Recomendados
Mais conteúdo relacionado
Mais procurados
Mais procurados (20)
Destaque
Destaque (20)
Semelhante a Prinecomi lectureppt ch04
Semelhante a Prinecomi lectureppt ch04 (20)
Mais de rsvanwassenhove
Último
Último (20)
Prinecomi lectureppt ch04
- 1. Elasticity 4
- 2. Previously • Demand and supply balance the desires of consumers and producers. • Demand and supply steer the market price toward equilibrium. • We learned the direction of changes in quantity demanded and quantity supplied as a result of a price change. • In this chapter, studying elasticity will help us understand the sensitivity of consumers and producers to changes in price.
- 3. Big Questions 1. What is the price elasticity of demand, and what are its determinants? 2. How do changes in income and the prices of other goods affect elasticity? 3. What is the price elasticity of supply? 4. How do the price elasticity of demand and supply relate to one another?
- 4. Price Elasticity of Demand • Elasticity – Responsiveness of buyers and sellers to changes in market conditions. • Why is it useful? – Prices or other demand and supply determinants could change. – Understanding elasticity will help us improve the predictive power of our basic economic model. – Instead of just knowing the direction of a variable change, we can study the size of the change.
- 5. Price Elasticity of Demand • Recall the law of demand – Demand curve is downward-sloping – This gives us the direction of the relationship between these two variables. • Price elasticity of demand – A measure of the responsiveness of quantity demanded to a change in price – This gives us the sensitivity of the relationship between these two variables.
- 6. Price Elasticity of Demand • Demand is elastic if – Quantity demanded changes significantly as the result of the price change – Elastic = “sensitive” or “responsive” • Demand is inelastic if – Quantity demanded changes a small amount as the result of the price change – Inelastic = “insensitive” or “unresponsive”
- 7. The Determinants of the Price Elasticity of Demand 1. Existence of substitutes –Goods with lots of substitutes • Canned vegetables, breakfast cereals, many types of products with multiple brands • More elastic –Goods with no good substitutes • Broadway theatre, rare coins, autographs, drinking water, electricity, Super Bowl tickets. • More inelastic
- 8. The Determinants of the Price Elasticity of Demand 2. Share of the budget spent on the good – Demand is more elastic for “big ticket” items that make up a large portion of income. – Demand is more inelastic for inexpensive items. – Which would you react to more? • 20% sale on a new vehicle you want • 20% sale on candy bar
- 9. The Determinants of the Price Elasticity of Demand 3. Time and adjustment process –Generally, demand for goods tends to become more elastic over time. –Over time, consumers are • More able to find substitutes • More able to adjust for price changes in other ways
- 10. Time Periods of Market Response Time period name How long? Demand Immediate Run No time to adjust behavior. Very inelastic or perfectly inelastic Short Run A little bit of time to adjust behavior. Slightly more elastic than the immediate run. Long Run Enough time to make a full adjustment to any changes in price. Even more elastic. Demand elasticity reflects the information of all substitutes.
- 11. Computing the Price Elasticity of Demand • Elasticity can help answer questions such as: –Should a firm raise or lower the price of a good to increase revenues? –If an excise tax is placed on a good, how much tax revenue will be generated?
- 12. The Price Elasticity of Demand Formula ∆ = change P Q E d d ∆ ∆ = % %
- 13. Example • University parking pass prices increase by 50%. • As a result, 25% less people demand a parking pass. 5.0 %50 %25 −= + − = P Q E d d ∆ ∆ = % % Plug in numbers
- 14. Example • What does the numerical result mean? – In this case, the quantity demanded response was relatively small (compared to the price change). – Demand is inelastic for parking. • Why is it negative? – There is an inverse relationship between price and quantity demanded. 5.0 %50 %25 % % −= + − = ∆ ∆ = P Q E d d
- 15. Midpoint Method • One issue with using the percent change formula. – Price decreases from $100 to $80 • A 20% change – Price increases from $80 to $100 • A 25% change! • Thus, the “direction” of the variable change will change our numerical elasticity result. How can we fix this?
- 16. Midpoint Method • The Midpoint Method is an alternative way to find elasticity. The formula is more complicated. ( ) ( ) ( ) ( )PP QQ E dd d ofaverage/ ofaverage/ ∆ ∆ = ( ) ( )[ ] ( ) ( )[ ]2// 2// 2112 2112 PPPP QQQQ Ed +− +− =
- 17. Midpoint Method • Example: – “Old” price. P1 = $6 results in Q1 = 15 – “New” price. P2 = $4 results in Q2 = 25 ( ) ( )[ ] ( ) ( )[ ]2// 2// 2112 2112 PPPP QQQQ Ed +− +− = ( ) ( )[ ] ( ) ( )[ ]2/46/64 2/2515/1525 +− +− =dE 25.1 5/2 20/10 −= − =dE Plug in numbers
- 18. Graphing Price Elasticity • If demand is relatively elastic –We are relatively sensitive to price changes –The demand curve is relatively flatter • If demand is relatively inelastic –We are relatively insensitive to price changes –The demand curve is relatively steeper
- 19. Graphing Price Elasticity 0 % % = ∆ ∆ = P Q E d d Numerator is zero!
