Download PED (Price elasticity of demand)

PED (Price elasticity of demand)
 Shows: How a price change affects the quantity demanded of a good/service
 Equation:
 Each part of equation ***(New-original)/original)***
o Exactly zero: perfectly inelastic; Exactly one: unit elastic
o Less than one: inelastic
o More than one: elastic
 Note: The # is usually negative but is always expressed as a positive
 Key Concepts:
price elastic, price inelastic, unit elastic, perfectly elastic,
perfectly inelastic
 Determinants:
o # & closeness of substitutes
o degree of (a) necessity, (b) time, and (c) proportion of income spent

Practice Problem: from http://www.sparknotes.com/economics/micro/elasticity/problems.html
o Yesterday, the price of envelopes was $3 a box, and Julie was willing to buy 10 boxes.
Today, the price has gone up to $3.75 a box, and Julie is now willing to buy 8 boxes. Is
Julie's demand for envelopes elastic or inelastic? What is Julie's elasticity of demand?
o To find Julie's elasticity of demand, we need to divide the percent change in quantity by
the percent change in price.
% Change in Quantity = (8 - 10)/(10) = -0.20 = -20%
% Change in Price = (3.75 - 3.00)/(3.00) = 0.25 = 25%
Elasticity = |(-20%)/(25%)| = |-0.8| = 0.8 . Less than 1 = ???
 Graphing:
XED (Cross price elasticity of demand)
 Shows: How the demand for one good affects the demand for another good
 Equation:
o Positive number: substitute goods
o Negative number: complementary goods
 Number closer to zero: Not particularly close subs./complements
 Number further from zero (e.g. greater than 1): Close subs/comps
 Key Concepts: substitutes, complements
 Practice Problem:
o
from http://www.economicsonline.co.uk/Competitive_markets/Cross_elasticity_of_demand.html
o If the price of Cinema Tickets increases from £5.00 to £7.50, and the demand for Popcorn
decreases from 1000 tubs to 700, the XED between the two products will be:
o % Change in quantity of popcorn = (700-1000)/1000 = -0.3 = -30%
o % Change in price of cinema tickets = (7.50-5.00)/5.00 = 0.5 = 50%
o -30/+50 = -0.6
o Because the number is negative, they are ____________. Because the number is less than
one, they are _______________ (strongly, loosely) connected.
 Graphing:
o from http://www.tutor2u.net/economics/content/diagrams/cross_2.gif
YED (Income elasticity of demand)
 Shows: How a change in income affects demand
 Equation:
o Positive number: normal goods
o Negative number: inferior goods
 Less than one: Income inelastic – Necessity goods
 Greater than one: Income elastic – Luxury goods
o In other words…



YED > 1 = luxury, elastic
YED between 0-1 = normal, inelastic
YED less than 0 = inferior, income inelastic
 Key Concepts: normal, inferior, necessity, luxury
 Practice Problem:
o
from http://economics.about.com/cs/micfrohelp/a/income_elast.htm
o Bob’s income rose from $40,000/year to $50,000. He demanded 150 taxi rides at
$40,000 and 180 at $50,000.
 % change in Q demanded: [180 - 150] / 150 = (30/150) = 0.2
 % change in income: [50,000 - 40,000] / 40,000 = (10,000/40,000) = 0.25
 .2/.25 = .8
o Because the YED is .8, taxi rides are ________________ (normal, inferior) and income
elasticity is ___________________ (elastic, inelastic)
 Graphing:
o from http://www.economicsonline.co.uk/How%20markets%20work%20graphs/Inferior-goods.png
PES (Price elasticity of supply)
 Shows: How a price change affects the quantity supplied of a good/service
 Equation:
o Exactly zero: perfectly inelastic; Exactly one: unit elastic
o Less than one: inelastic
o More than one: elastic
 Key Concepts:
price elastic, price inelastic, unit elastic, perfectly elastic,
perfectly inelastic
o The PES for primary commodities is relatively low
o The PES for manufactured products is relatively high
 Determinants:
o
o
o
o

Time
mobility of factors of production
unused capacity
ability to store stocks
Practice Problem: From http://mbaecon.wikispaces.com/elasticity+of+supply
o Last month, the price of textbooks increased from $100 to $110. The quantity
supplied increased from 20,000 to 25,000.
 [$110 - $100] / $100 = 10%
 [25,000 - 20,000] / 20,000 = 25%
 25 / .10
 PES = 2.5
o Because PES was 2.5, the price elasticity of supply is _____________ (elastic, inelastic).
o Graphing:

From http://otceconomics.edublogs.org/files/2013/03/supply-1r8ro2w.gif
Perfectly elastic/inelastic demand
From http://thismatter.com/economics/images/elastic-inelastic-demand-elasiticity-graph.png
Perfectly inelastic/elastic supply
From http://images.flatworldknowledge.com/rittenberg/rittenberg-fig05_011.jpg