1. Elasticity 6 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Price Elasticity of Demand Measures buyers’ responsiveness to price changes LO1 Formula for price elasticity of demand E d = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product X

3. Price Elasticity of Demand Formula Eliminate the minus sign Easier to compare elasticities LO1

4. Price Elasticity of Demand Elastic demand, E d > 1 Sensitive to price changes Large change in quantity for small price change Inelastic demand, E d < 1 Insensitive to price changes Small change in quantity for large price change Unit elastic demand, E d = 1 – Equal changes in quantity and price LO1

5. Extreme Cases LO1 D1D1 P Perfectly inelastic demand (Ed = 0) 0

6. Extreme Cases LO1 Perfectly elastic demand P D2D2 Perfectly elastic demand (Ed = ∞) 0

7. Price Elasticity of Demand Can not use slope to determine elasticity Can use slope to determine relative elasticity. LO2

8. Total Revenue Test Total Revenue = Price X Quantity Inelastic demand P and TR move in the same direction Elastic demand P and TR move in opposite directions Unit elastic demand TR doesn’t change when P changes LO2

9. Total Revenue Test LO2 Table 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test (1) Total Quantity of Tickets Demanded per Week, Thousands (2) Price per Ticket (3) Elasticity Coefficient (E d ) (4) Total Revenue (1) X (2) (5) Total Revenue Test 1$8$8,000 275.0014,000Elastic 362.6018,000Elastic 451.5720,000Elastic 541.0020,000Unit Elastic 630.6418,000Inelastic 720.3814,000Inelastic 810.20 8,000Inelastic

10. Summary of Price Elasticity of Demand LO2 Table 6.2 Price Elasticity of Demand: A Summary Absolute Value of Elasticity CoefficientDemand Is:Description Impact on Total Revenue of a: Price IncreasePrice Decrease Greater than 1 (E d > 1) Elastic or relatively elastic Q d changes by a larger percentage than does price Total Revenue decreases Total Revenue increases Equal to 1 (E d = 1) Unit or unitary elastic Q d changes by the same percentage as does price Total revenue is unchanged Total revenue is unchanged Less than 1 (E d < 1) Inelastic or relatively inelastic Q d changes by a smaller percentage than does price Total revenue increases Total revenue decreases

11. Determinants of Elasticity of Demand Substitutability More substitutes, demand is more elastic Proportion of Income Higher proportion of income, demand is more elastic Luxuries vs. Necessities Luxury goods, demand is more elastic Time More time available, demand is more elastic LO1

12. Price Elasticity of Demand LO1 Table 6.3 Selected Price Elasticities of Demand Product or Service Price Elasticity of Demand (E d )Product or Service Price Elasticity of Demand (E d ) Newspapers.10Milk.63 Electricity (household).13Household appliances.63 Bread.15Liquor.70 MLB Tickets.23Movies.87 Telephone Service.26Beer.90 Cigarettes.25Shoes.91 Sugar.30Motor vehicles1.14 Medical Care.31Beef1.27 Eggs.32China, glassware1.54 Legal Services.37Residential land1.60 Automobile repair.40Restaurant meals2.27 Clothing.49Lamb and mutton2.65 Gasoline.60Fresh peas2.83

13. Applications of E d Large Crop Yields Inelastic demand, lower total revenue Excise Taxes Inelastic demand, more total revenue Decriminalization of Illegal Drugs Inelastic demand, more total revenue Decrease street crime LO1

14. Price Elasticity of Supply Measures sellers’ responsiveness to price changes Elastic supply (E s > 1 ), producers are responsive to price changes Inelastic supply (E s < 1), producers are not responsive to price changes LO3 Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X E s =

15. Price Elasticity of Supply Time is primary determinant of elasticity of supply Time periods considered Immediate Market period Can’t adjust any resources Short Run Able to adjust some resources Long Run Able to adjust all resources LO3

16. Applications of Elasticity of Supply Antiques Inelastic supply Reproductions More elastic supply Volatile gold prices Inelastic supply LO3

17. Cross Elasticity of Demand Measures responsiveness of sales to change in the price of another good Substitutes – positive sign Complements – negative sign Independent goods - zero LO4 Percentage change in quantity demanded of product X E x,y = Percentage change in price of product Y

18. Income Elasticity of Demand Measures responsiveness of buyers to changes in income Normal goods – positive sign Inferior goods – negative sign LO4 Percentage change in quantity demanded E i = Percentage change in income