Download Elasticity - Helena Glebocki Keefe

Introduction to Microeconomics
Class 5
Price Elasticity of Demand and Supply
Ways that Demand and Supply Change
Changes in demand and supply come from:
–
Movement along the curve – some factor changes that
does not directly affect the willingness of buyer to pay or
seller to sell
–
Shift in the curve – some factor changes that directly
affects the willingness of buyer to pay or seller to sell
Price Elasticity
Price Elasticity of Demand:
• By how much does Qd change when there
is a price change?
•
•
Movement along the demand curve from A to B
Responsiveness of quantity demanded to price change
Price Elasticity of Supply:
• By how much does Qs change when there
is a price change?
•
•
Movement along the supply curve from A to B
Responsiveness of quantity supplied to price change
Price Elasticity
Price Elasticity of Demand:
• By how much does Qd change when there
is a price change?
•
•
Movement along the demand curve from A to B
Responsiveness of quantity demanded to price change
Price Elasticity of Supply:
• By how much does Qs change when there
is a price change?
•
•
Movement along the supply curve from A to B
Responsiveness of quantity supplied to price change
Midpoint Method for Price Elasticity
Change in Quantity =
Qb−Qa
Qb+Qa
2
Price Elasticity =
Change in Price =
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷𝒓𝒊𝒄𝒆
𝑄𝑏 − 𝑄𝑎
𝑃𝑏 − 𝑃𝑎
/
𝑄𝑏 + 𝑄𝑎
𝑃𝑏 + 𝑃𝑎
2
2
Pb−Pa
Pb+Pa
2
Elasticity of Curves
Determinants of Price Elasticity of Demand
• Close Substitutes: More Elastic
• Few/No Substitutes: Less Elastic
• Luxury Good: More Elastic
• Necessary Good: Less Elastic
• Short-run Price Change: Less Elastic
• Long-run Price Change: More Elastic
• Narrowly Defined: More Elastic
• Broad Category: Less Elastic
Elasticity of Curves
Determinants of Price Elasticity of Supply
• Easily Obtainable Inputs: More Elastic
• Limited Availability of Inputs: Less Elastic
• Easy Production: More Elastic
• Complex Production: Less Elastic
• Short-run Price Change: Less Elastic
• Long-run Price Change: More Elastic
• Excess Capacity in Production: More Elastic
• Large Inventory: More Elastic
Application 1a
Suppose a grocery store owner is deciding on how to raise his revenue. He is
considering the impact of a price change for two goods: bread and smoked
salmon.
•
If he increases the price of bread by 10% from $3.00 to $3.30, the quantity of
bread he can sell falls from 100 units to 98 units.
•
If he increases in the price of smoked salmon by 10% from $11.00 to $12.10, the
quantity of smoke salmon he can sell falls from 40 units to 25 units.
1.
2.
What is the price elasticity of demand for bread? Is it elastic or inelastic?
What is the price elasticity of demand for smoked salmon? Is it elastic or
inelastic?
Calculate the change in the grocer’s revenue if he increases the price of bread.
Calculate the change in the grocer’s revenue if he increases the price of smoked
salmon.
What should he do?
3.
4.
5.
Application Reflection
Why does this matter?
•
This application has multiple lessons in it:
1.
2.
3.
•
•
We calculate price elasticity of demand when the grocer changes the prices of two goods
We see that two goods can have two different elasticities, meaning people’s demand for each good
changes more/less depending on how necessary it is (remember: determinants of demand
elasticity)
Price changes directly affect revenue! (Revenue = P x Q)
Whether the grocer should increase or decrease the price of a good depends on its elasticity
of demand
Increase in price does not always increase revenue!
What’s the most important takeaway?
•
•
Different goods have different price elasticities, which reflect how people’s
demand for them changes at different prices
Revenue is determined by price and quantity, therefore a change in the price
and/or a change in quantity will change revenue
MUDDIEST POINT?
Application 1b
Now suppose that this grocer observes that his neighborhood is changing,
and many new people are moving in. The number of buyers is increasing.
• As a result, the price of his goods, on average increases from $5 to $7
and the quantity of grocery goods supplied increases from 1000 to 1250.
1.
2.
What is the price elasticity of supply?
Draw the impact of this change on the supply and demand model.
Application Reflection
Why does this matter?
