Elasticity:Elasticity:

Measuring ResponsivenessMeasuring Responsiveness

Dr. D. Foster - MicroeconomicsDr. D. Foster - Microeconomics

Inelastic

Elastic

ElasticityElasticity

A measure of responsiveness . . .A measure of responsiveness . . .

Price elasticity of demand.Price elasticity of demand.

Income elasticity of demand.Income elasticity of demand.Cross price elasticity of demand.Cross price elasticity of demand.Price elasticity of supply.Price elasticity of supply.

Price Elasticity of DemandPrice Elasticity of Demand

DD = E(Q = E(Qdd,P) = %,P) = %ΔΔQQDD/ / %%ΔΔPP

Responsive if | if |DD|| > 1 and demand is > 1 and demand is elastic..

Unresponsive if |if |DD|| < 1 and demand is < 1 and demand is inelastic..

Note: Technically, calculated Note: Technically, calculated DD is always <0. is always <0.

%Δ = percentage change in

Price Elasticity of DemandPrice Elasticity of Demand

DD = E(Q = E(Qdd,P) = %,P) = %ΔΔQQDD/ / %%ΔΔPP

Perfectly elasticPerfectly elastic

DD = =

Perfectly inelastic

D = 0

Price Elasticity of DemandPrice Elasticity of Demand

DD = E(Q = E(Qdd,P) = %,P) = %ΔΔQQDD/ / %%ΔΔPP

Along a straight line, changing elasticity!!Along a straight line, changing elasticity!!

Elastic

Inelastic

Price Elasticity of DemandPrice Elasticity of Demand

DD = E(Q = E(Qdd,P) = %,P) = %ΔΔQQDD/ / %%ΔΔPP

We talk about demand curves that are We talk about demand curves that are relatively elastic vs. relatively inelastic . . .relatively elastic vs. relatively inelastic . . .

Inelastic

Elastic

Price Elasticity of DemandPrice Elasticity of Demand

DD = E(Q = E(Qdd,P) = %,P) = %ΔΔQQDD/ / %%ΔΔPP

Elasticity tells us how TR will change Elasticity tells us how TR will change with a change in the price . . .with a change in the price . . .

If elastic, If elastic, ↑P will ↓TR (output effect dominates)↑P will ↓TR (output effect dominates) (conversely, a ↓P will ↑TR) (conversely, a ↓P will ↑TR)

If inelastic, ↑P will ↑TR (price effect dominates) (conversely, a ↓P will ↓TR)

Elasticity QuestionsElasticity Questions

A. What do execs at Pepsi expect TR to do when A. What do execs at Pepsi expect TR to do when they have a sale on their soft drink? Why?they have a sale on their soft drink? Why?

B. You manage a concert hall that seats 500. B. You manage a concert hall that seats 500. Consider the following demand information:Consider the following demand information:

What do youWhat do youcharge?charge? At a price of:At a price of: Amount sold is:Amount sold is:

$10$10 500500

$15$15 400400

$20$20 200200

Price Elasticity of DemandPrice Elasticity of Demand

DD = E(Q = E(Qdd,P) = %,P) = %ΔΔQQDD/ / %%ΔΔPP

How to calculate this . . .How to calculate this . . .

Easy if the %Easy if the %ΔΔ is given for both. is given for both. Find the Find the %%ΔΔ from the base. from the base. Find the Find the %%ΔΔ from the average. from the average.

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?

D =

5/97.5 .10/1.05

= .538

Price Elasticity of DemandPrice Elasticity of Demand

Determinants of elasticity . . .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 DemandPrice Elasticity of Demand

DD = E(Q = E(Qdd,P) = %,P) = %ΔΔQQDD/ / %%ΔΔPP

What happens when electricity prices rise?What happens when electricity prices rise?

$.05

Over next month$.50

10 111

Over 5 years

Over next year

6

ElasticityElasticity

A measure of responsiveness . . .A measure of responsiveness . . .

Price elasticity of demand: P and QPrice elasticity of demand: P and QDD

Income elasticity of demandIncome elasticity of demand

Cross price elasticity of demand

Price elasticity of supply

Income Elasticity of DemandIncome Elasticity of DemandHow responsive is the QHow responsive is the QDD to a to a ΔΔ in Income? in Income?

May be a Normal good (>0) or an inferior good (<0)May be a Normal good (>0) or an inferior good (<0)

YY = E(Q = E(Qdd,I) = %,I) = %ΔΔQQDD/ / %%ΔΔIncomeIncome

Cross Price Elasticity of DemandCross Price Elasticity of DemandHow responsive is the QD-x for one good if there is a ΔPy?

