1. Demand and Supply: Elasticities and Applications
Chapter 5

2. Price Elasticity of Demand
The responsiveness of consumers to a change in the price of a good/service
In other words: How much does changing the price of a good impact how much we demand of that good.

3. Price Elasticity of Demand
Practice: Think about your spending habits. Come up with one good that you do not care what it costs when it comes to buying it…you will buy the same amount no matter what happens. Come up with one good that you would definitely buy more of it was cheaper and less of if it was more expensive.

4. Price Elasticity of Demand
So how do we figure out exactly what the elasticity of demand is?
A lovely formula!
Ed = % change in Qd of X
% change in P of X

5. Price Elasticity of Demand
Here’s another way of looking at it!
Ed = (Q2 – Q1)/Q1
(P2 – P1)/P1
We always use absolute value when calculating elasticity!

6. Midpoint Formula Ed = (Q2 – Q1)/[(Q1 + Q2)/2] (P2 – P1)/[(P1 + P2)/2]
This is the formula you should actually use to calculate the elasticity of demand
(why do they give you the other one too?....I don’t know!)

7. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2

8. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Midpoint Formula = (Q2-Q1)/[(Q1+Q2)/2]
(P2-P1)/[(P1+P2)/2]

9. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Midpoint Formula = ( )/[ )/2]
($2.00-$1.00)/[($2.00+$1.00)/2]

10. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Midpoint Formula = -20/170
$1.00/$1.50

11. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Midpoint Formula =
.667

12. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Midpoint Formula =
Use absolute value and change to percent = 0.18

13. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Use absolute value and change to percent = 0.18
So what is our demand?! Inelastic? Elastic? Unit Elastic?

14. Elastic Demand
%change in Qd > %change in P
Elasticity Ratio > 1

15. Inelastic Demand %change in Qd < %change in P
Elasticity Ratio < 1

16. Unitary Elasticity
%change in Qd = %change in P
Elasticity Ratio = 1

17. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Use absolute value and change to percent = 0.18
So what is our demand?! Inelastic? Elastic? Unit Elastic?

18. Let’s Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $1 to $2
Use absolute value and change to percent = 0.18
Inelastic at this price point!

19. Your turn!
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $5 to $6

20. Your turn!
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
Calculate the price elasticity of demand when price changes from $5 to $6
(80-100)/[(100+80)/2]
($6-$5)/[$5+$6)/2]
(-20/90)/($1/$5.50)
-.222/.182 = -1.22
Absolute value = 1.22
Elastic Demand!

21. Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
If the price changes from $3 per cup to $4 per cup, is demand elastic, inelastic or unit elastic?

22. Practice
Price Per Cup of Coffee
Quantity Demanded
$10 $9 20 $8 40 $7 60 $6 80 $5
100 $4
120 $3
140 $2
160 $1
180
Free!
200
If the price changes from $3 per cup to $4 per cup, is demand elastic, inelastic or unit elastic?
Inelastic!

23. Why Use Percentages?
1.Using absolute changes would be affected by the units used
Example: If $ units used:
$3$2 causes 60100 Qd change
Seems very responsive
If cents used:
300200 causes 60100 Qd change
Does not seem as responsive

24. Why Use Percentages? Easier to compare different products
$ changes depend on the original cost of the good/service
$1 increase in a good/service which costs $1 has a different impact than a $1 increase in a good/service which costs $20,000

25. Why Use Percentages?
In other words…. - Adding $1 to the price of a pack of starbursts is going to have a different impact that adding $1 to the price of a new car!