•
•
•
Here we calculate elasticity of supply – some factor is changing that shifts demand (more
buyers) that causes an increase in the price -- therefore Qs must also change
By how much Qs increases depends on the price elasticity of supply
The grocer does not control the change in the market – he simply observes and responds by
ordering more groceries for his store because of the increased demand
What’s the most important takeaway?
•
•
Elasticity of supply shows the change in Qs when there is an increase in prices
Calculating elasticities – use the same formula!
– Pes: movement along supply (due to a shift in demand)
– Ped: movement along demand (due to a shift in supply)
MUDDIEST POINT?
Income Elasticity of Demand
By how much does Qd change when there is a change
in income?
Change in Quantity =
Qb−Qa
Qb+Qa
2
Change in Income=
Income Elasticity =
Income b−Income a
Income b+Income a
2
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑰𝒏𝒄𝒐𝒎𝒆
𝑄𝑏 − 𝑄𝑎
𝐼𝑛𝑐𝑜𝑚𝑒 𝑏 − 𝐼𝑛𝑐𝑜𝑚𝑒 𝑎
/
𝑄𝑏 + 𝑄𝑎
𝐼𝑛𝑐𝑜𝑚𝑒 𝑏 + 𝐼𝑛𝑐𝑜𝑚𝑒 𝑎
2
2
Application 2
Consider two brands of beer: PBR and Magic Hat and suppose the average
income of a 23 year-old is $45,000. The 23 year-old consumes on average
15 PBRs a month and 5 Magic Hats a month.
• When his income rises to $50,000, he consumes 11 PBRs and 9 Magic
Hats per month.
1.
2.
3.
What is his income elasticity of demand?
Which beer is a normal good and which is an inferior good?
Draw out the supply and demand model for each market and illustrate
the change.
Application Reflection
Why does this matter?
•
•
•
Demand changes when people have more income: most people buy more goods or nicer
goods, and less “cheap” goods
Income changes people’s demand and buying behavior, therefore Qd changes
Income Elasticity shows by how much people’s buying behavior changes
– If small: the good is essential, people will buy it regardless of how much money they have
– If large: the good is non-essential, people’s demand for it changes rapidly and sizably if
their income changes
What’s the most important takeaway?
•
•
Income Elasticity shows the change in Qd when someone has more/less income
Calculating elasticities – use the same formula but now denominator = change in
income
MUDDIEST POINT?
Cross Price Elasticity of Demand
By how much does Qd change when there is a change
in the price of a related good?
Change in Quantity (GOOD Y) =
QbGood𝑌−QaGood𝑌
QbGood𝑌+QaGood𝑌
2
Cross Price Elasticity =
Change in Price (GOOD X)=
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑮𝒐𝒐𝒅 𝒀
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑮𝒐𝒐𝒅 𝑿
𝑄𝑏𝑌 − 𝑄𝑎𝑌
𝑃𝑏X − 𝑃𝑎X
/
𝑄𝑏𝑌 + 𝑄𝑎𝑌
𝑃𝑏X + 𝑃aX
2
2
PbGoodX−PaGoodX
PbGoodX+PaGoodX
2
Application 3
Consider, once again, the market for beer.
• When the price of pretzels moves from $4 to $3, the consumption of
beer increases from 100 units to 120 units.
• When the price of wine moves from $10 to $8, the consumption of beer
decreases from 100 units to 90 units.
1.
2.
3.
What is the cross price elasticity of demand for each good?
How are these markets related?
Draw out the supply and demand model for each market and illustrate
the change.
Application Reflection
Why does this matter?
•
•
•
Demand changes when the price of a related goods changes
The cross-price elasticity of demand shows how sensitive the demand for one good is to a
price change of another good.
If Xped is large: the price change of Good A has a huge effect on demand for Good B
–
–
•
Peanut butter and jelly (compliment)
Wine and beer (substitute)
If Xped is small: Good A and Good B are not closely related
What’s the most important takeaway?
•
Some goods are closely related – when can quantify how they impact their
“partner” good with Xped.
MUDDIEST POINT?
Key Takeaways
• Understanding elasticity allows us to quantify the
changes in demand and supply we see in Chapter 4.
• Provides an additional analysis to understand how
responsiveness demand and supply are to price
changes, income changes and changes in prices of
related goods.