Download Unit 3 Objectives

Hello and Welcome to Unit 3
Chapters 6, 7 & 8
Unit 3
Objectives
• Explain the concept of elasticity.
• Discuss why the measurements of elasticity
are important.
• Contrast elastic and inelastic.
• Calculate elasticity of demand, elasticity of
income, and cross elasticity.
• Apply the concept of utility to the decision
making process.
More Objectives for
Unit 3
• Analyze the law of diminishing marginal
returns.
• Contrast the various costs and revenue
associated with a business.
• Differentiate between the long-run and
short-run.
Elasticity means Responsiveness!
• When you think of
elastic, you usually
think of a rubber band,
the waist band on
slacks, or a balloon.
Each of these items are
responsive to
something; tension, size
of waist, or the amount
of air in the balloon.
Before air
is added.
After air is added.
The balloon is responsive to
air. Elasticity.
Price Elasticity of Demand
• Measures the percentage
change in the quantity
demanded of a product
divided by the
percentage change in the
price of the same
product.
• Determines if the
consumers were very
responsive to the price
change or not.
Formula:
Q2 - Q1 X P2 + P1
P2 - P1
Q2 + Q1
Note: This formula is how
you calculate the formula
given in the text. % Q
%
P
Formula:
Q2 - Q1
X
P2 - P1
P2 + P1
Q2 + Q1
Q2 represents the second or new quantity.
Q1 represents the first or original quantity.
P2 represents the second or new price.
P1 represents the first or original price.
Sample
Calculation:
Q2 - Q1
X
P2 - P1
P2 + P1
Q2 + Q1
The original, current, price is $3 and the company wishes to
increase the price $4. At the price of $3 the quantity demanded
is 20 and if the price is increased to $4 the new quantity
demanded will equal $12. What is the elasticity for this
scenario?
P1 = $3
P2 = $4
e = 12 - 20
4-3
X
4+3
= -8
20 + 12
1
Q1 = 20
Q2 = 12
e = -8 X .219 = -1.752
X 7 =
32
Price elasticity of demand equals
-1.752 (for this example)
• Remember: use the absolute factor of your
answer. The answer will always be negative
for the price elasticity of demand because
price and quantity are inversely related.
• The answer would be stated as 1.752.
What does 1.752 mean?
•
•
•
•
This depends on your calculated answer.
If e > 1, the demand is said to be elastic.
If e = 1, the demand is said to be unit elastic.
If e < 1, the demand is said to be inelastic.
Therefore, the scenario given is said to have an
elastic demand.
Elasticity Definitions
• Elastic: Means that consumers are very
responsive to the price change.
• Unit Elastic: Means that consumers are
responsive to the price change, however the
total revenue for the business was not
changed.
• Inelastic: Means that consumers are not
very responsive to the price change.
Problem: Price Elasticity
Currently, the price of a pound of sugar is $.50 (at
the retail level) with a quantity demanded of 300
pounds. If the the price is increased to $ .60 per
pound, the quantity demanded decreases to 280
pounds.
Calculate the price elasticity of demand for sugar,
and determine if the demand is elastic, inelastic,
or unit elastic.
P1 = $.50
Q2 - Q1
X
P2 - P1
P2 = $.60
Q1 = 300
Q2 = 280
e=
280 - 300
.60 - .50
X
.60 + .50
280 + 300
P2 + P1
Q2 + Q1
P1 = $.50
Q2 - Q1
X
P2 - P1
P2 = $.60
Q1 = 300
Q2 = 280
e=
e=
280 - 300
.60 - .50
-20
.10
X
X
.60 + .50
280 + 300
1.10
580
P2 + P1
Q2 + Q1
P1 = $.50
Q2 - Q1
X
P2 - P1
P2 = $.60
P2 + P1
Q2 + Q1
Q1 = 300
Q2 = 280
e=
e=
280 - 300
.60 - .50
-20
.10
X
X
.60 + .50
280 + 300
1.10
580
e = -200 X .0019 = -.38
Inelastic--Consumers are
not very responsive to the
price change
Inelastic Demand
P
Total Revenue Test:
(Price X Quantity)
P1= .50 X 300 = 150
.60
.50
P2 = .60 X 280 = 180
Total Revenue increased
with this price change
(Not necessarily profits)
D
0
280 300
Sugar
Q
Elastic Demand
P
Total Revenue Test:
(Price X Quantity)
$4.50
P1= 3.00 X 300 = 900
$3.00
P2 = 4.50 X 150 = 675
D
0
150
300
Movie Theater Tickets
Q
Total Revenue decreased
with this price change
(Not necessarily profits)
Unit Elastic
P
Total Revenue Test:
(Price X Quantity)
$6.00
P1= 3.00 X 300 = 900
P2 =6.00 X 150 = 900
$3.00
D
0
150
300
Q
Total Revenue remained
unchanged with this
price change (Not
necessarily profits)
To Increase Revenue
• If in the elastic range of the demand curve,
lower the price.
