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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