26. Elasticity Varies with Price Range
Demand is more elastic in the upper left region of the demand curve than in the lower right region

27. Elasticity Varies with Price Range
In upper left:
%change in quantity is large because original quantity is small
%change in price is small because the original price is large

28. Elasticity Varies with Price Range
In lower right:
%change in quantity is small because original quantity is large
%change in price is large because the original price is small

30. Perfectly Inelastic Demand
%change in price does not change the quantity demanded
Demand Curve is Parallel to the Y Axis Q P D 15
700
100

31. Perfectly Elastic Demand
%change increase in price causes quantity demanded to fall to zero
%change decrease in price causes quantity demanded to increase to infinity
Demand Curve is Parallel to the X Axis P Q D 16 10 20

32. Midpoint Formula If original formula used, two different answers
P1=5; P2=4; Q1=4; Q2=5
Ed = (Q2 – Q1)/Q1
(P2 – P1)/P1
= (5-4)/4
(4-5)/5
= (1/4)/1/5
= 5/4=1.25

33. Midpoint Formula If original formula used, two different answers
P1=4; P2=5; Q1=5; Q2=4
Ed = (Q2 – Q1)/Q1
(P2 – P1)/P1
= (4-5)/5
(5-4)/4
= (1/5)/(1/4)=.8

34. Determinants of Supply
Explain how each of these impacts supply:
Technology
Subsidies/Taxes
Costs/Resource Prices
Other good prices
Number of Sellers
Expectations/Fears

35. Slope Does NOT Measure Elasticity
Slope is calculated from absolute changes in price and quantity, not percentage changes

36. Total Revenue Test
TR = PQ
Total revenue = Price X Quantity

37. Total Revenue Test Elastic Demand P increase leads to decrease in TR
P decrease leads to increase in TR
Firms tend to have sales on elastic goods

38. Total Revenue Test Inelastic Demand:
P increase leads to increase in TR
P decrease leads to decrease in TR
Government taxes inelastic goods e.g., (sin taxes)

39. Total Revenue Test Unitary Demand: P increasesNo change in TR
P decreasesNo change in TR

40. Determinants of Price Elasticity of Demand

41. 1. Substitutability
The larger the number of substitutes, the greater the elasticity of demand
There are how many different pizza places out there?
Vs.
There are how many utility companies out there?

42. 1. Substitutability
Individual products versus industry: Tide, All, Cheer versus laundry detergent
Our demand for the industry might be inelastic (we need clean clothes!)
But
Our demand for a specific brand might be elastic (I don’t care what makes them clean…just do it)

43. 2. Proportion of Income Step One: Look at your income
Step Two: Look at the price of the good/service
Step Three: What portion of your income does it take to buy the good/service?

44. 2. Proportion of Income
If it takes a large portion of your income to buy the good/service – greater the elasticity.
If it take a small portion of your income to buy the good/service – usually more inelastic.
Low-priced items are usually more inelastic than high-priced items: salt versus cars

45. 3. Luxuries versus Necessities
Necessities = inelastic
Luxuries = elastic

46. 3. Luxuries versus Necessities
Necessities = inelastic
Life saving heart surgery (probably doesn’t matter if the price increases…I’m gonna go ahead and have that)
Luxuries = elastic
Starbursts (while desirable…not worth it if the price goes up!)

47. 4. Time
Goods tend to have more elastic demand over longer time periods
Consider the market for gasoline:
When the price rises, the quantity of gasoline in the first few months/years changes very little
Over longer periods of time quantity will change as people switch to public transportation, buy fuel efficient cars or move closer to work.

48. Price Elasticity of Supply
The responsiveness of producers to price changes
Es = %change in quantity supplied of X
%change in price of X
Es >1elastic
Es < 1inelastic
Es = 1unitary
You can still use the midpoint method to calculate this!

49. Determinants of Price Elasticity of Supply
How flexible are sellers when it comes to changing the amount of the good they produce?
For example:
Land in Manhattan for development – inelastic supply because you can’t really create more of it
Soccer balls produced by a factory – elastic supply because you could operate your factory for longer, hire more workers, etc. to produce more if you wanted.

50. Determinants of Price Elasticity of Supply
Time Period
Long Time = All factors of production are adjustable = more elastic the supply
Firms have a longer amount of time to shift resources to adjust to a price change
Short Run = plant capacity is fixed = more inelastic supply
Harder to make changes in production quickly

51. Determinants of Price Elasticity of Supply
There is no revenue test for Price Elasticity of Supply

52. Homework
Read “Why Did OPEC Fail to Keep the Price of Oil High?” in your book starting on page 105
Answer question 10 on page 110
Be prepared to share your answer tomorrow.