• If in the inelastic range of the demand
curve, raise the price.
• Every demand curve has elastic, unit elastic,
and inelastic points.
• Remember: It depends on the specific
prices and quantities demanded that
determines the elasticity of demand.
Determinants of
Price Elasticity of Demand
• The existence of
substitutes
• The importance of the
product in the consumer’s
total budget
• The time period under
consideration
Elasticities Continued
• The greater the substitutes and the less the
necessity of a product, the more elastic the
demand. Examples: Candy or automobiles.
• The fewer the substitutes and the greater the
necessity of a product, the more inelastic the
demand. Examples: Electricity or Blood
Pressure Medicine.
Situation
• Your water heater just
quick working this
morning, while you
were taking your
shower.
• You can save $100 off
a new water heat if
you will wait 2 weeks
for delivery.
• Most people would
not wait the two
weeks. We would be
willing to forgo the
$100 because of the
time consideration.
Continued Situation
• It has now been 2
years since you
purchased your new
water heater and it is
working perfectly.
• You notice a sale in
which you could save
$250 if you purchase a
new water heater
today.
• Would you purchase
the water heater?
• Probably not. This is
not an item that we
have extras setting
around in case the one
we have quits
working.
• Again it is the
consideration of time.
Cross Elasticity
• Measures percentage change in the demand
for one good divided by the percentage
change in the price of another good.
• Cross elasticity is often used when dealing
the substitutes and complements.
Cross Elasticity:
Q2 - Q1
P2 + P1
P2 - P1 X Q2 + Q1
Currently their are two roller skating rinks in
town. Skate Key has a quantity demanded of
50 skaters at the price of $4, while Roller
Wheels has a quantity demanded of 70 skaters
at the same price.
If Skate Key lowers the admission fee to $3
Roller Wheels anticipates a decrease in
demand to 50 skaters.
Is the cross elasticity for
Roller Wheels elastic,
inelastic, or unit elastic?
Ce =
50 - 70
X
3-4
3+4
50 + 70
Q2 - Q1
P2 - P1
X P2 + P1
Q2 + Q1
Is the cross elasticity for
Roller Wheels elastic,
inelastic, or unit elastic?
Ce =
50 - 70
X
3-4
Ce =
-20
-1
X
3+4
50 + 70
7
120
Q2 - Q1
P2 - P1
X P2 + P1
Q2 + Q1
Is the cross elasticity for
Roller Wheels elastic,
inelastic, or unit elastic?
Ce =
50 - 70
X
3-4
Ce =
-20
-1
X
3+4
50 + 70
7
120
Ce = 20 X .0583 = 1.166
Q2 - Q1
P2 - P1
X P2 + P1
Q2 + Q1
Elastic--Roller Wheels
business would be
affected by the reduction
in price of Skate Key.
Roller Wheels should try
and offset this reduction
in price. They might
reduce price, but they
could offer other
incentives to skaters that
may be more appealing.
Income Elasticity
• Measures the percentage change in the
demand a good divided by the percentage
change in income.
Ie = Q2 - Q1
Y2 - Y1
X
Y2 + Y1
Q2 + Q1
Income elasticity is calculated the same way. The only
difference is that we are measuring the change in behavior
based on income instead of price.
Definitions
• Normal goods: products for which the income
elasticity is positive. As our income increases
we, consumers, tend to consumer more of these
products. Automobiles are normal goods.
• Inferior goods: goods for which the income
elasticity of demand is negative. As our income
rises we tend to eat less bologna and hot dogs
and eat more of higher cuts of meat.
Price Elasticity of Supply
• Measures the percentage change in the
quantity supplied divided by the percentage
change in price.
• NOTE: The only difference between the
price elasticity of supply and the price
elasticity of demand is the side of the
market being studied.
Short-Run vs. Long-Run
• Short-Run: a period of time short enough
that resources can not be changed quickly.
For example: A company can not quickly
build a new plant or start a new product into
production.
• Long-Run: A period of time long enough
that all resources are variable.
One last definition in chapter 6
• Tax incidence: a measure of who pays a tax.
• Example A: If the Government places an
additional excise tax on cigarettes and the
cigarette companies have highly elastic demands,
the cigarette manufacturers may choose to bear
the cost of the additional tax instead of raising
prices.
• Example B: If the Government places an
additional tax on electric companies, they may
choose to pass the tax along to the consumer
because utilities have an inelastic demand.
Please open the
next presentation.
Unit 2
Chapter 7