Elasticity: Measuring Responsiveness Dr. D. Foster - Microeconomics Inelastic Elastic

Elasticity A measure of responsiveness... A measure of responsiveness... Price elasticity of demand. Price elasticity of demand. Income elasticity of demand. Income elasticity of demand. Cross price elasticity of demand. Cross price elasticity of demand. Price elasticity of supply. Price elasticity of supply.

Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP if |  D | > 1 and demand is. Responsive if |  D | > 1 and demand is elastic. if |  D | < 1 and demand is. Unresponsive if |  D | < 1 and demand is inelastic. Note: Technically, calculated  D is always <0. %Δ = percentage change in

Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP Perfectly elastic  D =   D =  Perfectly inelastic  D = 0

Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP Along a straight line, changing elasticity!! Elastic Inelastic

Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP We talk about demand curves that are relatively elastic vs. relatively inelastic... Inelastic Elastic

Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP Elasticity tells us how TR will change with a change in the price... If elastic, ↑P will ↓TR (output effect dominates) (conversely, a ↓P will ↑TR) If elastic, ↑P will ↓TR (output effect dominates) (conversely, a ↓P will ↑TR) If inelastic, ↑P will ↑TR (price effect dominates) (conversely, a ↓P will ↓TR)

Elasticity Questions A. What do execs at Pepsi expect TR to do when they have a sale on their soft drink? Why? B. You manage a concert hall that seats 500. Consider the following demand information: What do you charge? What do you charge? At a price of: Amount sold is: $10500 $15400 $20200

Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP How to calculate this... Easy if the %Δ is given for both. Easy if the %Δ is given for both. Find the %Δ from the base. Find the %Δ from the base. Find the %Δ from the average. Find the %Δ from the average. What is elasticity if price rises by 10% and quantity demanded falls by 5%? What is elasticity if price rises from $1 to $1.10 and quantity demanded falls from 100 to 95?  D = 5/ /1.05 =.538

Price Elasticity of Demand Determinants of elasticity... The degree of substitutes available more substitutes = more elastic Amount of budget spent on this good higher proportion spent = more elastic Relative importance of this good more of a luxury = more elastic Time to respond to price change more time = more elastic

Price Elasticity of Demand  D = E(Q d,P) = %ΔQ D / %ΔP What happens when electricity prices rise? $.05 Over next month $ Over 5 years Over next year 6

Elasticity A measure of responsiveness... Price elasticity of demand: P and Q D Income elasticity of demand Cross price elasticity of demand Price elasticity of supply

Income Elasticity of Demand How responsive is the Q D to a Δ in Income? May be a Normal good (>0) or an inferior good ( 0) or an inferior good (<0)  Y = E(Q d,I) = %ΔQ D / %ΔIncome Cross Price Elasticity of Demand How responsive is the Q D-x for one good if there is a ΔP y ? If substitutes then >0; If complements then 0; If complements then <0  XZ = E(Q d,P og ) = %ΔQ D-X / %ΔP Z Price Elasticity of Supply How responsive is the Q S to a ΔP? Positive  S = E(Q s,P) = %ΔQ S / %ΔP

Elasticity Questions 1. If the price of butter goes up 50% and the quantity demanded falls by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? 1. If the price of butter goes up 50% and the quantity demanded falls by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? 2. If the price of the Rolling Stones’ CD, Semi-Serious, is reduced from $20 to $18, and the quantity demanded (say, on a per month basis) rises by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? 2. If the price of the Rolling Stones’ CD, Semi-Serious, is reduced from $20 to $18, and the quantity demanded (say, on a per month basis) rises by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why?

Elasticity Questions 3. If the price of gas goes up by 30% and the quantity demanded falls from 1,000,000 gallons/day to 900,000 gallons/day, what is the price elasticity of demand? Is this elastic or inelastic? Why? If the price, then, falls back by 30%, would you predict the response by consumers will be elastic or inelastic? Why? 3. If the price of gas goes up by 30% and the quantity demanded falls from 1,000,000 gallons/day to 900,000 gallons/day, what is the price elasticity of demand? Is this elastic or inelastic? Why? If the price, then, falls back by 30%, would you predict the response by consumers will be elastic or inelastic? Why? 4. A popular pair of Nike shoes, the Paris Hilton Liteweights, is reduced in price from $80 to $40, while the quantity demanded rises from 10,000 pairs/week to 20,000 pairs/week. What is the price elasticity of demand? Is this elastic or inelastic? Why? 4. A popular pair of Nike shoes, the Paris Hilton Liteweights, is reduced in price from $80 to $40, while the quantity demanded rises from 10,000 pairs/week to 20,000 pairs/week. What is the price elasticity of demand? Is this elastic or inelastic? Why?

Elasticity Questions 5. DishTV has lowered its subscription TV prices by 10% and its subscription base rose by 15%. (a) What is the price elasticity of demand for DishTV? Is this elastic or inelastic? Why? (b) If DirecTV sees its subscription base fall by 8%, what is the cross price elasticity of demand for DirecTV? For DishTV? (c) If incomes rise by 3% and subscription base for DishTV rises by 9%, what is the income elasticity of demand for DishTV?

Elasticity Questions 6. Consider this demand curve. As it is a straight line, there is an elastic portion, an inelastic portion and point of unitary elasticity. Identify where, along this demand, the total revenue would be maximized. [Total revenue equals price times quantity.]

Elasticity Questions 7. Consider Demand (D A ) with equilibrium at point A. A $.50 per unit tax is placed on this good... a) Does S’ show the new supply? Yes. Do you know why? b) What is the change in total revenue as you move to the new equilibrium at A’? c) What is the price elasticity of demand? d) What is the value of the taxes collected?

Elasticity Questions 8. Consider Demand (D B ) with equilibrium at point B. A $.50 per unit tax is placed on this good... a) Does S’ show the new supply? Yes. Do you know why? b) What is the change in total revenue as you move to the new equilibrium at B’? c) What is the price elasticity of demand? d) What is the value of the taxes collected?

Elasticity: Measuring Responsiveness Dr. D. Foster - Microeconomics Inelastic Elastic