Download Elasticity: Measuring the Responsiveness of Demand

Elasticity:
Measuring Responsiveness
Inelastic
Elastic
Dr. D. Foster - Microeconomics
Elasticity

A measure of responsiveness . . .
 Price
elasticity of demand.
Income elasticity of demand.
 Cross price elasticity of demand.
 Price elasticity of supply.

Price Elasticity of Demand
D = E(Qd,P) = %ΔQD/ %ΔP
Responsive if |D| > 1 and demand is elastic.
Unresponsive if |D| < 1 and demand is inelastic.
Note: Technically, calculated D is always <0.
%Δ = percentage change in
Price Elasticity of Demand
D = E(Qd,P) = %ΔQD/ %ΔP
Perfectly elastic
D = 
Perfectly inelastic
D = 0
Price Elasticity of Demand
D = E(Qd,P) = %ΔQD/ %ΔP
Along a straight line, changing elasticity!!
Elastic
Inelastic
Price Elasticity of Demand
D = E(Qd,P) = %ΔQD/ %ΔP
We talk about demand curves that are
relatively elastic vs. relatively inelastic . . .
Inelastic
Elastic
Price Elasticity of Demand
D = E(Qd,P) = %ΔQD/ %ΔP
Elasticity tells us how TR will change
with a change in the price . . .


If elastic, ↑P will ↓TR (output effect dominates)
(conversely, a ↓P will ↑TR)
If inelastic, ↑P will ↑TR (price effect dominates)
(conversely, a ↓P will ↓TR)
Elasticity Questions
A. What do execs at Pepsi expect TR to do when
they have a sale on their soft drink? Why?
B. You manage a concert hall that seats 500.
Consider the following demand information:
What do you
charge?
At a price of: Amount sold is:
$10
500
$15
400
$20
200
Price Elasticity of Demand
D = E(Qd,P) = %ΔQD/ %ΔP
How to calculate this . . .



Easy if the %Δ is given for both.
Find the %Δ from the base.
Find the %Δ from the average.
D =
5/97.5
.10/1.05
= .538
What is elasticity if price rises by 10% and quantity
demanded falls by 5%?
What is elasticity if price rises from $1 to $1.10 and
quantity demanded falls from 100 to 95?
Price Elasticity of Demand
Determinants of elasticity . . .




The degree of substitutes available
more substitutes = more elastic
Amount of budget spent on this good
higher proportion spent = more elastic
Relative importance of this good
more of a luxury = more elastic
Time to respond to price change
more time = more elastic
Price Elasticity of Demand
D = E(Qd,P) = %ΔQD/ %ΔP
What happens when electricity prices rise?
$.50
Over next month
$.05
Over 5 years
Over next year
1
6 10 11
Elasticity
A measure of responsiveness . . .
Price elasticity of demand: P and QD
Income elasticity of demand
Cross price elasticity of demand
Price elasticity of supply
Income Elasticity of Demand
How responsive is the QD to a Δ in Income?
May be a Normal good (>0) or an inferior good (<0)
Y = E(Qd,I) = %ΔQD/ %ΔIncome
Cross Price Elasticity of Demand
How responsive is the QD-x for one good if there is a ΔPy?
If substitutes then >0; If complements then <0
XZ = E(Qd,Pog) = %ΔQD-X/ %ΔPZ
Price Elasticity of Supply
How responsive is the QS to a ΔP? Positive
S = E(Qs,P) = %ΔQS/ %ΔP
Elasticity Questions
1. If the price of butter goes up 50%
and the quantity demanded falls by 10%,
what is the price elasticity of demand?
Is this elastic or inelastic? Why?
2. If the price of the Rolling Stones’
CD, Semi-Serious, is reduced from $20
to $18, and the quantity demanded (say,
on a per month basis) rises by 10%,
what is the price elasticity of demand?
Is this elastic or inelastic? Why?
Elasticity Questions
3. If the price of gas goes up by 30% and the
quantity demanded falls from 1,000,000 gallons/day
to 900,000 gallons/day, what is the price elasticity of
demand? Is this elastic or inelastic? Why? If the
price, then, falls back by 30%, would you predict the
response by consumers will be elastic or inelastic?
Why?
4. A popular pair of Nike shoes, the Paris Hilton
Liteweights, is reduced in price from $80 to $40,
while the quantity demanded rises from 10,000
pairs/week to 20,000 pairs/week. What is the price
elasticity of demand? Is this elastic or inelastic?
Why?
Elasticity Questions
5. DishTV has lowered its subscription TV prices
by 10% and its subscription base rose by 15%.
(a) What is the price elasticity of demand for
DishTV? Is this elastic or inelastic? Why?
(b) If DirecTV sees its subscription base fall by
8%, what is the cross price elasticity of demand for
DirecTV? For DishTV?
(c) If incomes rise by 3% and subscription base
for DishTV rises by 9%, what is the income
elasticity of demand for DishTV?
Elasticity Questions
6. Consider this
demand curve. As it
is a straight line,
there is an elastic
portion, an inelastic
portion and point of
unitary elasticity.
Identify where, along
this demand, the
total revenue would
be maximized.
[Total revenue equals
price times quantity.]
Elasticity Questions
7. Consider Demand (DA) with equilibrium at point A.
A $.50 per unit tax is placed
on this good . . .
a) Does S’ show the new
supply? Yes. Do you know
why?
b) What is the change in
total revenue as you move to
the new equilibrium at A’?
c) What is the price elasticity
of demand?
d) What is the value of the
taxes collected?
Elasticity Questions
8. Consider Demand (DB) with equilibrium at point B.
A $.50 per unit tax is placed
on this good . . .
a) Does S’ show the new
supply? Yes. Do you know
why?
b) What is the change in
total revenue as you move to
the new equilibrium at B’?
c) What is the price elasticity
of demand?
d) What is the value of the
taxes collected?
Elasticity:
Measuring Responsiveness
Inelastic
Elastic
Dr. D. Foster - Microeconomics