- 22. Graphing Price Elasticity ∞−= ∆ ∆ = % % P Q E d d Denominator is zero!
- 23. Remembering Elasticity • Relatively shallow (flat) demand curves are relatively more elastic. • Relatively steep demand curves are relatively more inelastic. • Ways to remember: – Steep demand curve looks like the letter “I,” so it is “I”nelastic. – Steep demand curve has an almost “I”nfinite slope, and is “I”nelastic
- 24. Examples P Q E d d ∆ ∆ = % % Elasticity Ed coefficient Interpretation Example Perfectly Inelastic Ed = 0 price does not matter saving your pet Relatively Inelastic 0 > Ed > -1 price is less important than Qd electricity Unitary Ed = -1 price and Qd are equally important Relatively Elastic -1 > Ed > -∞ price is more important than Qd An apple Perfectly Elastic Ed = -∞ (undefined) price is everything $10 bill
- 25. Time, Elasticity, and Demand Curve
- 26. Defining a Good • Think about price elasticity of demand and the goods we purchase. • Often, you could think of a good in two different ways. 1. The good in general 2. A specific brand (or type) of the good • Could this change the price elasticity of demand for the good?
- 27. Defining a Good • Gasoline (in general) –Inelastic demand; no feasible substitutes • Specific brand of gas –If the price of only Shell gas increases, you could buy Mobil gas instead. –A perfect substitute exists, demand is very elastic.
- 28. Defining a Good • Breakfast cereal (in general) – Somewhat elastic – Bagels, toaster pastries, and oatmeal are imperfect substitutes. • Specific brand of breakfast cereal – Very elastic. Many substitutes when the good considered is a specific brand. – Raisin Bran more expensive? Buy Cheerios instead.
- 29. Economics in Jingle All the Way Using the determinants of elasticity, figure out the following: • Which good has the more relatively inelastic demand? Turbo Man or Booster?
- 30. Economics in South Park • “Something Wal-Mart this way Comes” –A national big-box, low-price store comes into South Park. Why does this cause some local stores to go out of business?
- 31. Slope and Elasticity • Elasticity and the slope of the demand curve are related, but are NOT the same. • In fact, with a linear demand curve: – The slope will be the same at all points. – Elasticity will be different at all points. – Elasticity decreases (gets more inelastic) as we move down and right along a linear demand curve.
- 33. Demand Elasticity and Total Revenues • Demand elasticity changes along a linear demand function. Who cares? • Elasticity is related to total revenues. – Firms are interested in increasing total revenues. – Firms will need to know whether to increase or decrease price to increase revenues. • Total revenues = Price × Quantity Purchased – Graphically, this is a rectangle connecting the origin and a point on the demand curve.
- 34. Example P Q E d d ∆ ∆ = % % PQd −= 5 P Qd TR = (P) × (Qd) %∆P %∆Qd Ed Interpretation $5 0 $0 -22% 200% -9.1 Highly elastic $4 1 $4 -29% 67% -2.3 Relatively elastic $3 2 $6 -40% 40% -1.0 Unitary $2 3 $6 -67% 29% -0.4 Relatively inelastic $1 4 $4 -200% 22% -0.1 Highly inelastic $0 5 $0
- 35. Elasticity and Revenue • The previous table illustrated that: – Revenue is related to elasticity. – Revenue is maximized at the unit elastic point on the linear demand function. • Graphically, we can also show trade-offs when a firm changes the price of its good. – Increase price • Higher price per unit, but sell less units – Lower price • Lower price per unit, but sell more units
- 39. Income Elasticity • Changes in price – Cause a movement along a demand curve – Affect your consumption of a good • Changes in income – Shift the demand curve – Also affects your consumption of a good • Income elasticity – Responsiveness of the change in quantity purchased as a result of a change in income
- 40. Income Elasticity • Is this ratio positive or negative? – Income elasticity could be positive or negative, depending on the good. – If income elasticity is positive, there is also interest in whether it is a big or small positive number. I Q E d I ∆ ∆ = % %
- 41. Income Elasticities • Normal goods – Goods we purchase more of when income rises • Inferior goods – Goods we purchase less of when income rises • Normal goods fall into two categories: – Luxuries • Purchase a lot more when income rises – Necessities • Purchase a little more when income rises
- 42. Income Elasticities I Q E d I ∆ ∆ = % % Type of good Subcategory Income elasticity Example Inferior E I < 0 Macaroni and cheese Normal Necessity 0 < E I < 1 Milk Normal Luxury E I > 1 Diamond ring
- 43. Practice What You Know— Categorizing Goods • With regard to income elasticity, state whether you think the following goods are inferior, necessity, or luxury goods.
