Download Chapter 7 DEMAND AND ELASTICITY

5
Demand and Elasticity
A high cross elasticity of demand [between two goods
indicates that they] compete in the same market.
[This can prevent a supplier of one of the products]
from possessing monopoly power over price.
U.S. SUPREME COURT, DUPONT CELLOPHANE DECISION, 1956
Contents
● Elasticity: The Measure of Responsiveness
● Price Elasticity of Demand: Its Effect on
Total Revenue and Total Expenditure
● What Determines Demand Elasticity?
● Elasticity as a General Concept
● Changes in Demand: Movements Along the
Demand Curve vs Shifts in the Demand
Curve
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Contents (continued)
● The Time Period of the Demand Curve and
Economic Decision Making
● Real-World Application: Polaroid versus
Kodak
● Appendix: How to Find a Legitimate
Demand Curve from the Statistics
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity: The Measure of
Responsiveness
● Elasticity = measure of the responsiveness
of one variable to changes in another
variable
%  quantity
● Price elasticity of demand =
%  price
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
5-1(a) The Hypothetical
Demand Curves for Film
FIGURE
DS
B
Price per Package
$20
A
10
DS
0
3
4
Quantity Demanded
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
5-1(b) The Hypothetical
Demand Curves for Film
FIGURE
Df
Price per Package
$20
b
a
10
Df
0
1.5
4
Quantity Demanded
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity: The Measure of
Responsiveness
● Elastic demand = price elasticity of
demand > 1
● Inelastic demand = price elasticity of
demand < 1
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Elasticity: The Measure of
Responsiveness
● Equation for Price Elasticity of Demand
♦ %  Quantity  %  Price
♦ [(Q1 - Q0) / (average of Q1 and Q0)] 
[(P1 - P0) / (average of P1 and P0)]
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity: The Measure of
Responsiveness
● Percentages calculated in terms of the
averages of the prices and quantities
● Minus sign dropped
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
5-2a Sensitivity of Slope
to Units of Measurement
Price per Pizza
FIGURE
$18
17
16
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
D
A
B
D
280 500
360
1,000
1,500
2,000
2,500
3,000
Pizzas per Week
(a)
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5-2b Sensitivity of Slope
to Units of Measurement
Price per Pizza
FIGURE
$18
17
16
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
D
A
B
D
500
1,000 1,500 2,000 2,500 3,000
2,240
2,880
Slices of Pizza per Week
(b)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Price Elasticity of Demand and
the Shapes of Demand Curves
● The Relationship between Elasticity and
Slope
♦ Slope depends upon specific units while
elasticity does not.
♦ If a demand curve has a constant slope
(straight-line), the elasticity is not constant.
♦ If a demand curve has a constant elasticity
(unit elastic), the slope is not constant.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
5-1 Estimates of Price
Elasticities
TABLE
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
5-3 Demand Curves with
Different Elasticities
FIGURE
$0.75
D
“Perfectly
elastic”
demand
curve
D
$6
4
3
D
0
90
Quantity Demanded
(a)
Straightline
demand
A curve
D
Price
“Perfectly
inelastic”
demand
curve
Price
Price
D
C
1
0
0
Quantity Demanded
(b)
2
B
A'
C'
4 5
B'
D
7
Quantity Demanded
(c)
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5-3(d) Unit Elastic
Demand Curve
FIGURE
Unitelastic
demand
curve
Price
D
$30
20
S
T
10
0
U
7
14
D
U'
Quantity Demanded
(d)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Price Elasticity of Demand
●  price   revenues if the demand curve
is elastic
●  price   revenues if the demand curve
is inelastic
●  price  0  revenues if the demand
curve is unit elastic
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE
5-4 An Elastic Demand
Curve
$6
Price
5
D
R
S
W
V
D
4
3
2
1
T
0
4
U
12
Quantity Demanded
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
What Determines Demand
Elasticity?
