6
Elasticity
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Price Elasticity of Demand
• Measures buyers’ responsiveness to
•
price changes
Formula for price elasticity of demand
Percentage Change in Quantity
Demanded
of
Product
X
Ed =
Percentage Change in Price
of Product X
LO1
Price Elasticity of Demand
Formula
• Eliminate the minus sign
• Easier to compare elasticities
LO1
Price Elasticity of Demand
• Elastic demand, Ed > 1
• Sensitive to price changes
• Large change in quantity for small price change
• Inelastic demand, Ed < 1
• Insensitive to price changes
• Small change in quantity for large price change
• Unit elastic demand, Ed = 1
– Equal changes in quantity and price
LO1
Extreme Cases
P
D1
Perfectly
inelastic
demand
(Ed = 0)
0
Perfectly inelastic demand
LO1
Extreme Cases
P
D2
Perfectly
elastic
demand
(Ed = ∞)
0
Perfectly elastic demand
LO1
Price Elasticity of Demand
• Can not use slope to determine
•
LO2
elasticity
Can use slope to determine relative
elasticity.
Total Revenue Test
• Total Revenue = Price X Quantity
• Inelastic demand
• P and TR move in the same direction
• Elastic demand
•
LO2
• P and TR move in opposite directions
Unit elastic demand
• TR doesn’t change when P changes
Total Revenue Test
Table 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the
Elasticity Coefficient and the Total-Revenue Test
(3)
Elasticity
Coefficient
(Ed)
(1)
Total Quantity of
Tickets Demanded per
Week, Thousands
(2)
Price per Ticket
1
$8
2
7
5.00
14,000
Elastic
3
6
2.60
18,000
Elastic
4
5
1.57
20,000
Elastic
5
4
1.00
20,000
Unit Elastic
6
3
0.64
18,000
Inelastic
7
2
0.38
14,000
Inelastic
8
1
0.20
8,000
Inelastic
LO2
(4)
Total
Revenue
(1) X (2)
(5)
Total
Revenue
Test
$8,000
Summary of Price Elasticity of
Demand
Table 6.2 Price Elasticity of Demand: A Summary
Absolute Value
of Elasticity
Coefficient
Demand Is:
Impact on Total Revenue of a:
Description
Price Increase Price Decrease
Qd changes by a
larger
percentage than
does price
Total Revenue
decreases
Total Revenue
increases
Greater than 1
(Ed > 1)
Elastic or
relatively
elastic
Equal to 1
(Ed = 1)
Unit or unitary Qd changes by
elastic
the same
percentage as
does price
Total revenue
is unchanged
Total revenue
is unchanged
Less than 1
(Ed < 1)
Inelastic or
relatively
inelastic
Total revenue
increases
Total revenue
decreases
LO2
Qd changes by a
smaller
percentage than
does price
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
•
LO1
• Luxury goods, demand is more elastic
Time
• More time available, demand is more elastic
Price Elasticity of Demand
Table 6.3 Selected Price Elasticities of Demand
Product or Service
Price Elasticity
of Demand (Ed) Product or Service
Price Elasticity
of Demand (Ed)
Newspapers
.10
Milk
.63
Electricity (household)
.13
Household appliances
.63
Bread
.15
Liquor
.70
MLB Tickets
.23
Movies
.87
Telephone Service
.26
Beer
.90
Cigarettes
.25
Shoes
.91
Sugar
.30
Motor vehicles
1.14
Medical Care
.31
Beef
1.27
Eggs
.32
China, glassware
1.54
Legal Services
.37
Residential land
1.60
Automobile repair
.40
Restaurant meals
2.27
Clothing
.49
Lamb and mutton
2.65
Gasoline
.60
Fresh peas
2.83
LO1
Applications of Ed
• 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
Price Elasticity of Supply
• Measures sellers’ responsiveness to
price changes
• Elastic supply (Es > 1 ), producers
are responsive to price changes
• Inelastic supply (Es < 1), producers
are not responsive to price changes
Es =
LO3
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
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
Applications of Elasticity of
Supply
• Antiques
• Inelastic supply
• Reproductions
• More elastic supply
• Volatile gold prices
• Inelastic supply
LO3
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
Percentage change in quantity demanded of product X
Ex,y =
Percentage change in price of product Y
LO4
Income Elasticity of Demand
• Measures responsiveness of buyers
•
•
to changes in income
Normal goods – positive sign
Inferior goods – negative sign
Percentage change
in quantity demanded
Ei =
Percentage change in income
LO4