1. 1 Describing Supply and Demand: Elasticities 6 6-1 Price Elasticity: Demand  Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price  This tells us exactly how quantity demanded responds to a change in price E D =  Elasticity is independent of units % change in Quantity Demanded % change in Price  Price elasticity of demand is always expressed as a positive number

2. 1 Describing Supply and Demand: Elasticities 6 6-2 Price Elasticity: Demand  Demand is elastic if the percentage change in quantity is greater than the percentage change in price Elastic demand is when E D > 1  Demand is inelastic if the percentage change in quantity is less than the percentage change in price Inelastic demand is when E D < 1

3. 1 Describing Supply and Demand: Elasticities 6 6-3 Calculating Elasticities: Price Elasticity of Demand D P Q What is the price elasticity of demand between A and B? $20 10 $26 14 B A E D = %ΔQ%ΔP%ΔQ%ΔP Q 2 –Q 1 ½(Q 2 +Q 1 ) P 2 –P 1 ½(P 2 +P 1 ) = C 12 $23 = 10–14 ½(10+14) 26–20 ½(26+20) -.33.26 = 1.27 =

4. 1 Describing Supply and Demand: Elasticities 6 6-4 Calculating Elasticities: Price Elasticity of Demand E D = %ΔQ%ΔP%ΔQ%ΔP Q 2 –Q 1 ½(Q 2 +Q 1 ) P 2 –P 1 ½(P 2 +P 1 ) = Compute the approximate elasticity of demand from the following data: Price Quantity Initial situation $23 11.5 New situation $20 13.5

5. 1 Describing Supply and Demand: Elasticities 6 6-5 Calculating Elasticities: Price Elasticity of Demand E D = %ΔQ%ΔP%ΔQ%ΔP Q 2 –Q 1 ½(Q 2 +Q 1 ) P 2 –P 1 ½(P 2 +P 1 ) =

6. 1 Describing Supply and Demand: Elasticities 6 6-6 Elasticity is Not the Same as Slope  Elasticity is not the same as slope, but, the steeper a curve is at a given point, the less elastic demand or supply This curve is perfectly elastic, meaning that Q responds enormously to changes in price, E D = ∞ This curve is perfectly inelastic, meaning that Q does not respond at all to changes in price, E D = 0 P Q D D P Q

7. 1 Describing Supply and Demand: Elasticities 6 6-7 Elasticity Changes Along Straight-Line Curves  On straight-line supply and demand curves, slope stays constant, but elasticity changes P Q Elasticity declines along this straight-line demand curve as we move towards the Q axis $2 10 $6 42 $4 $8 $10 68 E D = 0 E D = 1 E D = ∞ E D > 1 E D < 1

8. 1 Describing Supply and Demand: Elasticities 6 6-8 Elasticity Changes Along Straight-Line Curves  On straight-line supply curve, slope stays constant, but elasticity changes P Q If it intersects the vertical axis (S 0 ), elasticity starts at infinity and declines, and eventually approaches 1. If it intersects the horizontal axis (S 1 ), it starts at zero and increases, and eventually approaches 1. $2 10 $6 42 $4 $8 $10 68 S0S0 S1S1 E s = ∞ E s = 0 E s declines E s rises

9. 1 Describing Supply and Demand: Elasticities 6 6-9 Price Elasticity: Supply  Price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price  This tells us exactly how quantity supplied responds to a change in price E S =  Elasticity is independent of units % change in Quantity Supplied % change in Price

10. 1 Describing Supply and Demand: Elasticities 6 6-10 Price Elasticity: Supply  Supply is elastic if the percentage change in quantity is greater than the percentage change in price Elastic supply is when E S > 1  Supply is inelastic if the percentage change in quantity is less than the percentage change in price Inelastic supply is when E S < 1

11. 1 Describing Supply and Demand: Elasticities 6 6-11 Calculating Elasticities: Price Elasticity of Supply P Q What is the price elasticity of supply between A and B? $4.50 476 $5.00 485 B A E S = %ΔQ%ΔP%ΔQ%ΔP Q 2 –Q 1 ½(Q 2 +Q 1 ) P 2 –P 1 ½(P 2 +P 1 ) = = 485–476 ½(485+476) 5–4.50 ½(5+4.50) Midpoint C 480.5 $4.75 0.0187 0.105 = 0.18 = S