53. Group Work We are going to assemble into groups of four
Once you are in your group, the youngest two people in the group are partners and the oldest two are partners
Each pair will be given a topic to take notes on as you read about it in your book.
Using these notes, the pair must devise a short lesson designed to share this information with the rest of the class

54. Group Work
You may utilize technology, posters, the board or any other supplies you feel are necessary in order to teach your lesson.
You must design a lesson plan that contains all the components listed on your half sheet.
When you are finished, you will turn your lesson plan into Mrs. Krieger
Young ones – your topic is Cross Elasticity of Demand
Oldies – your topics is Income Elasticity of Demand

56. Cross Elasticity of Demand
Responsiveness of quantity demanded of good/service X when the price of good/service Y changes
Exy = %change in quantity demanded of X
%change in price of Y

57. If Cross Elasticity of Demand is:
PositiveX and Y are Substitutes
NegativeX and Y are Complements
(Near) ZeroX and Y are Independent (i.e., no relation to each other)

58. Income Elasticity of Demand
Responsiveness of quantity demanded to a change in income
Ei = %change in quantity demanded of X
%change in income
Ei > 0Normal Goods
Ei < 0Inferior Goods

59. Government Intervention
Price Ceilings and Price Floors
Basically the same thing as a surplus or shortage caused by the government!

60. Price Ceilings and Floors
Everyone point to the ceiling now
Now point to the floor
Now forget everything you ever thought you knew about ceilings and floors

61. Price Ceiling
A Price Ceiling is actually located BELOW equilibrium price
It is a set price that suppliers may not charge more than – that’s why it’s called a ceiling

62. Price Ceiling

63. Examples of Price Ceilings
Live Nation
Ticketmaster

64. Price Floors A Price Floor is actually located ABOVE equilibrium price
This is a set price that suppliers may not charge less than – that’s why it’s called a floor

65. Price Floors

66. Famous Price Floor = MILK

67. Attempts to Correct Ticket Scalpers Got Milk? Campaign
Sell tickets to those in need – but at a higher price! Changing the quantity demanded
Got Milk? Campaign
Increase demand for milk and bring equilibrium price up to floor

68. Discussion Question
How would elasticity impact the shortage/surplus caused by a ceiling/floor?

69. Homework
Read pages 124 through 127 in your textbook talking about taxes.
Create a graphic organizer (chart is probably the easiest way to go) including information on the three steps to analyzing taxes on buyers and sellers and the implications of these taxes.

70. Homework For example: Taxes on Buyers Taxes on Sellers Step One
Step Two
Step Three
Implications

71. Taxes on Buyers Which curve would this impact? Demand or Supply?
This is a tax on consumers. Which curve deals with consumers?
The Demand Curve
This is the curve that is going to be shifting.

72. Taxes on Buyers Which curve would this impact? Demand or Supply?
This is a tax on consumers. Which curve deals with consumers?
The Demand Curve
This is the curve that is going to be shifting.

73. Taxes on Buyers Which way is our curve going to move?
Does this added tax make the product more or less desirable?
Less desirable – shifting to the left
The amount of the shift is determined by looking at the amount of the tax.

74. Taxes on Buyers Now we examine what actually happened with the tax:
Compare the new equilibrium to the old equilibrium
Money going to sellers goes down
Quantity will go down
The tax has reduced the size of the market!

75. Taxes on Buyers What does this mean?
Consumers pay higher prices due to the tax
Even though equilibrium price might be lower, there is still a 50 cent tax on top!
Sellers receive less for each product
Due to the decrease in equilibrium

76. Taxes on Buyers What does this mean? Taxes make markets shrink
Quantity at equilibrium goes down
Buyers and sellers both get hurt
Buyers pay more for the good
Sellers make less for the good