Price Elasticity of Demand What is it (in simple language)? It’s how much buyers will respond to a change in price. It’s the percentage change in quantity demanded ÷ the percentage change in price. Example: quantity demanded goes up 10% when price goes down 10%. 10% ÷ 10% = 1, elasticity = 1 (unit elastic) Price Elasticity of Demand Example #2: quantity demanded goes down 20% when price goes up 10%. 20% ÷ 10% = 2, elasticity = 2 (elastic or relatively elastic) Example #3: quantity demanded goes down 10% when price goes up 20%. 10% ÷ 20% = .5, elasticity = .5 (inelastic or relatively inelastic) Price Elasticity of Demand How do you calculate it? Yes, use the midpoint method. But don’t worry. Remember, on the AP test, you can’t use a calculator, so all the math is easy. Example: Price goes from $9 to $11 Change in Price: 2/10 = 20% Quantity goes from 21 units to 19 units. Change in Quantity: 2/20 = 10% Elasticity Coefficient = 10/20 = .5 On the AP test, all calculations of actual elasticity coefficients will be easy – and they will be rare. PRICE Elastic Unit Elastic Inelastic D QUANTITY OF ARTICHOKES Price Elasticity of Demand Elasticity Coefficients What does it mean for demand for a product to be inelastic? (or relatively inelastic) Ed < 1. What does it mean for demand for a product to be elastic? (or relatively elastic) Ed > 1. What does it mean for demand for a product to be unit elastic? Ed = 1. PRICE D QUANTITY OF ARTICHOKES PRICE Elasticity Coefficients: Special Cases Ed = 0 Perfectly Inelastic Demand QUANTITY OF INSULIN PRICE Elasticity Coefficients: Special Cases Ed is undefined. Perfectly Elastic Demand QUANTITY OF ? Price Elasticity of Demand Total Revenue If demand for a product is elastic (Ed > 1), then an increase in price will lead to a drop in total revenue. It’s simple: if buyers respond a lot to a change in price, then they’re going to buy a lot less if you raise the price. If demand for a product is inelastic (Ed < 1), an increase in price will lead to an increase in total revenue. It’s simple if buyers don’t respond a lot to a change in price, then they’re not going to buy a lot less when you raise the price. If demand for a product is unit elastic (Ed = 1), an increase in price won’t affect total revenue. Price Elasticity of Demand In class problems: DQ #1: Explain why the choice between 1, 2,3, 4 5, or 6 “units,” or 1000, 2000, 3000, 4000, 5000, and 6000 movie tickets makes no difference in determining the elasticity of demand. DQ #2: What effect would a rule stating that university students must live in university dormitories have on the price elasticity of demand for dorm rooms? What impact might this have on room rates? Price Elasticity of Demand In class problems: AP Review #1: Suppose that the total revenue received by a company selling basketballs is $600 when the price is $30 per basketball and $600 when the price is $20 per basketball. Is demand elastic, inelastic, or unit elastic over this price range? AP Review #2: What are the major determinants of price elasticity of demand? Use those determinants and your own reasoning in judging for demand for each of the following is probably elastic or inelastic: a) bottled water b) toothpaste c) Crest toothpaste d) ketchup e) diamond bracelets f) Microsoft Windows Price Elasticity of Demand Homework: Read the rest of Chapter 6 1. Explain price elasticity of supply. 2. What factors determine price elasticity of supply. 3. How is price elasticity of supply different over the market period, the short run, and the long run. Why is it different over these time periods? 4. Do discussion question #4 and problems 1, 2, 4, & 5.