1. Price Elasticity of Demand and Supply Key Concepts Key Concepts Summary ©2005 South-Western College Publishing

2. 2 What will this chapter teach me? This chapter teaches you to calculate the percentage change in the quantity demanded when the price changes by a given percentage. Then you will see how this relates to total revenue.

3. 3 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

4. 4 Suppose the price of a rock concert increases by 10%, what effect will this have on sales? That all depends on the price elasticity of demand for this rock concert

5. 5 What is elasticity? A term economists use to describe responsiveness, or sensitivity, to a change in price

6. 6 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

7. 7 %  in Q demanded %  in price E d = Price Elasticity of Demand

8. 8 Supposing a university’s enrollment drops by 20% because tuition rises by 10%, what is the price elasticity of demand?

9. 9 E d = -20% +10% = -.20 +.10 = 2

10. 10 Why is elasticity 2 in the previous example and not -2? Economists drop the negative sign because we know from the law of demand that quantity demanded and price are inversely related

11. 11 If there is an increase from 3 units to 5, what is the percentage increase? 2/3 = 66%

12. 12 If there is a decrease from 5 units to 3, what is the percentage decrease? 2/5 = 40%

13. 13 Problem - When we move along a demand curve between two points, we get different answers to elasticity depending on whether we are moving up or down the demand curve

14. 14 A B 2 3 P Q D

15. 15 Economists can solve this problem of different base points by using the midpoints as the base points of changes in prices and quantity demanded

16. 16  in quantity demanded sum of quantities/2 divided by  in price sum of prices/2 Price elasticity equals the

17. 17 What is elastic demand? A condition in which the percentage change in quantity demanded is greater than the percentage change in price

18. 18 $40 $30 $20 $10 10203040 A B Elastic Demand E d > 1 P Q

19. 19 Why is the demand curve in the previous slide elastic? The percentage change in the quantity demanded is greater than the percentage change in price

20. 20 Price decrease Increase in total revenue Elastic Demand

21. 21 10 15 =.66% change in Q = % change in P = 10 25 =.40 E d = % change in Q % change in P =.66.40 E d = 1.65

22. 22 $40 $30 $20 $10 10203040 A B Inelastic Demand E d < 1

23. 23 Why is the demand curve in the previous slide inelastic? The percentage change in the quantity demanded is less than the percentage change in price

24. 24 Price decrease Decrease in total revenue Inelastic Demand

25. 25 5 13 =.38 % change in Q = % change in P = 10 25 =.40 E d = % change in Q % change in P =.38.40

26. 26 What is a unitary elastic demand curve? The percentage change in the quantity demanded is equal to the percentage change in price

27. 27 $40 $30 $20 $10 10203040 E F Unitary Elastic Demand E d = 1 D

28. 28 Price decrease No change in total revenue Unitary Elastic Demand

29. 29 What is a perfectly elastic demand curve? A condition in which a small percentage change in price brings about an infinite percentage change in the quantity demanded

30. 30 $40 $30 $20 $10 10203040 Perfectly Elastic Demand E d = 8

31. 31 Price change Infinite change in quantity demanded Perfectly Elastic Demand

32. 32 What is a perfectly inelastic demand curve? A condition in which the quantity demanded does not change as the price changes

33. 33 $40 $30 $20 $10 10203040 Perfectly Inelastic Demand E d = 0

34. 34 Price change Zero change in quantity demanded Perfectly Inelastic Demand

35. 35 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?

36. 36 If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1

37. 37 If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1

38. 38 If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1

39. 39 $20 $15 $10 $5 5101520 $25 $30 $35 $40 2530354045 Price Elasticity of Demand Ranges Elastic Inelastic Unitary elastic

40. 40 $200 $150 $100 $50 5101520 $250 $300 $350 $400 2530354045 Total Revenue Curve Elastic Inelastic Unitary Elastic

41. 41 What factors influence demand sensitivity? Availability of substitutes Share of budget on the product Adjustment to a price change over time

42. 42 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

43. 43 A B D D Which demand curve is for a vital medicine and which is for candy?

44. 44 Why is A the demand curve for medicine? Because medicine is a necessity with few substitutes, and the price can change with little effect on the quantity demanded

45. 45 Why is B the demand curve for candy? Because candy has many substitutes, a price change can bring about a big change in the quantity demanded

46. 46 What does the share of one’s budget have to do with a price change? The larger the purchase is to one’s budget, the more sensitive consumers are to a price change, and the more elastic the demand curve

47. 47 What does time have to do with sensitivity? The longer consumers have to adjust, the more sensitive they are to a price change, and the more elastic the demand curve

48. 48 What are other elasticity measures? Income elasticity of demand Cross-elasticity of demand

49. 49 What is Income elasticity of demand? The ratio of the percentage change in the quantity demanded of a good to a given percentage change in income

