Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Copyright 2008 The McGraw-Hill Companies 6-2 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Chapter Objectives Price Elasticity of Demand and How It Can Be Applied The Usefulness of the Total Revenue Test for Price Elasticity of Demand Price Elasticity of Supply and How It Can Be Applied Cross Elasticity of Demand and Income Elasticity of Demand Consumer Surplus, Producer Surplus, and Efficiency Losses

Copyright 2008 The McGraw-Hill Companies 6-3 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity of Demand Think about it……… The law of demand says consumers will buy more when prices go down and less when prices go up..… HOW MUCH MORE OR LESS? DOES IT MATTER? To whom? Price elasticity, with respect to demand, provides an answer..

Copyright 2008 The McGraw-Hill Companies 6-4 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity of Demand Measures Responsiveness to Price Changes Elasticity Coefficient= % delta Q divided by % delta P P Q D P1 P2 Q1 Q Elasticity =.5, therefore, relatively inelastic….

Copyright 2008 The McGraw-Hill Companies 6-5 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show The percentage change in price The percentage change in quantity Elasticity is.5 Q P P1P1 P2P2 Q1Q1 Q2Q2 D Commonly Expressed as… PRICE ELASTICITY OF DEMAND  %P %  Q d

Copyright 2008 The McGraw-Hill Companies 6-6 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show 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 Percentage Change in Price of Product X E d = O 6.1

Copyright 2008 The McGraw-Hill Companies 6-7 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity of Demand Formula Restated Change in Quantity Demanded of X Original Price of X E d = Change in Price of X Original Quantity Demanded of X ÷ Using Averages Midpoint Formula Change in Quantity E d = Sum of Quantities/2 ÷ Change in Price Sum of Prices/2 W 6.1

Copyright 2008 The McGraw-Hill Companies 6-8 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity of Demand Why Use Percentages? Elimination of the Minus Sign Interpretations of E d Elastic Demand Inelastic Demand Unit Elasticity E d = = 2E d = =.5E d =.02 = 1

Copyright 2008 The McGraw-Hill Companies 6-9 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity of Demand Extreme Cases Perfectly Inelastic Demand Perfectly Elastic Demand 0 P Q P 0 Q D1D1 D2D2 Perfectly Inelastic Demand (E d = 0) Perfectly Elastic Demand (E d = ∞)

Copyright 2008 The McGraw-Hill Companies 6-10 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Determinants of Price Elasticity of Demand Substitutability Proportion of Income Luxuries versus Necessities Time Applications: –Large Crop Yields –Excise Taxes –Decriminalization of Illegal Drugs

Copyright 2008 The McGraw-Hill Companies 6-11 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show $ Q P The Total Revenue Test Total Revenue (TR) TR = P x Q Elastic Demand a b D1D1 W 6.2

Copyright 2008 The McGraw-Hill Companies 6-12 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show $ Q P The Total Revenue Test Total Revenue (TR) TR = P x Q Inelastic Demand c d D2D2 W 6.2

Copyright 2008 The McGraw-Hill Companies 6-13 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show $ Q P The Total Revenue Test Total Revenue (TR) TR = P x Q Unit-Elastic e f D3D3 W 6.2

Copyright 2008 The McGraw-Hill Companies 6-14 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Elasticity on a Linear Demand Curve $8,000 14,000 18,000 20,000 18,000 14,000 8,000 Elastic Unit Elastic Inelastic (1) Total Quantity of Tickets Demanded Per Week, Thousands (2) Price Per Ticket (3) Elasticity Coefficient (E d ) (4) Total Revenue (1) X (2) (5) Total-Revenue Test ] ] ] ] ] ] ] ] ] ] ] ] ] ] Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test Graphically… G 6.1

Copyright 2008 The McGraw-Hill Companies 6-15 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity and the Total-Revenue Curve Quantity Demanded Price Total Revenue (Thousands of Dollars) $ $ a b c d e f g h Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 D TR