- 44. Practice What You Know— Categorizing Goods • Steak • Toothpaste • Fast food • Pedicures • New vehicles • Used vehicles • Laptop computers • Lawn-care service • Milk • Gasoline • Cigarettes • Lottery tickets
- 45. Cross-Price Elasticity • While studying demand determinants, we learned that two goods can be related. • Recall the intuition of substitute and complement goods. • Cross-price elasticity – Measures the responsiveness of the quantity demanded of one good to a change in the price of another good (B)% (A)% P Q E d C ∆ ∆ =
- 46. Cross-Price Elasticities Relationship between goods Cross-price elasticity Example Substitutes EC > 0 Pizza Hut and Dominos No relationship E C = 0 A basketball and bedroom slippers Complements E C < 0 Turkey and gravy
- 47. Price Elasticity of Supply • Producers of different goods have different sensitivities to changes in price. • If the price of a good increases… – Will a firm produce a lot more of that good? – Will a firm increase production by only a small amount? – Why? • Price elasticity of supply – Measure of the responsiveness of the quantity supplied to a change in price
- 48. Price Elasticity of Supply Determinants • Flexibility of producers –More production flexibility implies more elastic supply. • Firms will be very responsive to changes in price. –A firm will have more production flexibility if it is able to: • Have extra capacity • Maintain inventory • Relocate easily
- 49. Price Elasticity of Supply Determinants • Time and adjustment process –Immediate run • Suppliers are stuck with what they have on hand; no adjustment. –Short run, long run • The more time that passes, the more the firm is able to adjust to market conditions. • Supply becomes more elastic over time.
- 50. Supply Elasticity over Time
- 51. Price Elasticity of Supply • Price elasticity of supply mathematically – Quantity supplied change as a result of a change in price • Will this ratio be positive or negative? Why? – Price elasticity of supply is positive because of the direct relationship between price and quantity supplied. P Q E S S ∆ ∆ = % %
- 52. Supply Elasticity Examples P Q E S S ∆ ∆ = % % Elasticity Price elasticity of supply Example Perfectly inelastic ES = 0 Oceanfront land Relatively inelastic 0 < E S < 1 Cell phone tower Relatively elastic E S > 1 Hot dog vendor
- 53. Combining Supply and Demand • We’ve previously drawn shifts in demand and supply, and studied the changes in equilibrium price and quantity. • How will the magnitude of the price and quantity change be affected if we change the demand or supply elasticity?
- 55. Drug Elasticity and Revenues • Think about the demand for illegal drugs. Do you think the demand is relatively elastic or inelastic. Why? – Relatively inelastic – No substitutes – May make up a small percent of income – Addiction may increase willingness to pay – Purchases may be made in the immediate or short run
- 56. Drug Elasticity and Revenues • Suppose that we wanted to enact a policy with the following goals: –Greatly decrease drug consumption –Make drug-dealing a less attractive business • Reaching the goals: –Should we try to decrease the supply of drugs or decrease the demand for drugs?
- 57. Drug Elasticity and Revenues • Decrease the supply of drugs –Tougher laws for drug dealers –More police enforcement • Decrease the demand for drugs –Drug education programs –Offer (legal) substitute activities to decrease drug demand
- 58. Drug Elasticity and Revenues • Draw a supply curve with a relatively inelastic demand. Draw this graph twice. • What happens if there is a leftward shift in supply? – Quantity only slightly decreases – The new equilibrium is at a higher point on the demand curve. Since demand is inelastic, this means that total drug revenues actually increase!
