ch. 5: elasticity and its application - jacob hochard 5: elasticity and its application elasticity:...
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Chapter 5: Elasticity and Its Application
Ch. 5: Elasticity and Its Application
Why are breakfast
foods cheaper than
tobacco products?
Chapter 5: Elasticity and Its Application
Elasticity: is a numerical measure of the responsiveness ofquantity demanded or quantity supplied to one of its determinants.
• How much more ice cream will a firm sell if it decreases itsprice by $0.50 per scoop?
• The Law of Demand says... a firm will sell more ice cream...but how much more?
• This relationship is called the price elasticity of demand.
Chapter 5: Elasticity and Its Application
Price elasticity of demand:
The price elasticity of demand, loosely speaking, measures theprice-sensitivity of buyers’ demand.
Price Elasticityof Demand =
Percentage change in quantity demanded (∆ Q)
Percentage change in Price (∆ P)
How do we calculate it, in practice?
Chapter 5: Elasticity and Its Application
Price elasticity of demand: calculating it
The price elasticity of demand, loosely speaking, measures theprice-sensitivity of buyers’ demand.
Price Elasticityof Demand =
Percentage change in quantity demanded (∆ Q)
Percentage change in Price (∆ P)
Chapter 5: Elasticity and Its Application
Price elasticity of demand:
Elasticity ranges from 0 to infinity.
A product with a low elasticity (0 to 1) is said to be inelastic;consumers will continue to purchase large amounts of that producteven when the price becomes extremely high.
Insulin
Oil Water
Cigarettes
Heroin
Medical treatmentElectricity
Chapter 5: Elasticity and Its Application
Price elasticity of demand:
Elasticity ranges from 0 to infinity.
A product with a high elasticity (greater than 1) is said to beelastic; consumers will reduce their purchase of that product whenthe price becomes extremely high.
Vacations
Newspapers
Chapter 5: Elasticity and Its Application
Real world elasticities:
Real world elasticities
0.1
0.2
Eggs
Healthcare
Rice
0.5
Housing
0.7
Beef
Restaurants
1.62.34.4
Chapter 5: Elasticity and Its Application
What causes a product to be more or less elastic?
• Availability of close substitutes.
• Necessities versus luxuries.
• Definition of the market (how narrow, how broad).Does food have many substitutes? how about bananas?
• Time horizon.If gas prices increase, can yousubstitute to a prius tomorrow?
Chapter 5: Elasticity and Its Application
Terminology
Elasticity terminology
Elasticity number Term
0 Perfectly inelastic
Greater than 0, less than 1
Inelastic
1 Unit elastic
Greater than 1, less than infinity
Elastic
Infinity Perfectly elastic
No matter what the price, the product will still be purchased.
If the price increases by 1 cent, no one will purchase the product.
?
Chapter 5: Elasticity and Its Application
Price-inelastic demand: oil
Quantity demanded (Millions of barrels of oil per day)
00 5
$40
$80
$120
Price of a barrel of oil
U.S. Daily Demand for Oil
$160
10 15 20 25
A steep demand curve represents inelastic
demand – quantity demanded is highly less
responsive to changes in price.
Notice if the price of oil increases 100% (from $80 to
$160) demand only drops 33% (from 15 to 10)
Perfectly price-inelastic demand
would be given by a perfectly
vertical demand curve.
Chapter 5: Elasticity and Its Application
Price-elastic demand: mountain dew
Quantity demanded (cans of mountain dew per day – millions)
00 5
$0.50
$0.75
$1.00
Price of a can of mountain
dew
U.S. Daily Demand for Mountain Dew
$1.25
10 15 20 25
A flat demand curve represents elastic
demand – quantity demanded is highly
responsive to changes in price.
Notice if the price of mountain dew increases by 10%
(from $0.75 to $0.825) demand drops 50% (from 20
to 10)
Perfectly price-elastic demand
would be given by a perfectly
horizontal demand curve.
