Microeconomics Chapter 5

!

Elasticity

0

10

20

30

40

50

60

70

80

90

100

0 1 2 3 4 5 6 7 8 9 10

Price

Quantity

Movement along the !Demand Curve

Price changes!!

demand curve does not change!

!quantity demanded!

changes

0

10

20

30

40

50

60

70

80

90

100

0 1 2 3 4 5 6 7 8 9 10

Price

Quantity

Shift in the Demand CurvePrice does not

change!!

demand curve shifts!!

quantity demanded!changes

Movement or Shift?

Variable Change Movement Shift

Price

Income

Related Goods

Tastes

Population and Demographics

Expectations

elasticity!price elasticity of demand!total revenue!total expenditure!income elasticity of demand!cross-price elasticity of demand!price elasticity of supply!

Key TermsELASTICITY EQUATION BENCHMARK

Price!Demand

Cross-!Price

Income

Price!Supply

MPF

Inelastic | Elastic ! 1

Compliments | Substitutes! 0

Inferior | Normal | Luxury! 0 1

Inelastic | Elastic ! 1

%∆QD

%∆QD1

%∆P

%∆P2

%∆QD%∆I

%∆QS%∆P

∆Q∆PQPx

Elasticity If I change one thing does another thing also change?

Elasticity A measure of how much one economic variable

responds to changes in

another economic variable

Price Elasticity of Demand

%%

QD

P

Percentage Change in Quantity Demanded!

Percentage Change in Price

Price Quantity Total Revenue

90 1 90

80 2 160

70 3 210

60 4 240

50 5 250

40 6 240

30 7 210

20 8 160

10 9 90

Demand Schedule

Total Revenue!Curve

0

52

104

156

208

260

10 20 30 40 50 60 70 80 90

Total!Revenue

Price Per Pizza

Percentage Change

%

New - OldOld

Ignore units in the scale

Price Elasticity of Demand

1

ElasticInelastic

<1 >1

1. Calculate Elasticity!2. Take Absolute Value!3. Compare to benchmark of 1

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Gasoline

Price

%rQD %rP

(4-5)÷5

(6-3)÷3

-.21

.2

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Ice Cream

Price

%rQD %rP

(3-5)÷5

(4-3)÷3

-.4.33

1.2

Price Increase

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Ice Cream

Price

%rQD %rP

(5-3)÷3

(3-4)÷4

.66-.25

2.67

Price Decrease!

Midpoint Formula

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Ice Cream

Price

%rQD %rP

(3-5)÷5

(4-3)÷3

-.4.33

1.2

Price Increase

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Ice Cream

Price

%rQD %rP

(5-3)÷3

(3-4)÷4

+66%-25%

2.67

Price Decrease

Midpoint Formula

Delta Q!over!

Q Bar

Delta P!over !P Bar

Q

QPP

Trick: Flip denominator and multiply

X =

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Ice Cream

Price7

4

1.75

Midpoint Formula

rQ Q rP

P x

24 1

3.5x

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Gasoline

Price

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

$90.00

$100.00

3 4.5 6

Gallons - Gasoline

PriceScales can be deceptive

!

What determines Price Elasticity of

Demand?

Close Substitutes Passage of Time

Luxuries vs. Necessities Definition of Market

Share of Budget

Close Substitutes

Elastic >1

Inelastic <1

Passage of Time

More Time!More Elastic

Luxuries vs. Necessities

Elastic Inelastic

Definition of Market

Elastic Inelastic

Demand for Gasoline in General

Demand for Gasoline in Rexburg

Share of the Budget

ElasticInelastic

Small Large

!

Price Elasticity and

Total Revenue

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Gasoline

Price$6.00 x 4 = $24

$3.00 x 5 = $15

Inelastic (<1)!Raising prices will increase total revenue

Net Gain = $9

Lose

Gain

Total RevenueTR = P x Q

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

1 2 3 4 5 6 7 8 9 10

Gallons - Ice Cream

Price$4.00 x 3 = $12

$3.00 x 5 = $15

Elastic (>1)!Raising prices will decrease total revenue

Net Gain = -$3

Lose

Gain

Total RevenueTR = P x Q

!

Cross-Price Elasticity of Demand

Cross-Price Elasticity of Demand

Percentage Change in Quantity Demanded of one good!