- 59. Drug Elasticity and Revenues • Leftward shift in supply: • Only a small decrease in drug transactions • Increase in drug prices • Increase in drug revenues • This may actually make drug-dealing more lucrative (and dangerous). P Q D S2 S1 E2 E1 Q1 Q2 P1 P2
- 60. Drug Elasticity and Revenues • What happens if there is a leftward shift in demand? –Quantity decreases more than the previous case –Drug revenues decrease
- 61. Drug Elasticity and Revenues • Leftward shift in demand • Larger decrease in drug transactions • Decrease in drug prices • Decrease in drug revenues • Drug dealing is now less attractive P Q S D2 D1 E2 E1 Q1 Q2 P1 P2
- 62. Drug Elasticity and Revenues • Thus, it appears that if we want to accomplish our two goals . . . – Policy of decreasing drug demand will be better than trying to decrease drug supply – Better to use resources on education and offering legal substitutes rather than increasing penalties and police enforcement
- 63. Conclusion • Elasticity is a measure of sensitivity (responsiveness) between two variables. • The ability to determine whether demand and supply are elastic or inelastic allows economists to calculate the effects of personal, business, and policy decisions. • Understanding elasticity helps our economic model say much more about the world.
- 64. Summary • The price elasticity of demand – A measure of the responsiveness of quantity demanded to a change in price • Demand will generally be more elastic if: – There are many substitutes available. – The item comprises a large share of your budget. – you have plenty of time to make a decision. P Q E d d ∆ ∆ = % %
- 65. Summary • Elasticity and slope are not the same. • Total revenue can be calculated by taking the price of the good and multiplying it by the quantity sold. • If demand is inelastic – Total revenue will rise as the price rises. • If demand is elastic – Total revenue will rise as the price falls.
- 66. Summary • The price elasticity of supply – A measure of the responsiveness of the quantity supplied to a change in price • Supply will generally be more elastic if producers have: – Flexibility in the production process – Ample time to adjust production P Q E S S ∆ ∆ = % %
- 67. Summary • The income elasticity of demand: – The change in the quantity purchased divided by the change in personal income. – Normal goods have a positive income elasticity. – Inferior goods have a negative income elasticity. • The cross-price elasticity of demand: – Responsiveness of the quantity demanded of one good to a change in the price of another good. – Positive values for the cross-price elasticity mean that two goods are substitutes. – Negative values indicate that the two goods are complements.
- 68. Practice What You Know Suppose that the price of candy bars increases by 100%. As a result of this, you decide to purchase 50% less candy bars. How would you describe your demand for candy bars? a. Demand is elastic. b. Demand is unit elastic. c. Demand is inelastic. d. Demand is perfectly inelastic.
- 69. Practice What You Know Suppose that Doug receives a pay increase at work, and his income increases by 20%. As a result, Doug decides to buy 12% less ground beef. For Doug, ground beef is a(n) ________. a. luxury good b. necessity good c. normal good d. inferior good
- 70. Practice What You Know Economists have studied that when the price of chicken increases, people purchase less rice. With these two goods, which of the following is true? (EC = Cross-price elasticity) a. EC < 0, chicken and rice are complements. b. EC > 0, chicken and rice are complements. c. EC < 0, chicken and rice are substitutes. d. EC > 0, chicken and rice are substitutes.
- 71. Practice What You Know In terms of price elasticity of demand, which of the following goods do you think is the least elastic (most inelastic)? a. new house b. electricity to power your home c. a specific brand of breakfast cereal d. new vehicle
- 72. Practice What You Know Suppose a firm is selling a product at a price on the inelastic portion of the demand line. This firm could increase revenue by doing what? a. lowering the price, selling more units b. lowering the price, selling less units c. increasing the price, selling more units d. increasing the price, selling less units
Notas do Editor
- Lecture tip: For the third bullet, mention also that we studied a change in demand (a shift in the demand curve), as well as a change in quantity demanded (sliding along the demand curve). A price change will cause us to slide along the demand curve to a different point on that same curve. Other factors changing (income, preferences, price of OTHER goods) will cause the demand curve to shift. We’ve seen the DIRECTION of the SLIDE or SHIFT, but now (with elasticity) we will learn more about the SIZE of these changes.
- Lecture tip: Determinants: This just means we’re asking what determines elasticity.
- Lecture tip: Emphasize that elasticity can compare the responsiveness of the relationship between any two variables. In this chapter, we will discuss many types of elasticity, which detail the sensitivity of the relationship between different pairs of variables. As stated before in the “Previously” slide (slide #2) . . . A price change will cause us to slide along the demand curve to a different point on that same curve. Other factors changing (income, preferences, price of OTHER goods) will cause the demand curve to shift. We’ve seen the DIRECTION of the SLIDE or SHIFT, but now (with elasticity) we will learn more about the SIZE of these changes.
- Lecture notes: The law of demand states that there is an inverse relationship between price and quantity demanded. The two variables move in opposite directions (one increases, the other decreases). This inverse relationship between these two variables occurs as we “slide” along a demand curve. Elasticity extends and strengthens our knowledge of demand. Mathematically, you could state that we previously knew the SIGN of the coefficient on our variables, now we are studying the MAGNITUDE of the coefficient on our variables.
