1. micro Economics Unit 4 Slide 1 Created: Jan. 2007 by Jim Luke. The tool of politics (which frequently becomes its objective) is to extract resources from the general taxpayer with minimum offense. -- James R. Schlesinger, Economist and Former Sec. Defense & Energy in Journal of Law and Economics, Oct.1968

2. micro Economics Unit 4 Slide 2 Created: Jan. 2007 by Jim Luke. Elasticity “Responsiveness to change” How economists measure the sensitivity of one variable to changes in another variable Applications: Price Elasticity of Demand Income Elasticity of Demand Price Elasticity of Supply Cross-Price Elasticity of Demand of two goods

3. micro Economics Unit 4 Slide 3 Created: Jan. 2007 by Jim Luke. Price Elasticity of Demand % change in Qty demanded divided by % change in P “Price Sensitivity” of Buyers More meaningful/useful than ‘slope’ Determined by:  Availability / quality of substitutes  % of consumer’s budget  Time for Reacting

4. micro Economics Unit 4 Slide 4 Created: Jan. 2007 by Jim Luke. Price Elasticity of Demand price elasticity of demand measures: % change in quantity demanded divided by the % change in price Categories  Perfectly Inelastic e= 0  Inelastic e<1.0  Unit-elastic e= 1.0  Elastic e>1.0  Perfectly Elastic e= 0

5. micro Economics Unit 4 Slide 5 Created: Jan. 2007 by Jim Luke. Price Elasticity of Demand Inelastic: % Quantity Change < % P change

6. micro Economics Unit 4 Slide 6 Created: Jan. 2007 by Jim Luke. Price Elasticity of Demand Constant (Unit) Elasticity of Demand e = 1.0

7. micro Economics Unit 4 Slide 7 Created: Jan. 2007 by Jim Luke. Demand Curves with Constant Price Elasticity

8. micro Economics Unit 4 Slide 8 Created: Jan. 2007 by Jim Luke. Price Elasticity of Demand: What do you think? ProductShort-runLong-run Cigarettes Electricity (residential) Air Travel Medical Care/Hospitalization GasolineMilk Fish (cod) WineMovies Natural Gas (residential) AutomobilesChevrolets

9. micro Economics Unit 4 Slide 9 Created: Jan. 2007 by Jim Luke. Price Elasticity of Demand: Survey Sez…. ProductShort-runLong-run Cigarettes-0.4 Electricity (residential)0.11.9 Air Travel0.11.9 Medical Care/Hospitalization0.30.9 Gasoline0.41.5 Milk0.41.5 Fish (cod)0.5 Wine0.71.2 Movies0.93.7 Natural Gas (residential)1.42.1 Automobiles1.92.2 Chevrolets 4.0

10. micro Economics Unit 4 Slide 10 Total Revenue = P x Q

11. micro Economics Unit 4 Slide 11 Elasticity and Total Revenue A price effect: After a price increase, each unit sold sells at a higher price, which tends to raise revenue. A price effect: After a price increase, each unit sold sells at a higher price, which tends to raise revenue. A sales effect: After a price increase, fewer units are sold, which tends to lower revenue. A sales effect: After a price increase, fewer units are sold, which tends to lower revenue.

12. micro Economics Unit 4 Slide 12 Price & Sales Effects Work Opposite Each Other

13. micro Economics Unit 4 Slide 13 Elasticity and Total Revenue   If demand for a good is elastic, an increase in price reduces total revenue. (Sales effect > Price effect).   If demand for a good is i nelastic, a higher price increases total revenue. (Price effect > Sales effect).   If demand for a good is unit-elastic, an increase in price does not change total revenue. (Sales effect = Price effect).

14. micro Economics Unit 4 Slide 14 Elasticity, Total Revenue, Taxes   Excise taxes: Which products? Why?   What products & stores run sales? Why?   Why don’t utilities run a sale?

15. micro Economics Unit 4 Slide 15 Price Elasticity of Demand Changes Along the Demand Curve

16. micro Economics Unit 4 Slide 16 Created: Jan. 2007 by Jim Luke. Price Elasticity of Supply Measures: % change in quantity supplied divided by % change in price Categories:  Perfectly inelastic  Inelastic  Unit Elastic  Elastic  Perfectly Elastic

17. micro Economics Unit 4 Slide 17 Created: Jan. 2007 by Jim Luke. Income Elasticity of Demand Measures: % change in demand divided by % change in income Categories  If income elasticity “ inferior good”  If income elasticity > 1.0 --> “income elastic”

18. micro Economics Unit 4 Slide 18 Created: Jan. 2007 by Jim Luke. Income Elasticities of Demand Product ElasticityProduct Elasticity Private educ.2.46Drs. services0.75 Automobiles2.45Coca-Cola0.68 Wine2.45Beef0.62 Owned house1.49Food0.51 Furniture1.48Coffee0.51 Dental service1.42Cigarettes0.50 Rest. meals1.40Gas & oil0.48 Shoes1.10Rental house0.43 Chicken1.06Beer0.27 Spirits 1.02Pork0.18 Clothing0.92Flour–0.36

19. micro Economics Unit 4 Slide 19 Created: Jan. 2007 by Jim Luke. Cross-Price Elasticity of Demand % change in the demand of one good divided by % change in the price of another good Substitutes: (+) sign Complements: (-) sign