 Recall from Chapter 2 that if the price of a computer game falls, then the number of games purchased rises  If the price of the computer game halves, then how does the number of games purchased change? Does it double? Triple? Increase by 20%?  We need to understand the Price Elasticity of Demand to know how much demand will change due to a change in price CH. 3 – COMPETITIVE DYNAMICS AND GOVERNMENT 3.1 – Price Elasticity of Demand

 Consumers can be very responsive or very unresponsive to price changes Elastic and Inelastic Demand Selling Ice Cream in Winter MonthsSelling Ice Cream in Summer Months

 In the winter months, a small change in price caused the demand to halve  In the summer months, a small change in price caused the demand to decrease by 1/6 Elastic and Inelastic Demand Selling Ice Cream in Winter MonthsSelling Ice Cream in Summer Months

 Perfectly Elastic Demand  Price of a product remains constant whatever quantities are demanded  Perfectly Inelastic Demand  Quantity demanded is completely unaffected by price. Perfectly Elastic & Inelastic Demand

 Perfectly Elastic Demand  A single soybean farmer might face the curve on the right – various quantities at one price  Perfectly Inelastic Demand  A producer of insulin might face the curve on the left – quantity demanded is constant. Perfectly Elastic & Inelastic Demand

 Demand elasticity plays a role in determining what effect a price change has on Total Revenue.  Total Revenue is the price of a product multiplied by its quantity demanded. TR = P X Q d Total Revenue

 Although it might seem that there is a connection between the slope the demand curve and the price elasticity of demand, there is not  Elasticity is expressed in terms of percentage changes in price and quantity demanded, but slope is change in rise over run, which is not always the same thing Slope of Demand Curve & Elasticity of Demand

 Price changes cause large variations in quantity demanded  Total Revenue and Price have an inverse relationship  When one increases, the other decreases and vice versa Elastic Demand

 Price changes cause small variations in quantity demanded  Total Revenue and Price have an direct relationship  When one increases, the other increases; if one decreases, the other decreases Inelastic Demand

 Unit Elastic Demand  Demand for which a percentage change in price causes an equal change in quantity demanded and thus no change in total revenue Unit Elastic Demand

 Portion of Consumer Incomes  It’s easier to pay $0.50 more for sugar that $500 more for a TV, thus, demand for big purchases tends to be more elastic than the demand for small purchases  Access to Substitutes  The more specific a product, the more elastic its demand will be  Necessities vs Luxuries  Necessities: inelastic demand; Luxuries: elastic demand  Time  Demand becomes elastic over time – just because something you buy every week becomes more expensive, doesn’t mean you suddenly stop buying it. Over a month or two however, you might find a replacement for it. Factors That Affect Price Elasticity of Demand

 Case Study: You can rent 500 DVDs a day at $5 each, and you rent 1500 DVDs when the price drops to $3. What is the price elasticity of demand? Calculating Price Elasticity of Demand

 Although we calculated e d = -2, we take the absolute value and get e d = 2. Calculating Price Elasticity of Demand eded Elasticity >1Elastic =1Unit-Elastic <1Inelastic

 Income Elasticity (e i )  The responsiveness of a product’s quantity demanded to a change in average consumer income Income Elasticity Case Study: Average consumer income increases from $20,000 to $40,000 and causes the quantity demanded of computer tablets to rise from 1000 to What is the income elasticity of computer tablets?

 Cross-Price Elasticity (e xy )  The responsiveness of a product’s quantity demanded to a change in the price of another product Cross-Price Elasticity Case Study: If a drop in the price of computer tablets from $1000 to $500 causes the quantity demanded of laptop computers to fall from 5000 to 3000, then what is the cross-price elasticity of these two products?

Cross-Price Elasticity  We found e xy = Cross-price elasticity does have a sign.  If the two products, x and y, are complementary, then the sign is negative  If the two products, x and y, are substitutes, then the sign is positive