- Lecture notes: Prices can and do change. When the price of a good increases, sometimes we buy a little bit less. For other goods, if the price increases, we may buy a lot less. See the rubber band. When we think of “elastic,” we may think of something that can be stretched. A new or tight rubber band can be thought of as very elastic, and will be responsive when you try to stretch or pull it. An old rubber band that has lost its elasticity (perhaps it is inelastic) won’t be responsive.
- Lecture notes: Determinants: What determines whether demand is elastic or inelastic? Goods with lots of substitutes: For brand name products, I like to use toiletries (toothpaste, deodorant, shampoo) as examples. Also, breakfast cereals have a lot of brand-name substitutes. One type of fruit or vegetable can substitute for another kind. No apples today? I’ll get a banana or orange instead. The price change intuition follows closely. Unless you are extremely brand loyal, an increase in the price of your shampoo may cause you to buy another substitute brand. Goods with no good substitutes: Can’t replace drinking water or electricity; only one Super Bowl, accept no substitutes! With a price increase in electricity, we don’t turn our air conditioning off. We may make SMALL changes, but nothing drastic.
- Lecture notes: Thinking about buying a new car? A 20% sale could greatly influence your decision to buy that vehicle (as opposed to another vehicle that is not on sale). You may call home to mom to brag about 20% savings on a car, but you won’t call to tell her you saved 20% on a candy bar. Also, if you visited a car dealer with the intent of buying a car, and found out that car was 50% more expensive than you thought, you would most likely not buy the car. On the other hand, if you wanted to buy a candy bar and found out it was 50% more expensive than you thought, this would probably not deter you from buying your favorite candy bar.
- Lecture notes: “Other ways” could include changing your behavior or situation in a more drastic way beyond just consuming less of the good or consuming a substitute good. In a couple of slides, we will see that one way to consume less gas is to move closer to where you work (this may occur since there is not currently many viable gasoline substitutes to power vehicles). This will decrease gas consumption.
- Lecture notes: Click through to show the table. Think of gasoline: In the immediate run, if you are out of gas, you MUST buy more gas right now, even if the price is very high. You cannot wait, and there is no time to adjust or search for lower prices. In the short run, you may have a little gas left, and have a little bit of time before you need to fill up. You could search around for a cheaper price at different gas stations. In the long run, you have enough time to fully adjust. You will be able to find the cheapest gas (and are therefore most elastic due to full information about substitutes). In addition, other adjustments may be made so you have to use less gas in the first place. For example, you could get an electric car or relocate closer to work so you can walk instead of drive.
- Lecture tip: Intuition of elasticity is helpful, but when viewed in a more tangible way, it is even more useful. It may seem odd to students that a firm (if it has the choice) would ever consider lowering prices. How would this help the firm? Help the students realize there is a trade-off here. If the price is lower, each unit sold will be sold at a lower price (this is a cost to the firm). However, with lower prices, consumers will purchase more units of the good (this is a benefit to the firm). The firm must ask if the benefits are greater than the costs. You may have to explain that an excise tax is just a tax placed on a specific good. Often, we can think of “sin taxes” on cigarettes and alcohol as examples.
- Lecture notes: Ed = Price elasticity of demand The triangle is the Greek letter “delta,” which is mathematically used to denote changes in a variable. If your students have taken calculus, they will recognize the symbol. But be careful mentioning this. This formula is NOT a derivative. It is a ratio of percentage changes. Later, we’ll see that even a linear demand function will have different elasticity values along the line.
- Lecture notes: Click to show the plugged-in numbers. We are plugging in the numbers to get our elasticity value. In this case, the division is pretty simple.
- Lecture notes: Note that elasticity is UNITLESS. The prices cancel out. The Qd terms cancel out. The percentage changes cancel out. We are just left with a number. What does the number mean? It’s a measure of sensitivity. A BIG negative number means MORE sensitivity. A SMALL negative number means LESS sensitivity.
- Lecture notes: With price elasticity of demand, we often estimate elasticity over a range on the demand function. Thus, we’ll have two reference points (and ‘old’ point and a ‘new’ point). If we switch the ‘old’ and ‘new’ point, we’ll get different estimates of elasticity as a result of different percent changes as shown in the slide. The percent change formula by itself is: new – old percent change = ------------ old Lecture tip: You may want to show the math of this on a separate overhead.
- Lecture tip: This may seem complicated, but it’s really just taking a difference and an average. This must be done for quantity demanded and price. The purpose of taking the average is to take away the “directional” problem. The average of two numbers is the same, no matter which number we list first. It’s best to explain each parenthetical term one at a time. Show “change in Qd” on top and bottom. Show “average of Qd” on top and bottom, etc. Click through to explain each term and highlight one at a time.
