Download Price Elasticities of Demand

Price Elasticities of
Demand
Definition:
• Price elasticity of demand is a measure
of the responsiveness of the quantity
demanded of a good to a change in its
price when all other influences on
buyers’ plans remain the same
• To determine price elasticity of demand:
compare the % change in the quantity
demanded with the percentage change
in price
Percentage Price in Change
• Starbucks raised the price of a latte from
$3 to $5 a cup. What is the percentage
change in price?
New price – Initial price
Percent change in price =
x 100
Initial Price
Percentage Change in Price
• Starbucks cuts the price of a latte from
$5 to $3 a cup. What now is the
percentage change in price?
New price – Initial price
Percent change in price =
x 100
Initial Price
Percentage Change in Price
• Elasticity compares the percentage
change in the quantity demanded with
the percentage change in price
• Midpoint Method -- To calculate the
percentage change that does not
depend on the direction of the price
change
Percentage Price in Change
• Midpoint Method Calculation
• Starbucks Latte price changing from $5
to $3. $5 for a new price and $3 for the
initial price.
Percent change in price =
New price – Initial price
(New Price + Initial Price) ÷ 2
x 100
Percentage Change in Price
• Average price is the same regardless
of whether the price rises or falls
Percentage Change in Quantity Demanded
• Price of a Latte rises from $3 to $5 a cup,
the quantity demanded decreases from
15 cups to 5 cups an hour.
• Uses the midpoint formula again
Percent change in price =
New price – Initial price
(New Price + Initial Price) ÷ 2
x 100
Percentage Change in Quantity
Demanded
• When the price of a good rises, the
quantity demanded of it decreases
– A positive change in price bring a negative
change in the quantity demanded
• When the price of a good falls, the
quantity demanded of it increases
– Negative change in price brings a positive
change in the quantity demanded
Elastic and Inelastic Demand
• Elastic Demand – when the percentage
change in the quantity demanded exceeds
the percentage change in price
• Unit Elastic Demand – percentage change in
the quantity demanded equals the
percentage change in price
• Inelastic Demand – percentage change in the
quantity demanded is less than the
percentage change in price
Elastic Demand
• Perfectly Elastic Demand – an almost
zero percentage change in the price
brings a very large percentage change in
the quantity demanded
• Consumers are willing to buy any
quantity of the good at a given price but
none at a higher price
Perfectly Elastic Demand
Elastic Demand
• A percentage
change in the
quantity
demanded
exceeds the
percentage
change in price
Unit Elastic Demand
• The percentage
change in the
quantity
demanded
equals the
percentage
change in price
Inelastic Demand
• Percentage
change in the
quantity
demanded is
less than the
percentage
change in
price
Perfectly Inelastic Demand
• Percentage
change in the
quantity
demanded is
zero for any
percentage
change in price
Influences on Price Elasticity of
Demand
• Two influences:
1. Availability of substitutes
1. Proportion of income spent
Influences on Price Elasticity of
Demand
• Demand for good is elastic if a substitute is
easy to find
– Soft drink containers
• Demand for good is inelastic if a substitute is
hard to find
– Oil substitutes?
Influences on Price Elasticity of
Demand
• Three factors that influence the ability
to find a substitute for a good:
1. Whether good is a luxury or a necessity
2. How narrowly it is defined
3. Amount of time available to find a
substitute for it
Price Elasticity of Demand
• The greater the proportion of income spend
on a good, the greater is the impact of a rise
in its price on the quantity of that good that
people can afford to buy and the more elastic
it is the demand for that good
• Toothpaste?
Computing Price Elasticity of Demand
Price elasticity =
of demand
Percentage change in quantity demanded
Percentage change in the price
• If the price elasticity of a demand is greater
than 1, the demand is elastic
• If the price elasticity of demand equals 1,
demand is unit elastic
• If the price elasticity of demand is less than 1,
demand is inelastic
Computing Price Elasticity of Demand
Elasticity Along a Linear Demand Curve
•Slope measures responsiveness. But slope and
elasticity are not the same thing!
•Along a linear (straight-line) demand curve,
the slope is constant but the elasticity varies.
•Along a linear demand curve, demand is:
– Unit elastic at the midpoint of the curve.
– Elastic above the midpoint of the curve.
– Inelastic below the midpoint of the curve.
Elasticity Along a Linear Demand Curve
Total Revenue and the Price Elasticity of Demand
• Total revenue is the amount spent on a good
and received by its sellers and equals the
price of the good multiplied by the quantity
sold
– Starbucks Latte -- $3
– Demand is 15 cups an hour
– Total Revenue is $45 an hour
• Total Revenue Test is a method of estimating
the price elasticity of demand by observing
the change in total revenue that results from
a price change
Total Revenue and the Price Elasticity
of Demand
• If demand is elastic:
• A given percentage rise in price brings a
larger percentage decrease in the quantity
demanded.
• And total revenue decreases.
• If demand is inelastic:
• A given percentage rise in price brings a
smaller percentage decrease in the quantity
demanded.
• And total revenue increases.
Total Revenue Test
Total revenue test:
– If price and total revenue change in the
opposite directions, demand is elastic.
– If a price change leaves total revenue
unchanged, demand is unit elastic.
– If price and total revenue change in the
same direction, demand is inelastic.
