1. Elasticity

2. What would you do? Winged Foot Gold Club Budget shortfall Out-of-town membership = $2,500 annual dues Questions: Do you raise the dues? If yes, how much? What will happen?

3. Elasticity How much change in quantity demanded does a change in price create? How much change in quantity demanded does a change in price create? Elastic = big changes Elastic = big changes Unitary Elasticity = equal changes Unitary Elasticity = equal changes Inelastic = small changes Inelastic = small changes

4. 2 Methods Total Revenue Method Total Revenue Method Compare changes in Price to changes in TR Compare changes in Price to changes in TR Calculation Method Calculation Method Calculate point elasticity Calculate point elasticity

5. Measuring Total Revenue TR = P * Q TR = P * Q Elastic Elastic Small Change in Price Small Change in Price Big change in Quantity Big change in Quantity TR changes in the opposite direction as Price TR changes in the opposite direction as Price Inelastic Inelastic Small change in P Small change in P Smaller change in Q Smaller change in Q TR Changes in the same direction as Price TR Changes in the same direction as Price NB Comparing TR with P, NOT QUANTITY NB Comparing TR with P, NOT QUANTITY

6. Total Revenue D P Q 0 $4 100 Revenue P x Q = $400

7. Guidelines for TR Method Elastic Demand Elastic Demand Opposite direction of movement Opposite direction of movement If Price goes up……….Revenue goes down If Price goes up……….Revenue goes down If Price goes down……Revenue goes up If Price goes down……Revenue goes up Inelastic Demand Inelastic Demand Same direction of movement Same direction of movement If Price goes up……….Revenue goes up If Price goes up……….Revenue goes up If Price goes down……Revenue goes down If Price goes down……Revenue goes down

8. Total Revenue - Inelastic D P Q 0 $4 100 Revenue 90 $5 A - Extra Revenue B - Lost Revenue Revenue gained from higher price (A) exceeds revenue lost from lower quantity (B). Price increases from 4 to 5 while TR increases from 400 to 450. When P & TR move in the same direction it is elastic. A – Revenue gained from raising price B – Revenue lost from less quantity sold

9. Total Revenue - Elastic D P Q 0 $4 100 Revenue gained Revenue Revenue Lost Revenue gained from higher price is exceeded by revenue lost from the lower quantity. Price increases from 4 to 5 while TR decreases from 400 to 350. When P & TR move in opposite direction it is elastic. $5 70 A – Revenue gained from raising price B – Revenue lost from less quantity sold

10. Point Elasticity Measures small changes on curve Measures small changes on curve = % change in Q / % change in P = % change in Q / % change in P = / = /

11. Elasticity Elastic Elastic >1 to infinity >1 to infinity Unitary elasticity Unitary elasticity =1 =1 Inelastic Inelastic 0 to <1 0 to <1

12. Elasticity Elasticity changes with location on curve Elasticity changes with location on curve Marginal Utility Marginal Utility Slopes at ends change Slopes at ends change Elasticity & Slope not the same Elasticity & Slope not the same Large change in high prices = small change in quantity Large change in high prices = small change in quantity Small changes at low prices = large change in quantity Small changes at low prices = large change in quantity

13. Changing Elasticities Inelastic – A large change in price… … leads to a small change in quantity Elastic – A small change in price… … leads to a large change in quantity 2 3 10 13 45 1114 Price Quantity

14. Elasticity Factors Substitutes Substitutes Income Income Necessities Necessities Time Time

15. Elasticity Examples

16. Example Revenue Table – Slices of Pizza Revenue Table – Slices of Pizza Price Quantity Revenue = P*Q Price Quantity Revenue = P*Q 0.50300150 0.50300150 1.00250250 1.00250250 1.50200300 1.50200300 2.00150300 2.00150300 2.50100250 2.50100250 3.00 50150 3.00 50150

17. Calculating Elasticity Consider two examples, the price of a slice of pizza changes from Consider two examples, the price of a slice of pizza changes from $1.00 to $1.50 $1.00 to $1.50 $2.00 to $2.50 $2.00 to $2.50 Use both methods to determine elasticity Use both methods to determine elasticity TR TR Calculations Calculations

18. TR Method 1.00 to 1.50 1.00 to 1.50 Price up (1.00 to 1.50) Price up (1.00 to 1.50) Revenue up (250 to 300) Revenue up (250 to 300) Same direction – Inelastic Same direction – Inelastic 2.00 to 2.50 2.00 to 2.50 Price up (2.00 to 2.50) Price up (2.00 to 2.50) Revenue down (300 to 250) Revenue down (300 to 250) Opposite direction – Elastic Opposite direction – Elastic

19. Calculating Elasticity #1 Calculate elasticity as Price increases from 1.00 to 1.50. Is the elasticity elastic or inelastic? Calculate elasticity as Price increases from 1.00 to 1.50. Is the elasticity elastic or inelastic? = / = / =(-50/250)/(.50/1) =(-50/250)/(.50/1) =-.2/.5 =-.2/.5 =-.4 =-.4 Inelastic Inelastic

20. Calculating Elasticity #2 Calculate elasticity as Price increases from 2.00 to 2.50. Is the elasticity elastic or inelastic? Calculate elasticity as Price increases from 2.00 to 2.50. Is the elasticity elastic or inelastic? = / = / =(-50/150)/(.50/2) =(-50/150)/(.50/2) =-.33/.25 =-.33/.25 =-1.33 =-1.33 Elastic Elastic

21. Example Summary Price change from 1.00 to 1.50 Price change from 1.00 to 1.50 TR method – Inelastic TR method – Inelastic Calculation – Inelastic Calculation – Inelastic Price change from 2.00 to 2.50 Price change from 2.00 to 2.50 TR method – Elastic TR method – Elastic Calculation – Elastic Calculation – Elastic NB Both methods will produce the same answer NB Both methods will produce the same answer

22. Arc Elasticity(Midpoint) Midpoint as opposed to endpoint Midpoint as opposed to endpoint More accurate for larger changes More accurate for larger changes Winged Foot example Winged Foot example = (Q 2 -Q 1 )/{(Q 2 +Q 1 )/2} /(P 2 -P 1 )/{(P 2 +P 1 )/2} = (Q 2 -Q 1 )/{(Q 2 +Q 1 )/2} /(P 2 -P 1 )/{(P 2 +P 1 )/2} NB Elasticity changes with position on graph. NB Elasticity changes with position on graph.

23. Other Elasticities Income Elasticity Income Elasticity = % change Q.D./ % change Income = % change Q.D./ % change Income Cross-Price Elasticity Cross-Price Elasticity = % change Q.D. Good #1 / % change price Good #2 = % change Q.D. Good #1 / % change price Good #2 Price Elasticity of Supply Price Elasticity of Supply % change Q.S. / % change Price % change Q.S. / % change Price

24. Additional Points Public Goods Public Goods Surplus & Shortages Surplus & Shortages Price Ceilings Price Ceilings Price Floors Price Floors Rationing Rationing