- Lecture tip: For “Plug in numbers,” emphasize that every variable (Q1, Q2, P1, and P2) will be replaced with a numerical value. Plug in the number and solve numerically. The midpoint method will “standardize” the result. In other words, we could switch the words “new” and “old,” along with the subscripts 1 and 2, and still get the same result of Ed = -1.25.
- Image: Animated Graph Figure 4.1A Lecture notes: If a good is perfectly inelastic, it means you are willing to pay anything to receive the good or service. Examples: Insulin (if you are diabetic) Health care for your beloved pet
- Image: Animated Graph Figure 4.1B Lecture notes: Examples of relatively inelastic goods include gasoline and cigarettes. When the price of gas goes up, people do not change their driving habits very much. With smoking, higher prices (usually in the form of sin taxes) are accompanied by only small decreases in smoking. This actually results in large revenues from cigarette taxes. Emphasize the word “relatively” when you say relatively inelastic. Technically, we cannot call this an inelastic demand curve, since there is actually an elastic and inelastic section on the line. It is, however, “relatively” more inelastic than a curve that is shallower.
- Image: Animated Graph Figure 4.1C Lecture notes: Examples of relatively elastic goods fruits, vegetables, and breakfast cereals. There are a lot of substitutes for these goods, but the substitutes may not be perfect, and there may be preferences for one fruit over another. However, the availability of substitutes (whether they are perfect or not) increases our sensitivity to the price of a good. Emphasize the word “relatively” when you say relatively elastic. Technically, we cannot call this an elastic demand curve, since there is actually an elastic and inelastic section on the line. It is, however, “relatively” more elastic than a curve that is steeper.
- Image: Animated Graph Figure 4.1D Lecture notes: Here, we are infinitely sensitive to price. If the price rises even by 1%, we will buy none of the good. If the price drops by 1%, we will want to purchase as much as we can of the good. Thus, the price cannot deviate from the height of the horizontal line. Mathematically, this will be dividing by zero, which in the limit approaches negative infinity. Examples include a $10.00 bill. (It must be sold at a price of $10.00). To some extent, we could also consider goods with perfect substitutes. No one will purchase gas for $3.00 if it is being sold at the station next door for $2.95. However, we still have a finite demand for gasoline.
- Lecture notes: In the textbook, another way is shown. A capital E has three horizontal lines, showing that elastic demand is relatively flat or horizontally sloped.
- Lecture tip: Click through to reveal the table one row at a time. Show how the equation could result in different elasticity values. Basically, it is comparing the relative sizes of the numerator and denominator.
- Image: Animated Figure 4.2 Lecture notes: We’ve already discussed immediate run, short run, and long run, and the responsiveness to price changes in each time period. Here, we can see the idea graphically. In each case, the price rises from P1 to P2. Immediate run: No change in quantity demanded. Qd remains at Q1; no time to adjust at all. Short run: Time for a small adjustment. Qd falls to Q2; a slight decrease. Long run: Time for full adjustment. Demand is more elastic, and Qd falls to Q3; the largest decrease is due to more responsiveness with a relatively more elastic long-run demand curve.
- “Beyond the Book Slide” Lecture notes: Usually, the more narrowly we define a good, the more substitutes it has. This is especially true if we are talking about a very specific brand of a good.
- “Beyond the Book Slide” Lecture tip: Ask the students what would happen if there are four gas stations at an interstate interchange and one of them was selling gas for 10 cents more per gallon; 10 cents isn’t that much money, but would anyone buy gas at that station?
- “Beyond the Book Slide” Lecture notes: Once again, if we consider a good in such a way that it will have more substitutes, it will have a more elastic demand. Considering just a very specific brand of cereal (as opposed to just cereal as a whole) will increase our substitute options.
- “Economics in the Media” Lecture Tip: The clip mentioned on the slide can be found in the Interactive Instructor’s Guide. Access the direct link by clicking the icon in the PowerPoint above.
- “Economics in the Media” LANGUAGE WARNING!!!! Lecture Tip: The clip mentioned on the slide can be found in the Interactive Instructor’s Guide. Access the direct link by clicking the icon in the PowerPoint above.
- Lecture notes: The downward-sloping demand gives the elasticity coefficient the negative sign. However, the slope is not the same as the elasticity. Lecture tip: Just for nomenclature, we will always call the relationship between price and quantity demanded a “demand curve,” even if that relationship is linear.
