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Principles of Economics 2nd edition by Fred M Gottheil PowerPoint Slides prepared by Ken Long ©1999 South-Western College Publishing 1 Chapter 4 Elasticity ©1999 South-Western College Publishing 5/16/20 17 2 This chapter discusses principles associated with Determinants of Normal & Inferior Price Substitute Elasticity and of Cross SupplyElasticity Elasticity Elasticity and Taxes Demand Sensitivity to Demand Sensitivity Complementary Demand Goods Goods Price Changes ©1999 South-Western College Publishing 3 How would you respond to a cut in the price of a Coke? That all depends on the price sensitivity of demand for Coke ©1999 South-Western College Publishing 4 A P P D D 0 Q B 0 Q Which demand curve is for spark plugs and which for Coca-Cola? ©1999 South-Western College Publishing 5 When consumers are very sensitive to a price change what does the demand curve look like? Relatively flat ©1999 South-Western College Publishing 6 When consumers are less sensitive to a price change what does the demand curve look like? Relatively steep ©1999 South-Western College Publishing 7 What factors influence Demand Sensitivity? • Low price goods • Income levels • Substitute goods • Basic goods • Linked goods • Time to adjust ©1999 South-Western College Publishing 8 What do low priced goods have to do with sensitivity? The lower the price of a good the less sensitive consumers are to a price change ©1999 South-Western College Publishing 9 How do income levels effect demand? Poor people are more sensitive to price changes than rich people ©1999 South-Western College Publishing 10 What do substitutes have to do with sensitivity? The more substitutes a good has, the more sensitive consumers are to a price change ©1999 South-Western College Publishing 11 What do basic goods have to do with sensitivity? The greater the need of a good to the consumer, the less sensitive the consumer is to a price change ©1999 South-Western College Publishing 12 What do linked goods have to do with sensitivity? When two goods have a complementary relationship, demand sensitivities are linked to one another ©1999 South-Western College Publishing 13 What are some examples of Complementary Goods? •computers and software •cars and gasoline • tapes and tape players ©1999 South-Western College Publishing 14 What does time have to do with sensitivity? The more time to adjust, the more sensitive consumers are to a price change ©1999 South-Western College Publishing 15 What is Elasticity? A term economists use to measure sensitivity ©1999 South-Western College Publishing 16 How do we measure the Price Elasticity of Demand? The percentage change in quantity demanded divided by the percentage change in price ©1999 South-Western College Publishing 17 If there is an increase from 3 units to 5, what is the percentage increase? 2/3 = 66% ©1999 South-Western College Publishing 18 If there is a decrease from 5 units to 3, what is the percentage decrease? 2/5 = 40% ©1999 South-Western College Publishing 19 P A 2 B 3 D Q ©1999 South-Western College Publishing 20 2 Problem - When we move along a demand curve between two points, we get different answers to elasticity depending if we are moving up or down the demand curve ©1999 South-Western College Publishing 21 If we go from 3 to 5, the percentage change is 2/3 , but if we go from 5 to 3, the percentage change is 2/5 , so the elasticities are different ©1999 South-Western College Publishing 22 The answer to this problem is to work with averages ... ©1999 South-Western College Publishing 23 Price elasticity equals the change in quantity demanded sum of quantities/2 divided by change in price sum of prices/2 ©1999 South-Western College Publishing 24 24 Quantity Bananas 200 Oranges 240 400 280 Price $20 $18 $40 $70 ©1999 South-Western College Publishing 25 2 5 What is the Price Elasticity of Demand for bananas? 2 40 = 220 19 40 X 19 760 = 2 220 440 ©1999 South-Western College Publishing 26 What is the Price Elasticity of Demand for oranges? 120 30 = 340 55 120 X 55 6,600 = 30 340 10,200 ©1999 South-Western College Publishing 27 If a college raises tuition, what happens to revenue? If demand is elastic revenue goes down If demand is inelastic revenue goes up ©1999 South-Western College Publishing 28 If price increases and the revenue increases, the demand curve within the price range is price inelastic, < 1 ©1999 South-Western College Publishing 29 If price increases and the revenue decreases, the demand curve within the price range is price elastic, > 1 ©1999 South-Western College Publishing 30 If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1 ©1999 South-Western College Publishing 31 What strategies do CocaCola and Pepsi use to make the demand for their products less elastic? http://www.cocacola.com http://www.pepsi.com ©1999 South-Western College Publishing 32 What is Cross Elasticity of Demand? The percentage change in the quantity demanded of one commodity resulting from a 1 percent change in price of another commodity ©1999 South-Western College Publishing 33 If negative - complements (steak & steak sauce) If positive - substitutes (butter & margarine) ©1999 South-Western College Publishing 34 What is Income Elasticity of Demand? The ratio of the percentage change in quantity demanded to the percentage change in income ©1999 South-Western College Publishing 35 When is a demand curve income elastic? When a 1% change in income generates a greater than 1% change quantity demanded ©1999 South-Western College Publishing 36 When ia demand curve income inelastic? When a 1% change in income generates a less than 1% change quantity demanded ©1999 South-Western College Publishing 37 What is an Inferior Good? A good that people buy less of as their incomes increase ©1999 South-Western College Publishing 38 What is a Normal Good? A good that people buy more of as their incomes increase ©1999 South-Western College Publishing 39 What is Price Elasticity of Supply? The ratio of the percentage change in quantity supplied to the percentage change in price ©1999 South-Western College Publishing 40 Does time effect Supply Elasticities? Yes! The more time, the more elastic the supply curve ©1999 South-Western College Publishing 41 Which type of good would be best to tax to raise the most revenue? Goods with inelastic demand curves ©1999 South-Western College Publishing 42 What does the Tobacco Resource Center do to increase the elasticity of demand for cigarettes? http://www.tobacco.neu.edu/ ©1999 South-Western College Publishing 43 • What factors influence Demand Sensitivity? • What is Elasticity? • How do we measure the Price Elasticity of Demand? • What is Cross Elasticity of Demand? • What is Income Elasticity of Demand? 44 END ©1999 South-Western College Publishing 45