$0.825
Chapter 5: Elasticity and Its Application
Price-elastic demand: perfectly inelastic demand
Quantity of insulin demanded
00
Perfectly inelastic demand:
demand for insulin
50 100 150 200
$10
$30
Price of a insulin
PointA
PointB
𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 =% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷=
𝟎%
𝟔𝟔.𝟔%= 𝟎
Demand for insulin
𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒑𝒆𝒓𝒇𝒆𝒄𝒕𝒍𝒚 𝒗𝒆𝒓𝒕𝒊𝒄𝒂𝒍
Chapter 5: Elasticity and Its Application
Price-elastic demand: inelastic demand
Gallons of gasoline demanded
00
Inelastic demand:
demand for gasoline
50
$3
$5
Price of a gallon of gasoline
PointA
PointB
𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 =% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷=
𝟑𝟎%
𝟒𝟎%= 𝟎. 𝟕𝟓
Demand for gasoline
𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒓𝒆𝒍𝒂𝒕𝒊𝒗𝒆𝒍𝒚 𝒔𝒕𝒆𝒆𝒑
65
Consumers’ price sensitivity is relatively low
Chapter 5: Elasticity and Its Application
Price-elastic demand: unit elastic demand
00
Unit elastic demand:
demand for ice cream
50
$2
Price of a scoop of
ice cream
PointA
PointB
𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 =% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷=
𝟓𝟎%
𝟓𝟎%= 𝟏
Demand for ice cream
𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒎𝒐𝒅𝒆𝒓𝒂𝒕𝒆𝒍𝒚 𝒔𝒕𝒆𝒆𝒑
75
Consumers’ price sensitivity is
moderate
100
$4
Scoops of ice cream demanded
Chapter 5: Elasticity and Its Application
Price-elastic demand: perfectly elastic demand
00
Perfectly elastic demand:
???
50
Price of a can of
perfectly elastic good
PointA
PointB
𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 =% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷=
𝟐𝟎𝟎%
𝟎%= 𝒊𝒏𝒇𝒊𝒏𝒊𝒕𝒚 (∞)
Demand curve for a perfectly elastic
good
𝑫𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆𝒑𝒆𝒓𝒇𝒆𝒄𝒕𝒍𝒚 𝒇𝒍𝒂𝒕
150
Consumers’ demand is completely
sensitive to price
$8
Quantity of perfectly elastic good demanded
Chapter 5: Elasticity and Its Application
How does price elasticity relate to total revenue generation?
In any given market, the demand revenue created at a given priceis the product of the price and the quantity demanded.
Quantity of sandwiches
00
Total revenue in the Jimmy John’s sandwich market
50 100 150 200
$3
$6
$9
$12Price of a sandwich
50 sandwiches X $9 per sandwich = 450 dollars of revenue
Chapter 5: Elasticity and Its Application
How does price elasticity relate to total revenue generation?
There is a tradeoff between increasing price and decreasingquantity in total revenue generation.
• Increasing the price makes each unit more valuable butreduces the number of units being sold.
• Decreasing the price makes each unit less valuable butincreases the number of units being sold.
The effect on revenue will depend on the price elasticity ofdemand! .
Price increase, inelastic demand
If price elasticity of demand is < 1, a rising price will increase at afaster rate than the falling quantity.
Increasing the price will increase revenue.
Price increase, unit elastic demand
If price elasticity of demand is = 1, a rising price will increase atthe same rate as the falling quantity. These forces are perfectlyoffsetting!
Increasing the price will leave the revenue unchanged.
Price
Quantity demanded
Unit elastic demand – perfectly offsetting quantity and price effects.
q’ q
p’
p
Revenue’
Revenue
Price increase, unit elastic demand
If price elasticity of demand is > 1, a rising price will increase at aslower rate than the falling quantity.
Increasing the price will decrease the revenue.
Other forms of elasticity:
Income elasticity of demand: a measure of how much thequantity demanded of a good responds to a change in consumers’income.
Cross-price elasticity of demand: a measure of how much thequantity demanded of a good responds to a change in the price ofanother good.
Price elasticity of supply: a measure of how much the quantitysupplied of a good responds to a change in consumers’ income.