50. 50 %  in Q demanded %  in income E d = Income Elasticity of Demand

51. 51 What is cross- elasticity of demand? The ratio of the percentage change in quantity demanded of a good to a given percentage change in price of another good

52. 52 %  Q demanded of good A %  price of good B E c = Cross-elasticity of Demand

53. 53 What is the price elasticity of supply? The ratio of the percentage change in the quantity supplied of a product to the percentage change in its price

54. 54 %  in Q supplied %  in price E s = Price Elasticity of Supply

55. 55 $40 $30 $20 $10 10203040 Perfectly Elastic Supply = 8

56. 56 $40 $30 $20 $10 10203040 Perfectly Inelastic Supply E s = 0

57. 57 $40 $30 $20 $10 10203040 Unit Elastic Supply E s = 1 S.5%

58. 58 Who pays the tax levied on sellers of goods such as gasoline, cigarettes, and alcoholic beverages? It all depends; the corporation pays all, some, or very little of the tax

59. 59 What decides who pays what part of the tax increase? The more elastic the demand, the more the corporation pays; the less elastic the demand, the more the consumer pays

60. 60 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.7 5 $2.00 2530354045 s1s1 s2s2 D Buyers Sellers Partially shifted tax to buyers

61. 61 Increase in gasoline tax Decrease in supply Consumers and suppliers share burden of tax

62. 62 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.75 $2.00 2530354045 s1s1 s2s2 D Buyers Fully shifted tax to buyers

63. 63 Increase in gasoline tax Decrease in supply Consumers bear full burden of tax

64. 64 Key Concepts

65. 65 What is elasticity? What is price elasticity of demand? What is elastic demand? What is a unitary elastic demand curve? What is a perfectly elastic demand curve? What is a perfectly inelastic demand curve? What factors influence demand sensitivity? What are other elasticity measures? What is Income elasticity of demand? What is cross-elasticity of demand? What is the price elasticity of supply?

66. 66 Summary

67. 67 Price elasticity of demand is a measure of the responsiveness of the quantity demanded to a change in price. Specifically, price elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in price.

68. 68 %  in Q demanded %  in price E d = Price Elasticity of Demand

69. 69 What is the midpoint formula for the price elasticity of demand?

70. 70  in quantity demanded sum of quantities/2 divided by  in price sum of prices/2 Price elasticity equals the

71. 71 Elastic demand is a change of more than one percent in quantity demanded in response to a one percent change in price. Demand is elastic when the elasticity coefficient is greater than one and total revenue (price time quantity) varies inversely with the direction of the price change.

72. 72 $40 $30 $20 $10 10203040 Elastic Demand

73. 73 Inelastic demand is a change of less than one percent in quantity demanded in response to a one percent change in price. Demand is inelastic when the elasticity coefficient is less than one and total revenue varies directly with the direction of the price change.

74. 74 $40 $30 $20 $10 10203040 Inelastic Demand

75. 75 Unitary elastic demand is a one percent change in quantity demanded in response to a one percent change in price. Demand is unitary elastic when the elasticity coefficient equals one and total revenue remains constant as the price changes.

76. 76 $40 $30 $20 $10 10203040 Unitary elastic Demand

77. 77 Perfectly elastic demand is a decline in quantity demanded to zero for even the slightest rise or fall in price. This is an extreme case in which the demand curve is horizontal and the elasticity coefficient equals infinity.

78. 78 $40 $30 $20 $10 10203040 Perfectly Elastic Supply = 8

79. 79 Perfectly inelastic demand is no change quantity demanded in response to price changes. This is an extreme case in which the the demand curve is vertical and the elasticity coefficient equals zero.

80. 80 $40 $30 $20 $10 10203040 Perfectly Inelastic Supply E s = 0

81. 81 Determinants of price elasticity of demand include (a) the availability of substitutes, (b) the percentage of budget spent on the product, and (c) the length of time allowed for adjustment. Each of these factors is directly related to the elasticity coefficient.

82. 82 Income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in income. For a normal good or service, income elasticity of demand is positive. For an inferior good or service, income elasticity of demand is negative.

83. 83 Cross elasticity of demand is the percentage change in the quantity demanded of one product caused by a change in the price of another product. When the cross-elasticity of demand is negative, the two products are complements.

84. 84 Price elasticity of supply is a measure of the responsiveness of the quantity demanded to a change in price. Price elasticity of supply is the ratio of the percentage change in quantity supplied to the percentage change in price.

85. 85 Tax incidence is the share of a tax ultimately paid by buyers and sellers. Facing a downward- sloping demand curve and an upward-sloping supply curve, sellers cannot raise the price by the full amount of the tax. If the demand curve is vertical, sellers will raise the price by the full amount of a tax.

86. 86 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.75 $2.00 2530354045 s1s1 s2s2 D Buyers Fully shifted tax to buyers

87. 87 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.75 $2.00 2530354045 s1s1 s2s2 D Buyers Sellers Partially shifted tax to buyers

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