- Image: Animated Figure 4.3 Lecture notes: A carry-over from the previous slide, the symbol in the title is a “does not equal” sign. At $5 the consumer purchases zero lattes, at $4 she purchases one latte, at $3 she purchases two, and she continues to buy one additional latte with each $1 drop in price. As you progress downward along the demand curve, price becomes less of an inhibiting factor and, as a result, the price elasticity of demand slowly becomes more inelastic. Eventually the price falls to zero. At that point, price no longer matters because the lattes are free. Whenever price is irrelevant, we say that the price elasticity is perfectly inelastic. Notice that the slope of a linear demand curve is constant. However, when we calculate the price elasticity of demand between the various points in the figure, it becomes clear that demand becomes increasingly inelastic as you move down the demand curve, as shown by the change in the Ed from -9.1 to -0.1. Along any straight demand curve, the price elasticity of demand is not constant. You can see this by noting how the price elasticity of demand changes from highly elastic near the top of the demand curve to highly inelastic near the bottom of the curve.
- Lecture notes: In future chapters, we’ll talk about profit maximization. When is revenue maximization useful? Lecture tip: You could discuss situations where costs are fixed or sunk, so only revenue matters at the margin. Selling tickets to a scheduled event, selling parking passes. Emphasize also that with the previous supply/demand model, we assumed a competitive market with a lot of buyers and sellers. In this case, if the firm is just picking a price on the demand curve, it is NOT a competitive market. In fact, it is more representative of a price-setting monopoly.
- Lecture tip: Click through the slide to show/hide different rectangles. Emphasize the demand equation for this example, and note that the price elasticity of demand formula is shown again as well. The red shape at the end emphasizes that revenue is maximized at the unit elastic portion of the demand line.
- Lecture notes: Once again, this is the intuition of the trade-off. I could sell more, but I must lower my price to do that. (Big assumption): Assume all units are sold at the same price. We are not price-discriminating here. Price discrimination is talked about in a later chapter.
- Image: Animated Figure 4.4A Lecture notes: In the elastic region of the demand curve, lowering price will increase total revenue. The gains from increased purchases (the blue-shaded area) are greater than the losses (the pink-shaded area) from a lower purchase price. At a price of $4, one unit is sold and total revenue is $4. When the price is lowered to $3, two units are sold so the total revenue is now $3×2 = $6. So, by lowering the price from $4 to $3, the business has generated $2 more in revenue. But to generate this extra revenue, the business gives up $1 for each unit it sells because $1 in sales revenue is lost from lowering the price from $4 to $3. This is represented by the pink-shaded area under the demand curve in the figure.
- Image: Animated Figure 4.4B Lecture notes: In the unitary region of the demand curve, lowering price will no longer increase total revenue. The gains from increased purchases (the blue-shaded area) are equal to the losses (the pink-shaded area) from a lower purchase price. When the price drops from $3 to $2, the total revenue stays at $6. This result occurs because demand is unitary, as shown in Figure 4.6. This special condition exists when the percentage price change is exactly offset by an equal, and opposite, percentage change in the quantity demanded. In this situation, revenue remains constant. At $2, three lattes are purchased so the total is $2 × 3 which is the same as it was when $3 was the purchase price. As a result, we can see that total revenues have reached a maximum. Between $3 and $2, the price elasticity of demand is unitary. This finding does not necessarily mean that the firm will operate at the unitary point, since maximizing profit, not revenue, is the ultimate goal of a business and we have not yet accounted for costs in our calculation of profits.
- Image: Animated Figure 4.4C Lecture notes: In the inelastic region of the demand curve, lowering price will decrease total revenue. The gains from increased purchases (the blue-shaded area) are smaller than the losses (the pink-shaded area) from a lower purchase price. Once we reach a price below unitary demand, we move into the realm of inelastic demand in the figure shown. When the price falls to $1, total revenue declines to $4. This result occurs because the price elasticity of demand is now relatively inelastic, or price insensitive. In other words, latte consumers adding a fourth drink will not gain as much benefit as they did when they purchased the first. Even though the price is declining by $1, price is increasingly unimportant; as you can see by the blue squares, it does not spur a large increase in consumption.
- Lecture notes: Price is not the only variable that determines how much of a good we buy. Other factors, such as income determine our consumption as well. A different type of elasticity (with different variables now) is income elasticity. Now, we ask how sensitive our consumption is with regard to a change in INCOME. Lecture tip: Be careful to note the difference again between a movement and a shift in demand.
- Lecture notes: Notice that the equation is very similar to the one we’ve seen before. The numerator is the same, but the denominator is different. We are looking at a change in income instead of a change in price, but we are still examining the effect on quantity demanded. Note that we are holding price CONSTANT here. How much more (or less) do you buy when income changes, all other things equal?
