a change in the price of another good. Cross Price Elasticity = % Change in Qx % Change in Py A complement has a negative cross price elasticity. As Py increases, the demand for Y decreases, and demand for goods that are consumed with Y also decreases. A substitute has a positive cross price elasticity As Py increases, the demand for Y decreases, and demand for goods that can be consumed instead of Y also decreases.

If Mr. Smith thinks the last dollar spent on shirts yields less satisfaction than the last dollar spent on cola, and Smith is a utility-maximizing consumer, he should a. decrease his spending on cola. b. decrease his spending on cola and increase his spending on shirts. c. increase his spending on shirts. d. increase his spending on cola and decrease his spending on shirts. Which of the following would be the best example of consumer surplus? a. Jane does not get cell-phone service because she feels that it is worth less than the $30 a month fee. b. Sam pays $8 for a haircut that is worth $10 to him. c. Ralph buys a house for $104,000, the maximum amount that he would be willing to pay for it. d. Sue purchases a book for $20 and uses a credit card to pay for it.

“I like ice cream, but after eating homemade ice cream last night, I want to have something else for dessert today.” This statement most clearly reflects a. the budget constraint. b. consumer irrationality. c. the second law of demand: Price elasticity increases with time. d. the law of diminishing marginal utility. If Sarah’s income rises by 20 percent, and, as a result, she purchases 40 percent more designer clothing, her income elasticity for designer clothing is a. 0.5. b. 1.0. c. 2.0. d. seriously distorted. Suppose the state of New York imposes a one dollar per pack tax on cigarettes, which increases their price by 30 percent, and as a result, the quantity sold declines by 20 percent. The price elasticity of demand for cigarettes is equal to a. –0.20. b. –0.67. c. –1.50. d. –3.00.

Studies indicate that the demand for fresh tomatoes is much more elastic than the demand for salt. These findings reflect that a. tomatoes are a necessity while salt is a luxury. b. it takes longer for consumers to adjust to a change in the price of salt than to a change in the price of tomatoes. c. salt will not spoil as easily as fresh tomatoes. d. more good substitutes exist for fresh tomatoes than for salt. If a Krispy Kreme doughnut shop near campus increases its prices by 5 %, but revenues from its sales are unchanged, the price elasticity of demand for the services offered by the doughnut shop must be a. elastic. b. of unitary elasticity. c. inelastic. d. equal to 0.5. If the price of gasoline goes up, and Dan now buys fewer candy bars because he has to spend more on gas, this would best be explained by a. the substitution effect. b. the income effect. c. the highly elastic demand for gasoline. d. weight watchers effect.

Which of the following is true for this demand curve? a. An increase in price from $2 to $3 will reduce total expenditures on the product. b. In the $2 to $3 range, the price elasticity of the demand curve is approximately unitary. c. At a price of $2, the price elasticity of the demand curve equals approximately –2.5. d. In the $2 to $3 range, the demand curve is inelastic.