Download ELASTICITY AND DEMAND

Elasticity and Demand
Elasticity and Demand
• The law of demand tells us that there is an
inverse relationship between price and
quantity demanded.
• But it does not tell us how responsive
consumers are to price changes.
Elasticity and Demand
• To find out exactly how responsive
consumers are to a price change, we need
the price elasticity of demand for that good or
service.
• Price elasticity of demand:
– A measure of how responsive people are to price
changes.
Elastic vs. Inelastic
• Elastic demand – occurs when slight changes
in price produce very large changes in
quantity demanded.
• Inelastic demand- occurs when large price
change produce only small changes in
quantity demanded.
Computing Price Elasticity
• Price elasticity of demand = EP.
• Ep = percentage change in quantity
demanded of a product divided by the
percentage change in the price of that
product.
EP = % ^ QD.
%^P.
• If EP > 1.00 then we have elastic demand.
• If EP < 1.00 then we have inelastic demand.
Elasticity and Total Revenue
Elastic demand
• If demand is elastic, a decrease in price will
result in an increase in revenue.
• The price cut will lead to a very large increase
in quantity demanded. (Sales)
• This increase in sales swamps the lower
price per unit.
Elastic demand
• If demand is elastic what will happen to
revenue when prices are increased?
• The price hike will lead to a very large
decrease in quantity demanded. (Sales)
• This decrease in sales swamps the higher
price per unit.
Inelastic Demand
• If demand is in inelastic, a decrease in price
will result in a decrease in revenue.
• The price cut will lead to a very small
• Increase in quantity demanded. (Sales)
• But the lower price per unit swamps the slight
increase in sales.
Inelastic Demand
• If demand is inelastic what will happen to
revenue when prices are increased?
• The price hike will lead to a very small
decrease in quantity demanded. (Sales)
• But the higher price per unit swamps the
slight decrease in sales.
Determinants of Elasticity of
Demand
A. Substitutes
•
The greater the number of substitutes
available, the easier it is to switch between
products.
•
Therefore, the greater the number of
substitutes available, the higher the
elasticity of demand for a good.
Determinants of Elasticity of
Demand
B. Closeness of the Substitutes
•
The closer the substitutes are to the original
product, the easier it is to switch between
products.
•
Therefore, the closer the substitutes are to
the original, the higher the elasticity of
demand for a product.
Determinants of Elasticity of
Demand
C. Luxuries vs. Necessities
•
Necessities have low elasticity's of demand.
•
Luxuries have a high elasticity of demand.
Determinants of Elasticity of
Demand
D. Time
•
The longer the time period, the more time
people have to search for substitutes.
•
The longer the time, the more elastic the
demand will be.
Elasticity Problems
• Discuss and explain why the demand for the
good is elastic or inelastic.
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oranges
cigarettes
Winston cigarettes
gasoline
butter
diamond engagement rings
automobiles
tickets to a live, professional football game
your econ textbook, from 1 week before the
semester starts to 1 week after the end of the
semester
Accounting vs. Economic Profits
• Accountants and economists count costs and
profits differently!
Accounting vs. Economic Profits
1. Accountants
•
Total profits = total revenues –
total costs
Accounting Profits
• A dentist has a practice that generates
revenues of $500,000.
• All expenses total $400,000.
• Accounting profits equal $100,000.
Economists’ Profits
2. Economists
•
Economic profits = total revenues –
total costs –
total implicit costs
Economists’ Profits
• The total revenues of the same dentist
are $500,000.
• Total explicit, direct costs are $400,000.
Opportunity or Implicit Costs
• What are implicit costs?
• The opportunity costs.
• Opportunity cost is the value of the best
alternative given up.
Opportunity Cost of Capital
• Suppose the dentist had used $400,000 of
his or her own money to start this business.
What if they had taken this money and
invested it for an annual rate of return of
10%? What did they give up when they
invested this money in their business?
• Opportunity cost of capital = $40,000.
Opportunity Cost of Labor
• Suppose the dentist could have earned
$50,000 working for a company. What did
they give up in order to set up their own
business?
• Opportunity cost of labor = $50,000
• Total opportunity costs =
• $40,000 + $50,000
Total Opportunity Costs
• The total opportunity costs are:
• $40,000 + $50,000 = $90,000
Total Economic Profits
Economic Profits = Total Revenues
– Total Costs
– Total Opportunity Costs
• $500,000 - $400,000 - $90,000 =
$10,000.
Total Economic Profits
Economic Profits =
$500,00
- $400,000
- -$90,000
- = $10,000
Short Run vs. the Long Run
Short Run
• Short Run =
the time period in which all
inputs of production are fixed.
• Often defined as:
=
All inputs of production except
labor, are fixed.
Short Run vs. Long Run
• Long Run =
Long Run
the time period in which all
inputs of production can be
varied.
• In other words, firms can make all the
necessary adjustments to changing market
conditions.