Total Revenue Test
• At $3 a cup, the quantity
demanded is 15 cups an
hour.
• Total revenue is $45 an
hour.
• When the price rises to
$5 a cup, the quantity
demanded decreases to
5 cups an hour.
• Total revenue decreases
to $25 an hour.
• Demand is elastic.
Total Revenue Test
• At $50 a book, the
quantity demanded is 5
million books.
• Total revenue is $250
million.
• When the price rises to
$75 a book, the quantity
demanded decreases to 4
million books.
• Total revenue increases to
$300 million.
• Demand is inelastic.
Addiction and Elasticity
•Nonusers’ demand for addictive substances is
elastic.
•So a moderately higher price leads to a
substantially smaller number of people trying a
drug.
•Existing users’ demand for addictive
substances is inelastic.
• So even a substantial price rise brings only a
modest decrease in the quantity demanded.
Price Elasticities of
Demand Notes
Definition:
• Price elasticity of demand is
• To determine price elasticity of demand:
compare the % change in the quantity
demanded with the percentage change
in price
Percentage Price in Change
• Starbucks raised the price of a latte from
$3 to $5 a cup. What is the percentage
change in price?
–
=
x
Percentage Change in Price
• Starbucks cuts the price of a latte from
$5 to $3 a cup. What now is the
percentage change in price?
–
=
x
Percentage Change in Price
• Elasticity compares the percentage
change in the quantity demanded with
the percentage change in price
• Midpoint Method --
Percentage Price in Change
• Midpoint Method Calculation
• Starbucks Latte price changing from $5
to $3. $5 for a new price and $3 for the
initial price.
=
–
(
+
)÷2
x
Percentage Change in Price
Percentage Change in Quantity Demanded
• Price of a Latte rises from $3 to $5 a cup,
the quantity demanded decreases from
15 cups to 5 cups an hour.
• Uses the midpoint formula again
Percent change in price =
New price – Initial price
(New Price + Initial Price) ÷ 2
x 100
Percentage Change in Quantity
Demanded
• When the price of a good rises, the
quantity demanded of it decreases
• When the price of a good falls, the
quantity demanded of it increases
Elastic and Inelastic Demand
• Elastic Demand –
• Unit Elastic Demand –
• Inelastic Demand –
Elastic Demand
• Perfectly Elastic Demand –
• Consumers are willing to buy any
quantity of the good at a given price but
none at a higher price
Perfectly Elastic Demand
Elastic Demand
Unit Elastic Demand
Inelastic Demand
Perfectly Inelastic Demand
Influences on Price Elasticity of
Demand
• Two influences:
1. Availability of ________________
1. Proportion of ___________spent
Influences on Price Elasticity of
Demand
• Demand for good is elastic if a substitute is
easy to find
• Demand for good is inelastic if a substitute is
hard to find
Influences on Price Elasticity of
Demand
• Three factors that influence the ability
to find a substitute for a good:
Price Elasticity of Demand
• The greater the proportion of income spend
on a good, the greater is the impact of a rise
in its price on the quantity of that good that
people can afford to buy and the more elastic
it is the demand for that good
Computing Price Elasticity of Demand
Price elasticity =
of demand
Percentage change in quantity demanded
Percentage change in the price
• If the price elasticity of a demand is greater
than 1, the demand is ____________
• If the price elasticity of demand equals 1,
demand is ____________
• If the price elasticity of demand is less than 1,
demand is ____________
Computing Price Elasticity of Demand
Elasticity Along a Linear Demand Curve
•Slope measures responsiveness. But slope and
elasticity are not the same thing!
•Along a linear (straight-line) demand curve, the
slope is constant but the elasticity varies.
•Along a linear demand curve, demand is:
– ____________ at the midpoint of the curve.
– ____________ above the midpoint of the curve.
– ____________ below the midpoint of the curve.
Elasticity Along a Linear Demand Curve
Total Revenue and the Price Elasticity of Demand
• Total revenue is the amount spent on a good
and received by its sellers and equals the
price of the good multiplied by the quantity
sold
– Starbucks Latte -- $3
– Demand is 15 cups an hour
– Total Revenue is $45 an hour
• Total Revenue Test is a method of estimating
the price elasticity of demand by observing
the change in total revenue that results from
a price change
Total Revenue and the Price Elasticity
of Demand
• If demand is elastic:
• If demand is inelastic:
Total Revenue Test
Total revenue test:
– If price and total revenue change in the
opposite directions, demand is ________
– If a price change leaves total revenue
unchanged, demand is ____________.
– If price and total revenue change in the
same direction, demand is ____________.
Total Revenue Test
• At $3 a cup, the quantity
demanded is 15 cups an
hour.
• Total revenue is
____________
• When the price rises to $5 a
cup, the quantity demanded
decreases to 5 cups an hour.
• Total revenue decreases to
____________.
• Demand is ____________.
Total Revenue Test
• At $50 a book, the
quantity demanded is 5
million books.
• Total revenue is
____________
• When the price rises to
$75 a book, the quantity
demanded decreases to 4
million books.
• Total revenue increases to
____________.
• Demand is ____________.
Addiction and Elasticity
•Nonusers’ demand for addictive substances is
____________.
•Existing users’ demand for addictive
substances is ____________.
•