12. 1 Describing Supply and Demand: Elasticities 6 6-12 Substitution and Elasticity  A general rule is: the more substitutes a good has, the more elastic its supply or demand  If a good has substitutes, a rise in the price of that good will cause the consumer to shift consumption to those substitute goods What makes supply or demand more or less elastic? Substitution

13. 1 Describing Supply and Demand: Elasticities 6 6-13 Substitution and Demand  The number of substitutes a good has is affected by several factors. Four of the most important factors: 1.The time period being considered 2.The degree to which a good is a luxury 3.The market definition 4.The importance of the good in one’s budget

14. 1 Describing Supply and Demand: Elasticities 6 6-14 Elasticity, Total Revenue, and Demand  The elasticity of demand tells suppliers how their total revenue will change if their price changes  Total revenue is price multiplied by quantity, TR = (P)(Q) If E D > 1, an increase in price decreases total revenue. (Price and total revenue move in opposite directions.) If E D = 1, an increase in price leaves total revenue unchanged. If E D < 1, an increase in price increases total revenue. (Price and total revenue move in the same direction.)

15. 1 Describing Supply and Demand: Elasticities 6 6-15 Elasticity and Total Revenue P Q If E D = 1, an increase in price leaves total revenue unchanged $2 10 $6 42 $4 $8 $10 68 TR E = PxQ = areas A+B = $4x6 = $24 E F TR F = PxQ = areas A+C = $6x4 = $24 A C B Demand Application: Unit Elastic Demand E D = 1

16. 1 Describing Supply and Demand: Elasticities 6 6-16 Elasticity and Total Revenue P Q If E D < 1, an increase in price increases total revenue $2 10 $6 42 $4 $8 $10 68 TR G = PxQ = areas A+B = $1x9 = $9 G H TR H = PxQ = areas A+C = $2x8 = $16 A C B Demand Application: Inelastic Demand E D < 1

17. 1 Describing Supply and Demand: Elasticities 6 6-17 Elasticity and Total Revenue P Q If E D > 1, an increase in price decreases total revenue $2 10 $6 42 $4 $8 $10 68 TR J = PxQ = areas A+B = $8x2 = $16 J K TR K = PxQ = areas A+C = $9x1 = $9 A C B Demand Application: Elastic Demand E D > 1

18. 1 Describing Supply and Demand: Elasticities 6 6-18 Relationship Between Elasticity and Total Revenue Price RisePrice Decline Elastic (E D > 1)TR decreasesTR increases Unit Elastic (E D = 1)TR constant Inelastic (E D < 1)TR increasesTR decreases

19. 1 Describing Supply and Demand: Elasticities 6 6-19 Elasticity of Individual and Market Demand  Price discrimination occurs when a firm separates the people with less elastic demand from those with more elastic demand  Firms that price discriminate charge more to the individuals with inelastic demand and less to individuals with elastic demand  Examples of price discrimination: Airlines pricing The phenomenon of selling new cars The almost-continual-sale phenomenon

20. 1 Describing Supply and Demand: Elasticities 6 6-20 Income and Cross-Price Elasticity  Income elasticity of demand measures the responsiveness of demand to changes in income  Normal goods are those whose consumption increases with an increase in income E Income = % change in Demand % change in Income Necessity: 0 1 Luxury: E Income > 1  Inferior goods are those whose consumption decreases with an increase in income, E Income < 0

21. 1 Describing Supply and Demand: Elasticities 6 6-21 Income and Cross-Price Elasticity  Cross–price elasticity of demand measures the responsiveness of demand to changes in prices of other goods  Substitutes are goods that can be used in place of another, E cross-price > 0 E cross-price = % change in Demand % change in P of related good  Complements are goods that are used conjunction with other goods, E cross-price < 0

22. 1 Describing Supply and Demand: Elasticities 6 6-22 Elasticity and Shifting Supply and Demand  The more elastic the demand (supply), the greater the effect of a supply (demand) shift on quantity and the smaller the effect on price. S1S1 D P Q Demand is relatively elastic S0S0 Supply shifts out and caused a greater effect on quantity than on price Q0Q0 Q1Q1 P0P0 P1P1

23. 1 Describing Supply and Demand: Elasticities 6 6-23 S1S1 D P Q Demand is relatively inelastic S0S0 Supply shifts out and caused a greater effect on price than on quantity P0P0 P1P1 Elasticity and Shifting Supply and Demand Q0Q0 Q1Q1