● Nature of the good
● Availability of close substitutes
● Fraction of income absorbed
● Passage of time
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Elasticity as a General
Concept
● Elasticity can be used to measure the
responsiveness of anything to anything else.
● Income Elasticity
♦ Income elasticity of demand = %  quantity
demanded  %  income
● Price Elasticity of Supply
♦ Price elasticity of supply = %  quantity of
supply  %  price
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity as a General
Concept
● Cross Elasticity of Demand
♦ Cross elasticity of demand (for product X to a
change in the price of product Y) = % 
quantity demanded of X  %  price of Y
♦ If two goods are substitutes (complements),
their cross elasticity of demand is positive
(negative).
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Changes in Demand:
Movements Along vs Shifts
●  price  movement along the demand
curve
●  any other factor that affects spending
decisions  shift between demand curves
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Changes in Demand:
Movements Along vs Shifts
● Demand Shifters
♦ Consumer incomes rise
♦ Tastes change in favor of the good
♦ The price of substitute goods
♦ The price of complementary goods
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5-5 Shifts in a Demand
FIGURE
Curve
D1
D0
R
S
T
28
D0
Price
Price
$35
D2
U
D1
D0
D0
D2
40
60
Quantity of Sweaters in Thousands
(a)
Quantity of Sweaters
(b)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Demand Curve and
Economic Decision Making
● The demand curve shows the quantity of
demand buyers would hypothetically
purchase at different prices during the same
time period.
● It does not show the quantity actually
bought at different prices at different times.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Expected Demand at Various
Six-Month Prices
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Real-World Application:
Polaroid versus Kodak
● In 1989, Polaroid vs Kodak—copyright
infringement
● Key issue: how much profit Polaroid lost?
● Price elasticity of demand
♦ growth in instant camera sales due to
■Kodak competition (lower price) OR
■Kodak’s reputation (Polaroid might have benefited
from Kodak increasing potential number of
customers)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Real-World Application:
Polaroid versus Kodak
● Cross elasticity of demand
♦ After 1980, decline in sales due to
■decreasing cost of 35-mm photography
● then Kodak not to blame
■Kodak’s infringement
● Kodak damages due increase
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Real-World Application:
Polaroid versus Kodak
● Third issue: How much could Polaroid’s
total revenue increased if Kodak not
infringe?
♦ Polaroid claimed lots! $9 billion or more
♦ Kodak claimed neighborhood of $450 million
(very close to judge’s verdict)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Appendix:
How Can We Find a
Legitimate Demand
Curve from the
Statistics?
Finding a Legitimate
Demand Curve
● In the real world we usually only observe
historical price-quantity combinations, so it
is often difficult to distinguish between
movement along a demand curve and shifts
between demand curves.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Finding a Legitimate
Demand Curve
● Prices and quantities observed at different
times in the real world may result from
shifting demand curves and not movement
along a demand curve.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
5-2 Historical Data on
Price and Quantity
TABLE
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Finding a Legitimate
Demand Curve
● Simply connecting the points may not give a
good estimate of a demand curve.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
5-6 Plot of Historical Data
on Price and Quantity
FIGURE
$8.20
Average Price
8.00
T
May
Feb.
April
R
7.80
S
March
7.60
7.40
Jan.
7.20
7.00
0
T
90
91
92
93
94
95
96
97
98
Quantity Demanded in Thousands
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5-7 Plot of Historical Data
and True Demand Curves
FIGURE
$8.20
T
F
Feb.
8.00
Average Price
R
W
S
7.80
March
M
M
7.60
F
7.40
J
7.20
Jan.
J
7.00
T
0
90
91
92
93
94
95
96
97
98
Quantity Demanded in Thousands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
5-3 Annual Rainfall in St.
Louis, 1993-2001
TABLE
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5-8 Legitimate Demand
Curve Est. from Statistical Data
FIGURE
S00
D
2000
Price
S93
S
1994
S96
1999
2001
1998
S
1993
1996
1997
S95
1995
S
D
S
Quantity of Umbrellas Sold
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