Price Elasticity of Demand and Supply ©2006 South-Western College Publishing

2 What is elasticity? A term economists use to describe responsiveness, or sensitivity, to a change in price

3 What is price elasticity of demand? The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price

4 %  in Q demanded %  in price E d = Price Elasticity of Demand

5 How is the percent increase or decrease of two numbers calculated? Percent change is the difference between the two numbers divided by the original number

6 New - Old x 100% Old

Ranges of Elasticity Inelastic Demand uQuantity demanded does not respond strongly to price changes. Elastic Demand uQuantity demanded responds strongly to changes in price.

Elasticity and Total Revenue uTotal revenue is the amount paid by buyers and received by sellers of a good. uComputed as the price of the good times the quantity sold. TR = P x Q

Elasticity and Total Revenue: Inelastic Demand $3 Quantity 0 Price 80 Revenue = $240 Demand $1 Demand Quantity 0 Revenue = $ Price An increase in price from $1 to $3... …leads to an increase in total revenue from$100 to $240

Elasticity and Total Revenue: Elastic Demand Demand Quantity0 Price $4 50 Demand Quantity0 Price Revenue = $100 $5 20 Revenue = $200 An increase in price from $4 to $5... …leads to a decrease in total revenue from$200 to $100

11 Price increase Decrease in total revenue Elastic Demand

12 Price increase Increase in total revenue Inelastic Demand

13 Price increase No change in total revenue Unitary Elastic Demand

14 If demand is elastic - total revenue goes down If demand is inelastic - total revenue goes up If a college raises tuition, what happens to revenue?

15 Coke and Pepsi are close substitutes, and the demand for each is relatively elastic. What strategies do Coca-Cola ( and Pepsi ( use to make the demand for their products less elastic?

16 What do substitutes have to do with a price change? The more substitutes a product has, the more sensitive consumers are to a price change, and the more elastic the demand curve

Taxes Governments levy taxes to raise revenue for public projects.

What was the impact of tax? u Taxes discourage market activity. u When a good is taxed, the quantity sold is smaller. u Buyers and sellers share the tax burden.

19 The Tax Wedge Quantity of Pizzas 0 Price Price without tax Pizza demand Pizza supply Tax wedge Price we pay Amount producers receive

So, how is the burden of the tax divided? The burden of a tax falls more heavily on the side of the market that is less elastic.