Summary of Price Elasticity of Demand LO2 Price Elasticity of Demand: A Summary Absolute Value of Elasticity CoefficientDemand Is:Description Impact on Total Revenue of a: Price IncreasePrice Decrease Greater than 1 (E d > 1) Elastic or relatively elastic Q d changes by a larger percentage than does price Total Revenue decreases Total Revenue increases Equal to 1 (E d = 1) Unit or unitary elastic Q d changes by the same percentage as does price Total revenue is unchanged Total revenue is unchanged Less than 1 (E d < 1) Inelastic or relatively inelastic Q d changes by a smaller percentage than does price Total revenue increases Total revenue decreases 4-16

Copyright 2008 The McGraw-Hill Companies 6-17 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show P Q Price Elasticity of Supply O 6.2 Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X E s = Perfectly Inelastic Supply Market Period: Not Enough Time to Shift Resources D1D1 D2D2 SmSm Q0Q0 PmPm P0P0 Greatest Price Impact

Copyright 2008 The McGraw-Hill Companies 6-18 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity of Supply O 6.2 Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X E s = Inelastic Supply E s < 1 Short Run: Resources Not Easily Shifted to Alternative Uses P Q D1D1 D2D2 SsSs Q0Q0 PsPs P0P0 QsQs Lower Price Impact

Copyright 2008 The McGraw-Hill Companies 6-19 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X E s = Elastic Supply E s > 1 Long Run: Resources Easily Shifted to Alternative Uses P Q D1D1 D2D2 SlSl Q0Q0 PlPl P0P0 QlQl Least Price Impact O 6.2

Applications of Elasticity of Supply Antiques Inelastic supply Reproductions More elastic supply Volatile gold prices Inelastic supply LO3 4-20

Copyright 2008 The McGraw-Hill Companies 6-21 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Cross Elasticity of Demand Substitute Goods – Positive Sign Complementary Goods- Negative Sign Independent Goods – Zero or Near-Zero Value Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product Y E xy =

Copyright 2008 The McGraw-Hill Companies 6-22 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Income Elasticity of Demand Normal Goods – Positive Sign Inferior Goods- Negative Sign Percentage Change in Quantity Demanded Percentage Change in Income E i =

E x,y and E i LO4 Cross and Income Elasticities of Demand Value of CoefficientDescriptionType of Good(s) Cross elasticity: Positive (E wz > 0) Negative (E xy < 0) Quantity demanded of W changes in same direction as change in price of Z Quantity demanded of X changes in opposite direction from change in price of Y Substitutes Complements Income elasticity: Positive (E i >0) Negative (E i <0) Quantity demanded of the product changes in same direction as change in income Quantity demanded of the product changes in opposite direction from change in income Normal or superior Inferior 4-23

Income Elasticity Insights High income elasticities Most affected by a recession Low or negative income Least affected by a recession LO4 4-24

Copyright 2008 The McGraw-Hill Companies 6-25 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Elasticity and Pricing Power: 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

Copyright 2008 The McGraw-Hill Companies 6-26 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Producer Surplus LO2 Price (per bag) Quantity (bags) S Q1Q1 P1P1 Equilibrium price Producer surplus 5-26

Copyright 2008 The McGraw-Hill Companies 6-27 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Efficiency Revisited LO2 Price (per bag) Quantity (bags) S Q1Q1 P1P1 D Consumer surplus Producer surplus 5-27

Copyright 2008 The McGraw-Hill Companies 6-28 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Quantity (bags) Price (per bag) Efficiency Losses LO2 c S Q1Q1 Q2Q2 D b d a e Efficiency loss from underproduction 5-28

Copyright 2008 The McGraw-Hill Companies 6-29 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Efficiency Losses LO2 c S Q1Q1 Q3Q3 D b f a g Quantity (bags) Price (per bag) Efficiency loss from overproduction 5-29

Copyright 2008 The McGraw-Hill Companies 6-30 Price Elasticity of Demand Total Revenue Test Elasticity on a Linear Demand Curve Price Elasticity and the Total- Revenue Curve Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity Income Elasticity Consumer and Producer Surplus Last Word Key Terms End Show Key Terms price elasticity of demandprice elasticity of demand midpoint formula elastic demand inelastic demand unit elasticity perfectly inelastic demandperfectly inelastic demand perfectly elastic demandperfectly elastic demand total revenue test (TR)total revenue test (TR) total-revenue test price elasticity of supplyprice elasticity of supply market period short run long run cross-elasticity of demandcross-elasticity of demand income elasticity of demandincome elasticity of demand