1. Chapter 4 Elasticity

2. Movement along demand and supply curves when the price of the good changes. QUESTION: HOW CAN WE PREDICT THE MAGNITUDE OF THESE REACTIONS? ANSWER: ELASTICITIES!!

3. Elasticity Elasticity: a general concept used to quantify the response in one variable when another variable changes. Elasticity of A with respect to B

4. Price Elasticity of Demand Measures how responsive consumers are to changes in the price of a product.

5. PRICE ELASTICITY OF DEMAND Price elasticity of demand is always negative. Elasticity is not the same as the slope of the demand curve. Ed = (% change Qd)/ (% change P) p1 p2 q1q2 D Price increase Quantity demand decrease Q P

6. The shape of a demand curve gives you some idea of the good’s general elasticity. (1) p D Q P D Q P Perfectly elastic Relatively elastic

7. D Q P D Q P Perfectly inelastic Relatively inelastic The shape of a demand curve gives you some idea of the good’s general elasticity.(2)

8. To calculate price elasticity of demand, use the midpoint formula.

9. Example-To find the price elasticity of demand between points a and b : P1=$2 P2=$3 Q1=10Q2=5 D Price increase Quantity demand decrease Q P a b

10. Example-To find the price elasticity of demand between points a and b : P1=$2 P2=$3 Q1=10Q2=5 D Price increase Quantity demand decrease Q P a b The price elasticity of demand at the midpoint between points a and b is -1.67.

11. Interpret the result What exactly does this tell you about the demand for this product in this price range?

12. Let’s try another, inelastic demand P1=$2 P2=$3 Q1=10Q2=9 D Price increase Quantity demand decrease Q P a b

13. Let’s try another, inelastic demand P1=$2 P2=$3 Q1=10Q2=9 D Price increase Quantity demand decrease Q P a b

14. The following categories help to describe consumer responsiveness: If the elasticity coefficient is less than -1 demand is elastic. Consumers are relatively responsive to price changes. If the elasticity coefficient is between -1 and 0 demand is inelastic. Consumers are not very responsive to price changes. If the elasticity coefficient is equal to -1, demand is unitary elastic.

15. Why we need elasticity? Why would a business firm need to calculate them, and how would the firm use the information? Now that you can calculate price elasticities of demand, what would you use them for?

16. There is an important relationship between price elasticity of demand and total revenues: When demand is inelastic, price and total revenues are directly related. Price increases generate higher revenues. When demand is elastic, price and total revenues are indirectly related. Price increases generate lower revenues.

17. Now...what factors help to determine price elasticity of demand? Notice that this gives the firm information that it can use to establish pricing policy.

18. DETERMINANTS OF PRICE ELASTICITY OF DEMAND Availability of substitutes -- demand is more elastic when there are more substitutes for the product. Importance of the item in the budget -- demand is more elastic when the item is a more significant portion of the consumer’s budget. Time frame -- demand becomes more elastic over time.

19. Other types of elasticities INCOME ELASTICITY CROSS-PRICE ELASTICITY

20. Other types of elasticities PRICE ELASTICITY OF SUPPLY

21. CHAPTER SUMMARY The price system rations goods and services to the consumers who are willing and able to pay market prices. Governments and firms sometimes try to bypass the price mechanism, generating excess demand and excess supply. Elasticity is a general concept that can be used to measure several types of market responsiveness.

22. Review questions Understand the meaning of elasticity. Apply the method to calculate elasticity.