1 Elasticity

2 “Demand Shifters” [TIMER] 1. Taste [direct] 2. Income [normal-direct] [inferior-inverse] 3. Market Size [number of consumers-direct] 4. Expectations [of consumers about future *price-direct, about future availability-inverse, or about future income–direct. about future availability-inverse, or about future income–direct. 5. Related Good *Prices [substitutes-direct] [complements-inverse] Changes in “D” [curve] 1. Non price change [“TIMER”] 2. Whole “D” curve shifts [There is a change in “QD” but it is not caused by a change in “price.” QD-”single price”D-”all prices” [QD-”single price”; D-”all prices”] Complement [ inverse ] Substitute [ Direct ] Butter Bread Bagels P D3D3D3D3 D1D1D1D1 D3D3D3D3 QD 3 QD 1 QD 2 D1D1D1D1 D2D2D2D2 P P1P1P1P1 QD 1 QD 2 P2P2P2P2 D1D1D1D1 D2D2D2D2 D P

3 What is Elasticity? A term economists use to describe sensitivity of quantity demanded or supplied to a change in price.

4 quantity demanded price The percentage change in quantity demanded divided by the percentage change in price How do we measure the Price Elasticity of Demand?

5 Price Elasticity of Demand E d = % change in Q d % change in P E d = % in Q d % in P

6 Notes on E d E d negative, but ignore negative

7 Classifying E d E d = 1 Unitary elasticity E d > 1 Elastic demand E d < 1 Inelastic demand

8 Extreme elasticities E d = 0 Perfectly inelastic (vertical demand curve) E d =  Perfectly elastic (horizontal demand curve)

9 D P Q Perfectly inelastic demand P Q D Perfectly elastic demand

10 When consumers are very sensitive to a price change what does the demand curve look like? Very horizontal

11 When consumers are less sensitive to a price change what does the demand curve look like? Very vertical

New.2-inelastic 50%10% elastic10% 20% inelastic75% 25% elastic.6/.2 20% 5/25 60% 60/ Initial Price Elasticity of Demand % change in P % change in Q d QuantityPrice E d = % in Q d % in P

13

14 What factors influence Demand Sensitivity (elasticity)? Number and closeness of Substitute goods % of income a good makes up Basic goods or “needs” Time to adjust

15 What do substitutes have to do with sensitivity? The more substitutes a good has, the more sensitive consumers are to a price change

16 A B D D Which demand curve is for spark plugs and which for Coca-Cola?

17 The lower the % of ones budget a good is, the less sensitive consumers are to a price change What does % of income a good makes up have to do with sensitivity? SALT!

18 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? WATER!

19 The more time to adjust, the more sensitive consumers are to a price change What does time have to do with sensitivity?

20 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?

21 Elasticity and Total Revenue (TR) TR = PQ (price times quantity) E d = % change in Q d % change in P

22 Q P D When prices are low, TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE So is total revenue

23 Q P D Total revenue rises with price to a point... TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

24 Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

25 Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

26 Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE Total Revenue Test

27 Q P D Total revenue rises with price to a point... then declines InelasticDemand InelasticDemand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

28 Q P D Total revenue rises with price to a point... then declines ElasticDemand Elastic Demand InelasticDemand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE InelasticDemand

29 Q P D Total revenue rises with price to a point... then declines ElasticDemand ElasticDemand InelasticDemand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE InelasticDemand Unit Elastic

30 Summary, elasticity, price changes, and total revenue Total revenue falls Total revenue rises E d < 1 Total revenue rises Total revenue falls E d > 1 Total revenue same E d = 1 Price increase Price Decrease

31 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?

32 E c = %  Quantity of X %  Price of Y Cross Elasticity of Demand

33 E c If E c negative - complements (steak & steak sauce) E c If E c positive - substitutes (butter & margarine) E c Unrelated goods should have a E c close to zero

34 The ratio of the percentage change in quantity demanded to the percentage change in income What is Income Elasticity of Demand?

35 E i = %  Quantity %  Income E i > 0 Normal goods E i < 0 Inferior goods E i > 1 Luxury goods 0 < E i < 1 Necessities

36 When does a good face an income elastic demand curve? A 1% change in income generates a greater than 1% change quantity demanded

37 When does a good face an income inelastic demand curve? A 1% change in income generates a less than 1% change quantity demanded

38 What is Price Elasticity of Supply? The ratio of the percentage change in quantity supplied to the percentage change in price

39 E s = %  Q supplied %  Price E s = 1 Unitary E s > 1 Elastic E s < 1 Inelastic

40 Extreme cases of E s E s = 0, perfectly inelastic (vertical supply curve E s = , perfectly elastic (horizontal supply curve) S P Q S P Q

41 Does time effect Supply Elasticities? Yes! The more time, the more elastic the supply curve

42 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

43 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

44 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

45 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

46 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

47 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

48 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

49 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

50 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils) TU MU

51 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils) TU MU Observe Diminishing Marginal Utility