Unit 3 - Elasticity n Price Elasticity of Demand Price elasticity of demand m easures the responsiveness of buyers’ purchasing habits to a price change. Microeconomics

Unit 3 - Elasticity n Price Elasticity of Demand Definition: Ep = the percentage change in a product’s quantity demanded divided by the percentage change in its price. Microeconomics

Unit 3 - Elasticity n Price Elasticity of Demand Formula: (change in Qd / average Qd) (change in Pr / average Pr) Where Qd = quantity demanded, and Pr = price. Microeconomics Ep =

Unit 3 - Elasticity n Price Elasticity of Demand Example 1 Let’s say that a grocery store observes that at $2.00 per gallon of milk, buyers purchase 800 gallons per day. The next week, the grocery store increases its price to $3.00 per gallon and buyers purchase 700 gallons per day. What is the price elasticity of demand for milk? Microeconomics

Unit 3 - Elasticity n Price Elasticity of Demand Example 1 answer  the change in quantity demanded = 100  the average quantity demanded = 750  the change in price = $1  the average price = $ / $1/$ Microeconomics Ep = =.3325

Unit 3 - Elasticity n Price Elasticity of Demand Example 1 answer Officially, the answer is , because the quantity demanded decreased (change of -100). However, because price elasticity of demand is always negative, we ignore the negative sign. Microeconomics

Unit 3 - Elasticity n Price Elasticity of Demand If a product’s elasticity is less than 1, then we say that it is inelastic. If a product’s elasticity is greater than 1, then we say that it is elastic. If a product’s elasticity is equal to 1, then we say that it is unit elastic. Microeconomics

A product with a price elasticity of demand equal to 3.5 is: 1. Inelastic 2. Unit elastic 3. Elastic 4. None of the above

A product with a price elasticity of demand equal to 3.5 is: 0 of Inelastic 2. Unit elastic 3. Elastic 4. None of the above

Unit 3 - Elasticity n Price Elasticity of Demand Example 2 A movie theatre sells 1,800 tickets when it charges a price of $11. After it lowers its price to $9, it sells 2,600 tickets. What is the price elasticity of demand for tickets for this movie theatre? Microeconomics

In the previous example (1,800 and 2,600 tickets, and price of $11 and $9), what is the price elasticity of demand? 0 of

Unit 3 - Elasticity n Price Elasticity of Demand Example 2 answer 800/ /10.2 Because the value is greater than 1, movie tickets at this theatre are price elastic. Microeconomics Ep = = 1.818

Unit 3 - Elasticity n Price Elasticity of Demand Determinants of price elasticity of demand are:  The availability of close substitutes. The more substitutes, the greater the elasticity.  The product’s expense to the consumer relative to her/his income or wealth. The higher the expense, the greater the elasticity.  The period of time under consideration. The longer the time period, the greater the elasticity. Microeconomics

Unit 3 - Elasticity n Price Elasticity of Demand Price elasticity determinants of gasoline  The availability of close substitutes. Gasoline does not have many substitutes. This makes gasoline inelastic.  The product’s expense to the consumer relative to her/his income or wealth. For many people gasoline is a considerable expense. This makes gasoline elastic.  The period of time under consideration. Within a short period of time, people cannot change their driving behavior much. This makes gasoline inelastic when looking at a short-run demand curve.  Overall, especially in the short run, gasoline is probably inelastic. Microeconomics

Unit 3 - Elasticity n Price Elasticity of Demand Elasticity and Revenue Revenue = quantity demanded x price If quantity demanded increases by 10%, and price decreases by 5% (this means that the product is elastic), then revenue increases. Microeconomics

If a product is elastic and its price decreases, then the supplier’s total revenue: 1. Decreases 2. Increases 3. Stays the same 4. None of the above 0 of 30

If a product is inelastic and its price decreases, then the supplier’s total revenue: 1. Decreases 2. Increases 3. Stays the same 4. None of the above 0 of 30

If a product is unit elastic and its price decreases, then the supplier’s total revenue: 1. Decreases 2. Increases 3. Stays the same 4. None of the above 0 of 30

Unit 3 - Elasticity n Price Elasticity of Demand Elasticity and Revenue Summary  If a product is elastic and price increases, then revenue decreases.  If a product is inelastic and price increases, then revenue increases.  If a product is elastic and price decreases, then revenue increases.  If a product is inelastic and price decreases, then revenue decreases.  If a product is unit elastic and price changes, then revenue stays the same. Microeconomics

When you graph a demand curve, you notice that a flatter (closer to horizontal) demand curve is associated with a: 1. Higher price elasticity of demand 2. Lower price elasticity of demand 3. Perfectly inelastic demand situation 4. None of the above 0 of 30

Price Quantity D1 (inelastic demand curve) $ D2 (elastic demand curve) $ Unit 3 - Elasticity

n Elasticity and Competition A perfectly competitive firm faces a demand curve which is perfectly elastic (horizontal). The more elastic the product, the flatter the curve. Microeconomics

Price Quantity D1 (Perfectly Elastic Demand Curve) $ D2 (Perfectly Inelastic Demand Curve) Unit 3 - Elasticity

n Income Elasticity of Demand Income elasticity of measures the responsiveness of buyers’ purchasing habits in response to an income change. Microeconomics

Unit 3 - Elasticity n Income Elasticity of Demand Definition: Definition: Ei = the percentage change in a product’s quantity demanded divided by the percentage change in buyers’ incomes. The value can be positive (normal good) or negative (inferior good). Microeconomics

Unit 3 - Elasticity n Income Elasticity of Demand Formula: (change in Qd / average Qd) (change in Y / average Y) Where Qd = quantity demanded, and Y = income. Microeconomics Ei =

Unit 3 - Elasticity n Cross Price Elasticity of Demand The price change of a substitute or complementary product affects the quantity demanded of the other substitute or complementary product. Substitutes have a positive cross price elasticity of demand. Complements have a negative cross price elasticity of demand. Microeconomics

Unit 3 - Elasticity n Cross Price Elasticity of Demand The formula for cross price elasticity of demand is: the % change in the quantity demanded of product A the % change in the quantity demanded of product A the % change in the price of related product B the % change in the price of related product B Microeconomics Ecp =