1 Principles of Economics 2nd edition by Fred M Gottheil © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long

2 Chapter 4 Elasticity 11/26/2015 © ©1999 South-Western College Publishing

3 This chapter discusses principles associated with Normal & Inferior Goods Substitute and Complementary Goods Cross Elasticity Price Elasticity of Demand Determinants of Demand Sensitivity to Price Changes Demand Sensitivity Supply Elasticity Elasticity and Taxes © ©1999 South-Western College Publishing

4 How would you respond to a cut in the price of a Coke? That all depends on the price sensitivity of demand for Coke © ©1999 South-Western College Publishing

5 A B D D Which demand curve is for spark plugs and which for Coca-Cola? © ©1999 South-Western College Publishing

6 Very horizontal When consumers are very sensitive to a price change what does the demand curve look like? © ©1999 South-Western College Publishing

7 Very vertical When consumers are less sensitive to a price change what does the demand curve look like? © ©1999 South-Western College Publishing

8 What factors influence Demand Sensitivity? Low price goods Income levels Substitute goods Basic goods Linked goods Time to adjust © ©1999 South-Western College Publishing

9 The lower the price of a good the less sensitive consumers are to a price change What do low priced goods have to do with sensitivity? © ©1999 South-Western College Publishing

10 Poor people are more sensitive to price changes than rich people How do income levels effect demand? © ©1999 South-Western College Publishing

11 The more substitutes a good has, the more sensitive consumers are to a price change What do substitutes have to do with sensitivity? © ©1999 South-Western College Publishing

12 The greater the need a good has to the consumer, the less sensitive the consumer is to a price change What do basic goods have to do with sensitivity? © ©1999 South-Western College Publishing

13 When two goods have a complementary relationship, demand sensitivities are linked to one another What do linked goods have to do with sensitivity? © ©1999 South-Western College Publishing

14 What are some examples of Complementary Goods? computers and software cars and gasoline tapes and tape players © ©1999 South-Western College Publishing

15 The more time to adjust, the more sensitive consumers are to a price change What does time have to do with sensitivity? © ©1999 South-Western College Publishing

16 What is Elasticity? A term economists use to describe sensitivity © ©1999 South-Western College Publishing

17 The percentage change in quantity demanded divided by the percentage change in price How do we measure the Price Elasticity of Demand? © ©1999 South-Western College Publishing

18 If there is an increase from 3 units to 5, what is the percentage increase? If there is an increase from 3 units to 5, what is the percentage increase? 2/3 = 66% © ©1999 South-Western College Publishing

19 If there is a decrease from 5 units to 3, what is the percentage decrease? 2/5 = 40% © ©1999 South-Western College Publishing

20 A B 2 3 P Q D 20 © ©1999 South-Western College Publishing

21 Problem - When we move along a demand curve between two points, we get different answers to elasticity depending if we are moving up or down the demand curve © ©1999 South-Western College Publishing

22 If we go from 3 to 5, the percentage change is 2/3, but if we go from 5 to 3, the percentage change is 2/5, so the elasticities are different © ©1999 South-Western College Publishing

23 The answer to this problem is to work with averages... © ©1999 South-Western College Publishing

24 Price elasticity equals the change in quantity demanded sum of quantities/2 divided by change in price sum of prices/2 © ©1999 South-Western College Publishing 24

25 Quantity Price Bananas Oranges $20 $18 $40 $70 © ©1999 South-Western College Publishing 25

26 What is the Price Elasticity of Demand for bananas? X 19 2 = = © ©1999 South-Western College Publishing

27 What is the Price Elasticity of Demand for oranges? X = = 6,600 10,200 © ©1999 South-Western College Publishing

28 more money per unit fewer units are sold When price increases, what two things happen? © ©1999 South-Western College Publishing

29 elastic If demand is elastic - revenue goes down inelastic If demand is inelastic - revenue goes up If a college raises tuition, what happens to revenue? © ©1999 South-Western College Publishing

30 If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1 © ©1999 South-Western College Publishing

31 If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1 © ©1999 South-Western College Publishing

32 If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1 © ©1999 South-Western College Publishing

33 What strategies do Coca- Cola and Pepsi use to make the demand for their products less elastic? © ©1999 South-Western College Publishing

34 The percentage change in the quantity demanded of one commodity resulting from a 1 percent change in price of another commodity What is Cross Elasticity of Demand? © ©1999 South-Western College Publishing

35 If negative - complements (steak & steak sauce) If positive - substitutes (butter & margarine) © ©1999 South-Western College Publishing

36 The ratio of the percentage change in quantity demanded to the percentage change in income What is Income Elasticity of Demand? © ©1999 South-Western College Publishing

37 When does a good face an income elastic demand curve? A 1% change in income generates a greater than 1% change quantity demanded © ©1999 South-Western College Publishing

38 When does a good face an income inelastic demand curve? A 1% change in income generates a less than 1% change quantity demanded © ©1999 South-Western College Publishing

39 Something that people will buy less of as their incomes increase What is an Inferior Good? © ©1999 South-Western College Publishing

40 Something that people will buy more of as their incomes increase What is a Normal Good? © ©1999 South-Western College Publishing

41 What is Price Elasticity of Supply? The ratio of the percentage change in quantity supplied to the percentage change in price © ©1999 South-Western College Publishing

42 Does time effect Supply Elasticities? Yes! The more time, the more elastic the supply curve © ©1999 South-Western College Publishing

43 Which type of good would be best to tax to raise the most revenue? Goods that face a price inelastic demand curve will generate the most revenue © ©1999 South-Western College Publishing

44 What does the Tobacco Resource Center do to increase the elasticity of demand for cigarettes? © ©1999 South-Western College Publishing

45 What factors influence Demand Sensitivity?What factors influence Demand Sensitivity? What is Elasticity? How do we measure the Price Elasticity of Demand?How do we measure the Price Elasticity of Demand? What is Cross Elasticity of Demand?What is Cross Elasticity of Demand? What is Income Elasticity of Demand?What is Income Elasticity of Demand?

46 ENDEND © ©1999 South-Western College Publishing