Download lec6 - people.vcu.edu

Today
Price elasticity of demand
Chapter 18
Elasticity
How does a Change in Supply
Affect Price & Quantity?
Want a quantitative answer.
Suppose new safety regulations
increase the cost of producing
toasters. How much does price
increase?
How much does quantity decrease?
How much do P & Q change?
S’
P
S
Depends on:
shape of D
curve
P
where you are
on the D curve.
D
Q
Q
Price Elasticity of Demand
How responsive the quantity
demanded is to changes in price.
Availability of Substitutes
The more and better the substitutes,
the higher the price elasticity, since
as the price rises consumers switch
to other products easily.
Note: the more broadly one defines a
good, the lower the elasticity.
Ex: citrus fruits v. fresh produce
Ex: toothpaste v. Aim toothpaste
Proportion of Income Spent on
the Good
The higher the proportion, the higher
the price elasticity.
Ex: salt v. housing
Price Elasticity of Demand:
Formula
  %QD =  QD/ave. Q
%P
 P/ave. P
 QD/ave. Q = Q0-Q1
(Q0+Q1)/2
 P/ave. P= P0-P1
(P0+P1)/2
An Example
S’
P
%  QD =(7-3) (100)
(7+3)/2
%  P =(5-7) (100)
(5+7)/2
D =4/5
-2/6
= -2.4
Q
S
7
5
3
7
Interpreting the Answer
Negative sign: The price elasticity of
D will always have a negative sign.
(Why?)
By convention, we usually drop the
negative sign & focus on the absolute
value of .
Note: sign is still imp’t for other
elasticities we’ll study later.
Interpreting the Magnitude
 = %  QD/ %  P = 2.4
The quantity demanded will fall by 2.4
% for every 1% increase in price.
Ex: If price rises 15%, then QD will
fall by 36%.
Elastic Demand
We say that demand is elastic when  > 1.
%  QD> %  P
Total revenue (P x Q) moves in the same
direction as QD.
If price rises, QD falls by a larger %, total
revenue falls.
If price falls, QD rises by a larger %, total
revenue rises.
Unit Elastic
We say that demand is unit elastic
when  = 1.
%QD = %  P
Total revenue (P x Q) unchanged as
price changes.
Inelastic
We say that demand is inelastic when  < 1.
%QD< %  P
Total revenue (P x Q) moves in the same
direction as price.
If price rises, QD falls by a smaller %, total
revenue rises.
If price falls, QD rises by a smaller %, total
revenue falls.
Relating Elasticity to the Shape
of & Location on D curve
P
>1
=1
<1
D
Q
Straight-line
demand curve:
Elasticity falls as
you move down
the D curve.
See textbook for
a numerical
example.
Revenue Maximization &
Straight-Line Demand
P
>1
 = 1, unit
<1
D
Q
When elastic, what
happens to revenue as
price falls?
When inelastic, what
happen to revenue as
price falls?
Where is revenue
maximized?
Revenue Max. & Profit Max.
Are they the same thing?
Perfectly Inelastic Demand
P
 = %QD/ %  P
=0
(Violates the Law
of Demand)
D
Q
Perfectly Elastic Demand
P
D
Q
 = %  QD/ % P
=
Violates the Law
of Demand
Comparing 2 straight-line D
curves
P
pt. C
DA
Begin at pt. C.
Same P change.
Change in Q
very different
DB
Q
Comparing 2 straight-line D
curves
DA is steeper, less elastic (more
inelastic) compared to DB at the point
where they cross.
Short Run versus Long Run
Short run (SR): the period after
some change, but before adjustments
to the change are complete.
Long run (LR): the period after some
change, once all adjustments to the
change have been made.
Elasticity in the SR & LR
Short Run
Quantity demanded has a limited
response to changes in price.
Demand is less elastic
Long Run
response to changes in price is complete.
Demand is more elastic.
Demand in the LR and SR
P
pt. A
pt. B
DSR
DLR represents
complete
adjustment to new
P.
DSR shows initial
response to P,
given initial P.
pt. C
DSR
DSR
DLR
Q
Coming Up
Other demand elasticities.
Price elasticity of supply.
Group Work
Problems relating to price elasticity
of demand.
work 1 &3 first, even-numbered
groups work 2 & 4 first.
1. Sale of Fresh Green Beans
Month
June
July
Price/lb.
$0.80
$0.65
Quantity in lbs.
125
150
Calculate the price elasticity of demand using the data above.
Show your work.
Is the demand for green beans price elastic, unit elastic, or
price inelastic?
2. Price Elasticity
Suppose that  = 1.25 and price falls
from $7.00 to $5.00. By what
percentage will the quantity
demanded increase? Show your work.
Will revenue rise or fall as a result?
How do you know?
3. Pricing parking spaces in a
parking lot
You think that if you reduce prices then
you will be able to fill more spots and
therefore earn more money. Your friend
says that you should raise prices and
thereby increase revenue even if fewer
people park there.
Suppose you find out that the elasticity of
demand (at your current price) is equal to
0.80. How can this information settle your
debate?