Percentage Change in Price!of another good

%%

QD

P1

2

Cross-Price Elasticity of Demand

0

SubstitutesCompliments

<0 >0

1. Calculate Elasticity!2. Compare to benchmark of 0

%%

QD1

P2

35%

50%=.7 >0

Substitutes

%%

QD1

P2

-40%

50%=-.8 <0

Compliments

Cross-Price Elasticity of Demand

0

SubstitutesCompliments

<0 >0

%%

QD

P1

2

!

Income Elasticity of Demand

!

Normal, Inferior, or Luxury? Percentage Change in !Quantity Demanded !

Percentage Change in Income

Income Elasticity of Demand

%%

QD

I

Income Elasticity of Demand

0

LuxuryInferior

<0 >1

1. Calculate Elasticity!2. Compare to benchmark of 0 and 1

1

Normal

%%

QD

I

10%

20%=.5

>0!<1

Normal

%%

QD

I

-50%

20%=-2.5 <0

Inferior

%%

QD

I

100%

20%= 5 >1

Luxury

Income Elasticity of Demand

0

LuxuryInferior

<0 >11

Normal

%%

QD

I

!

Price Elasticity of Supply

!

Price Elasticity of Supply

%%

QS

P

Percentage Change in !Quantity Supplied!

Percentage Change in Price

Price Elasticity of Supply

1

ElasticInelastic

<1 >1

1. Calculate Elasticity!2. Compare to benchmark of 1

%%

QS

P

10%

20%=.5 <1

Inelastic

%%

QS

P

40%

20%= 2 >1

Elastic

Price Elasticity of Supply

1

ElasticInelastic

<1 >1

%%

QS

P

!

What determines Price Elasticity of

Demand?

Close Substitutes Passage of Time

Luxuries vs. Necessities Definition of Market

Share of Budget

Cross-Price Elasticity of Demand

0

SubstitutesCompliments

<0 >0

1. Calculate Elasticity!!

!

2. Compare to benchmark of 0

%∆QD1

%∆P2

Income Elasticity of Demand

0

LuxuryInferior

<0 >1

1. Calculate Elasticity!!

!

2. Compare to benchmark of 0 and 1

1

Normal

%∆QD%∆I

ELASTICITY EQUATION BENCHMARK

Price Elasticity !of Demand

Cross-Price!Elasticity

Income!Elasticity

Price Elasticity!of Supply

Midpoint!Formula

Inelastic | Elastic ! 1

Compliments | Substitutes! 0

Inferior | Normal | Luxury! 0 1

Inelastic | Elastic ! 1

%∆QD%∆P

%∆QS%∆P

%∆QD1

%∆P2

%∆QD%∆I

∆Q∆PQPx

1. Prices increase from $5.00 to $6.00. Quantity demanded decreases from 100 units to 80 units.!!What is the price elasticity of demand?!What is the total revenue at $5.00 per unit?!What is the total revenue at $6.00 per unit?!!2. If I increase prices from $20 to $25, quantity demanded decreases from 1,000 units to 900 units. Should I raise prices? Why?!!3. Prices increase from $10 to $15 for product A. Quantity demanded for product B increases from 500 units to 600 units!!What is the cross-price elasticity of demand? Are these products compliments or substitutes?!!

4. Prices increase from $10 to $15 for product C. Quantity demanded for product B decreases from 40 units to 30 units!!What is the cross-price elasticity of demand? Are these products compliments or substitutes?!!5. Your income increase from $10 to $15 per hour. Quantity demanded for product E decreases from 20 units to 15 units!!What is the income elasticity of demand? Is this product an inferior, normal, or luxury good?!!6. Your income decreases from $12 to $10 per hour. Quantity demanded for product F increases from 10 units to 12 units!!What is the income elasticity of demand? Is this product an inferior, normal, or luxury good?!

Elasticity Quiz 1. Prices increase from $5.00 to $6.00. Quantity demanded decreases from 100 units to 80 units.!!What is the price elasticity of demand?!Midpoint Formula !!!!What is the total revenue at $5.00 per unit?!!$5 x 100 = $500!!What is the total revenue at $6.00 per unit?!!$6 x 80 = $480

∆Q∆PQPx 20

1905.50x 1.22110

90= = =