If If substitutes then >0; If complements then <0substitutes then >0; If complements then <0

XZ = E(Qd,Pog) = %ΔQD-X/ %ΔPZ

Price Elasticity of SupplyPrice Elasticity of SupplyHow responsive is the QHow responsive is the QSS to a ΔP? Positive to a ΔP? Positive

S = E(Qs,P) = %ΔQS/ %ΔP

Elasticity QuestionsElasticity Questions 1. If the price of butter goes up 50% 1. If the price of butter goes up 50% and the quantity demanded falls by 10%, and the quantity demanded falls by 10%, what is the price elasticity of demand? what is the price elasticity of demand? Is this elastic or inelastic? Why?Is this elastic or inelastic? Why?

2. If the price of the Rolling Stones’ 2. If the price of the Rolling Stones’ CD, Semi-Serious, is reduced from $20 CD, Semi-Serious, is reduced from $20 to $18, and the quantity demanded (say, to $18, and the quantity demanded (say, on a per month basis) rises by 10%, on a per month basis) rises by 10%, what is the price elasticity of demand? what is the price elasticity of demand? Is this elastic or inelastic? Why?Is this elastic or inelastic? Why?

Elasticity QuestionsElasticity Questions 3. If the price of gas goes up by 30% and the 3. If the price of gas goes up by 30% and the quantity demanded falls from 1,000,000 gallons/day quantity demanded falls from 1,000,000 gallons/day to 900,000 gallons/day, what is the price elasticity of to 900,000 gallons/day, what is the price elasticity of demand? Is this elastic or inelastic? Why? If the demand? Is this elastic or inelastic? Why? If the price, then, falls back by 30%, would you predict the price, then, falls back by 30%, would you predict the response by consumers will be elastic or inelastic? response by consumers will be elastic or inelastic? Why?Why?

4. A popular pair of Nike shoes, the Paris Hilton 4. A popular pair of Nike shoes, the Paris Hilton Liteweights, is reduced in price from $80 to $40, Liteweights, is reduced in price from $80 to $40, while the quantity demanded rises from 10,000 while the quantity demanded rises from 10,000 pairs/week to 20,000 pairs/week. What is the price pairs/week to 20,000 pairs/week. What is the price elasticity of demand? Is this elastic or inelastic? elasticity of demand? Is this elastic or inelastic? Why?Why?

Elasticity QuestionsElasticity Questions5. 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 QuestionsElasticity Questions6. Consider this 6. Consider this demand curve. As it demand curve. As it is a straight line, is a straight line, there is an elastic there is an elastic portion, an inelastic portion, an inelastic portion and point of portion and point of unitary elasticity. unitary elasticity. Identify where, along Identify where, along this demand, the this demand, the total revenue would total revenue would be maximized.be maximized. [Total revenue equals[Total revenue equals

price times quantity.]price times quantity.]

Elasticity QuestionsElasticity Questions7. Consider Demand (D7. Consider Demand (DAA) with equilibrium at point A.) with equilibrium at point A.

A $.50 per unit tax is placed A $.50 per unit tax is placed on this good . . .on this good . . .

a) Does S’ show the new a) Does S’ show the new supply? Yes. Do you know supply? Yes. Do you know why?why?

b) What is the change in b) What is the change in total revenue as you move to total revenue as you move to the new equilibrium at A’?the new equilibrium at A’?

c) What is the price elasticity c) What is the price elasticity of demand?of demand?

d) What is the value of the d) What is the value of the taxes collected?taxes collected?

Elasticity QuestionsElasticity Questions8. Consider Demand (D8. Consider Demand (DBB) with equilibrium at point B.) with equilibrium at point B.

A $.50 per unit tax is placed A $.50 per unit tax is placed on this good . . .on this good . . .

a) Does S’ show the new a) Does S’ show the new supply? Yes. Do you know supply? Yes. Do you know why?why?

b) What is the change in b) What is the change in total revenue as you move to total revenue as you move to the new equilibrium at B’?the new equilibrium at B’?

c) What is the price elasticity c) What is the price elasticity of demand?of demand?

d) What is the value of the d) What is the value of the taxes collected?taxes collected?

Elasticity:Elasticity:

Measuring ResponsivenessMeasuring Responsiveness

Dr. D. Foster - MicroeconomicsDr. D. Foster - Microeconomics

Inelastic

Elastic