1. Elasticities and the Quantitative Analysis of Supply and Demand

3. Elasticity is a measure of responsiveness to a stimulus. uWhat is the responsiveness of your grade-point average to hours of study time? uWhat is the responsiveness of wheat production to rain fall? uWhat is the responsiveness of electricity usage to the average daily temperature?

4. The quantity demanded by a consumer will depend upon the following factors: uThe good’s own price. uThe consumer’s income. uPrices of related goods. uThe consumer’s tastes and and preferences. uExpectations and other special influences.

5. The quantity supplied will depend upon: uthe good’s own price uprices of inputs used in producing the good. utechnology uprices of other goods the seller could supply uexpectations and other factors

6. The price elasticity of demand, E D, measures the responsiveness of the quantity demanded to changes in the good's own price. E D is the percentage change in the quantity demanded that results per one percent change in price.

7. Suppose that a 10% increase in the price of cigarettes results in a 4% decrease in the quantity demanded. For each 1% increase in price, the quantity demanded goes down 0.4%.

8. Suppose that a 10% increase in the price of tickets to a Ry Cooder concert results in a 25% decrease in the quantity demanded. The demand for concert tickets is more responsive to price than is the demand for cigarettes. We say the demand for concert tickets is more elastic (w.r.t. price) than is the demand for cigarettes.

9. P Q P1P1 P2P2 Q1Q1 Q2Q2 D Calculating the Price Elasticity of Demand P 1  P 2 Q 1  Q 2

10. Important points: The minus sign is dropped when calculating E D. The formula is based on percentage changes, not unit changes. The average price and quantity (midpoints) are used.

11. 12 3 456 7 8 8 7 6 5 4 3 2 1 E D > 1 E D < 1 E D = 1 E D = 0.23 E D = 4.33 Q P a c b

12. Demand is said to be elastic with respect to price if E D > 1. %  Q d > %  P Demand is said to be inelastic with respect to price if E D < 1. %  Q d < %  P Demand is said to be unit elastic with respect to price if E D = 1. %  Q d = %  P

13. Example: E D = 0.58 for food E D = 1.26 for furniture. Goods that are necessities typically have price elasticities of demand that are relatively smaller.

14. Example: E D = 0.4 for gasoline E D = 1.4 for natural gas Goods having ready substitutes typically have higher price elasticities of demand.

15. Example: The price elasticity of demand for food will be smaller than the price elasticity of demand for ice cream. E D typically will be larger as the market/good is more narrowly defined.

16. E D typically will be larger as buyers have a longer period of time to respond to price changes.

17. Inferences that can be made when the price elasticity of demand is known.

18. Suppose that E D = 2.5 and that there is a 5% increase in price. What will be the percentage increase in the quantity demanded? Inferences that can be made when the price elasticity of demand is known. Example 1:

19. Suppose that the price elasticity of demand for cigarettes is 0.7 for teens. How much would the price have to increase in order for teen smoking to be reduced 35%? Example 2:

20. Suppose that the price elasticity of demand for cigarettes is 0.7 for teens. How much would the price have to increase in order for teen smoking to be reduced 35%? Example 2:

21. The relationship between price and revenue changes: The importance of E D

22. 12 3 456 7 8 8 7 6 5 4 3 2 1 E D > 1 E D < 1 E D = 1 E D = 0.23 E D = 4.33 Q P a c b The relationship between price and revenue changes: The importance of E D Demand is elastic Demand is inelastic

23. 12 3 456 7 8 8 7 6 5 4 3 2 1 E D > 1 E D < 1 E D = 1 E D = 0.23 E D = 4.33 Q P a c b Demand is elastic Demand is inelastic When demand is elastic (E D > 1), there is an inverse relationship between changes in price and changes in total revenue.  P   TR  P   TR E D > 1 implies that %  Q d > %  P. TR = P Q   

24. 12 3 456 7 8 8 7 6 5 4 3 2 1 E D > 1 E D < 1 E D = 1 E D = 0.23 E D = 4.33 Q P a c b Demand is elastic Demand is inelastic When demand is inelastic (E D < 1), there is a direct relationship between changes in price and changes in total revenue.  P   TR  P   TR E D < 1 implies that %  Q d < %  P. TR = P Q   

25. “Good weather is often bad for farmers' incomes." S1S1 S2S2 D P Q P1P1 P2P2 Q1Q1 Q2Q2 TR 1 = P 1  Q 1 TR 2 = P 2  Q 2  P   TR This follows from the “total revenue test” and demand for many farm products being price inelastic.

26. Q Q PP Figure 1a Figure 1b 10 12 14 1.00 0.80 D1D1 D2D2 Figure 2 Q P E D =.8182 E D =1.5 At the point where two demand curves intersect, the flatter demand curve is relatively more elastic with respect to price, as compared to the steeper demand curve. Consider two alternative demand curves for a particular good.

27. D1D1 Q P SaSa SbSb P0P0 P1P1 Q0Q0 Q2Q2 D2D2 Q P SaSa SbSb P0P0 Q0Q0 Q2Q2 D1D1 D2D2 Figure 4 Q P SaSa SbSb P0P0 P1P1 Q0Q0 Q2Q2

28. D1D1 D2D2 Figure 3 Q P SaSa P0P0 P1P1 P2P2 Q0Q0 Q1Q1 Q2Q2 D1D1 D2D2 Q P SaSa SbSb P0P0 P1P1 P2P2 Q0Q0 Q1Q1 Q2Q2 D1D1 Q P SaSa SbSb P0P0 P1P1 Q0Q0 Q1Q1 D1D1 D2D2 Q P SaSa SbSb P0P0 P2P2 Q0Q0 Q2Q2

29. FACT: For a given increase in supply the increase in equilibrium quantity will be larger and the decrease in equilibrium price will be smaller as the demand is more elastic with respect to price. D1D1 D2D2 Figure 3 Q P SaSa SbSb P0P0 P1P1 P2P2 Q0Q0 Q1Q1 Q2Q2 D1D1 D2D2 Q P SaSa SbSb P0P0 P1P1 P2P2 Q0Q0 Q1Q1 Q2Q2

30. FACT: For a given increase in demand, the increase in equilibrium quantity will be larger and the decrease in equilibrium price will be smaller as supply is more elastic with respect to price. D1D1 Q P SaSa P0P0 Q0Q0 SbSb Da 1 Q P S1S1 P0P0 Q0Q0 S2S2 DbDb Q2Q2 Q1Q1 P1P1 P2P2