- Lecture notes: Normal and inferior should be review. Luxuries and necessities should be new. Remind students to look at these goods with regard to the numerical income elasticity rather than by thinking about connotation about what they think a necessity or luxury is.
- Lecture notes: Fast food may be considered a luxury by low-income people, but inferior by high-income people. Laptops used to be luxuries, but now maybe are more of a necessity. Gasoline is often considered a derived demand. Just because we get more money doesn’t mean we’ll just buy more gas by itself. However, with more money, we may take more trips, go shopping more, go to the movies more, etc., and this will require us to buy more gas. Cigarettes are an interesting example. Students may know that cigarettes are pretty expensive, so they may say luxury. Others may say necessity, citing addiction. However, you can ask students this question: At an aggregate level, who smokes more, high- or low-income people? Low-income people tend to smoke more, which would make cigarettes inferior. The same argument could be said for lottery tickets.
- Lecture notes: We are looking at how much more or less you buy of good A when the price of good B changes.
- Lecture notes: Price elasticity of supply can be considered by more competitive firms that do not set their own prices. In this case, we can think of a competitive firm just responding to an exogenous price change (perhaps as the result of increased demand).
- Lecture notes: Elastic supply: De Beers diamonds has diamonds in inventory that aren’t put on the market. If the price goes up, it is very easy to put these diamonds for sale on the market when the price is higher. Easy for a hot dog vendor to relocate to a higher-demand area (where price is higher). Inelastic supply: Sporting events: not easy to add more stadiums (or even more seats within an existing stadium) if the price goes up.
- Lecture notes: Analogous to demand. Supply becomes more responsive in the long run when there is more time to adjust to changing market conditions.
- Image: Animated Figure 4.5 Lecture notes: Increased flexibility and more time, each act to make supply more elastic. Therefore, when the price rises from P1 to P2, the initial impact is that producers are unable to expand output—it remains at Q1, since inventories are fixed and there is no time available to increase production. However, when we relax those conditions, the firm becomes more flexible in the short run (S2) and output expands to Q2. Eventually, in the long run (S3) when there is time to make all of the desired changes, the firm is able to produce even more, and it moves to Q3 in response to higher prices.
- Lecture notes: Once again, the equation has a familiar look to it. The denominator is the same as the demand elasticity formula (we are looking at a price change), but the numerator is different. Here, we are examining the resulting change in quantity supplied.
- Click to show the table one row at a time.
- Lecture tip: The next slide will give an example of this for oil. You could state some determinants of elasticity again here. Suppose there is a demand increase (shift). Realizing that supply becomes more elastic in the long run, what will the result of a demand increase be: *In the short run?
- Image: Animate Figure 4.6 Lecture notes: When an increase in demand causes the price to rise from $60 to $100, initially producers are unable to expand output very much; production expands from Q1 to Q2. However, in the long run, as producers expand production, the price will fall back to $80.
- “Beyond the Book Slide”
- “Beyond the Book Slide”
- “Beyond the Book Slide” Lecture notes: Decreasing the supply of drugs means going after the dealers. Decreasing the demand for drugs means trying to make people want to consume less drugs. Drug education programs will hopefully make people more aware of the dangers of drug use.
- “Beyond the Book Slide”
- “Beyond the Book Slide” Lecture notes: The purple area is an overlap of red and blue. Blue by itself represents lost drug revenue from the supply shift. Red by itself represents gain in drug revenue. Note that the gain outweighs the loss, so overall drug revenue actually increases. This could make drug-dealing more profitable.
- “Beyond the Book Slide”
- “Beyond the Book Slide” Lecture notes: In this case, overall drug revenue decreases since price and quantity fall. This leftward demand shift makes drug-dealing less attractive.
- “Beyond the Book Slide”
- “Clicker Question” Correct answer: C Price is “less important” than quantity. Mathematically, the numerator (%QD change) is less than the denominator (%Price change), so the magnitude is smaller than 1. This is inelastic; relatively insensitive.
- “Clicker Question” Correct answer: D MORE income leads to LESS consumption. This is a characteristic of an inferior good.
- “Clicker Question” Correct answer: A EC &lt; 0 (key words are INCREASE in chicken price, purchase LESS rice).
- “Clicker Question” Correct answer: B Houses and vehicles are elastic since the make up a big portion of your budget. A specific type of cereal is elastic since it has a lot of substitutes. Electricity has no viable substitutes.
- “Clicker Question” Correct answer: D Why is (c) not correct? The demand curve is downward-sloping. We can’t increase the price and sell more, or we would be picking a point that isn’t even on the demand line. By increasing the price and selling less units, we are moving toward the unit elastic point in which revenue is maximized.