Wheat

1
Wheat
S1
S0
Price
D
Quantity
2
Bottled Water
S
D1
D0
Quantity
3
BMWs
S
Price
D1
D0
Quantity
4
Oil
S1
S0
Price
D1
D0
Quantity
5
Chapter 5

• Elasticity of Demand and Elasticity of Supply

6
Price Elasticity of Demand

• Shows the responsiveness of quantity demanded to
  a change in the price
• Shows whether total (sales) revenue will rise or
  fall when the price changes

7
Price Elasticity of Demand--Specifics

• Shows the percentage change in quantity demanded
  for given percentage change in the price
• Price elasticity of demand
• Percentage change in quantity
• Percentage change in price

8
Calculation of Elasticity of Demand--CDs
Demand for CDs
Price Quantity
P
9 3 8 5 7
7 6 9 5 11 4
13 3 15 2 17
P
D
Q
9
Calculation of Elasticity of Demand

• Suppose the current price of CDs7/each and the
  price increases to 9/each.
• What is the price elasticity of demand and what
  does it tell us?

10
Percentage ChangesMidpoint Method

• Percentage Change in Price
• ((7-9)/8) X100-25
• Percentage Change in Quantity
• ((7-3)/5) X 10080

11
Elasticity of Demand

• Percentage change in quantity demanded divided by
  percentage change in price
• -(80/25)-3.2
• If P rises by 10, then Q falls by 32

12
Demand Elasticity Facts

• Why use the midpoint method?
• Ignore the minus sign
• Elasticity of demand declines as we move down the
  demand curve

13
Another Calculation

• Suppose we consider lowering the price of CDs
  from 4 to 2.
• Percentage price change
• ((4-2)/3 X 10067
• Percentage quantity change
• ((17-13)/15) X 10027
• Elasticity of demand27/670.40

14
Elasticity of Demand
Price
Elasticity of demand 3.2
9
7
Elasticity of Demand 0.40
4
D
2
Quantity
15
Homework Assignment 3
T-Shirts
Price Quantity
20 0 18 4 16 8 14 12 12 16 10
20 8 24 6 28
16
Homework Assignment 3

• Using the interval P12 to P16, calculate the
  price elasticity of demand.
• Using the demand curve for T-shirts, find the
  price where total revenue is maximized.
• Find a value for the demand elasticity above this
  price.
• Find a value for the demand elasticity below this
  price.

17
More Demand Elasticity Facts

• unit free measure of responsiveness of quantity
  demanded to a price change
• Can be used to provide information about the
  shape of a demand curve

18
Inelastic and Elastic Demand
Price
Inelastic Demand
Elastic Demand
Quantity
19
Influences on Elasticity

• Substitution Effects
• Luxuries vs. necessities
• Narrowness of definition
• Elapsed time since price change
• Income Effects
• Percentage of income spent on a good

20
Examples of Inelastic Demand

• Food 0.12
• Tobacco 0.61
• Oil 0.91

21
Examples of Elastic Demand

• Professional Services 1.09
• Motor Vehicles 1.14
• Furniture 1.26

22
Perfectly Inelastic Demand
Insulin
Price
D
Elasticity of Demand0
Quantity
23
Perfectly Elastic Demand
Water from a single spring
Price
D
Elasticity of Demand?
Quantity
24
Price Elasticity and Total RevenueCD Example
Price Quantity Total Revenue
9 3 27 8 5 40
7 7 49 6 9 54
5 11 55 4 13 52
3 15 45 2 17 34
25
Price ElasticityOne More Calculation

• Suppose P falls from 6 to 4, so Q rises from 9
  to 13 units.
• Percentage change in price40
• Percentage change in quantity36
• Price elasticity of demand36/40?1.0

26
Price Elasticity and Total Revenue (Continued)
Elasticity of demand 1.6
Price
9
Elasticity of Demand1.0
7
5
4
Elasticity of Demand 0.40
D
2
Quantity
27
Examples

• If the price elasticity of demand is 1.4 and we
  raise the price, what happens to total revenue?
  How about if we lower the price?
• If the price elasticity of demand is 0.9 and we
  raise the price, what happens to total revenue?
  Lower the price?

28
More examples

• Should the same price be charged for all types of
  Florida vanity license plates?
• How should parking fees be set at UCF so as to
  maximize total revenue?

29
Elasticity of Supply

• Elasticity of supply shows the percentage change
  in quantity supplied for a given percentage
  change in price
• Calculation method the same as for elasticity of
  demand

30
Elastic and Inelastic Supply
Inelastic supply Curve
Price
Elastic Supply Curve
Quantity
31
Perfectly Inelastic Supply
S
Price
Beachfront Lots
Quantity
32
Perfectly Elastic Supply
Price
Natural Soda Ash
S
Quantity
33
Other Types of Demand Elasticity

• Cross-price elasticity
• Income elasticity

34
Cross-Price Elasticity of Demand

• Shows the responsiveness of quantity demanded of
  a good when the price of another good changes
• Calculated as the percentage change in quantity
  demanded divided by percentage change in price of
  the other good

35
Example

• Suppose the cross-price elasticity of demand
  between Pepsi and Coca-Cola equals 0.6
• Then, a 10 percent increase in the price of Coke
  leads to a 6 increase quantity demanded of Pepsi.

36
Cross Price Elasticity of Demand

• If positive, the goods are substitutes
• If negative, the goods are complements
• If zero, the goods are unrelated

37
Income Elasticity

• Shows the responsiveness of quantity demanded of
  a good to an increase in income.
• Calculated as the percentage change in quantity
  demanded divided by the percentage change in
  income.

38
Income Elasticity of Demand

• Greater than 1.0 for income elastic goods
• Between zero and one for normal goods
• Less than zero for inferior goods

39
Examples of Income Elastic Goods

• Foreign Travel 3.08
• Restaurant Meals 1.61
• Cars 1.07

40
Examples of Income Inelastic Goods

• Tobacco 0.86
• Alcoholic Beverages 0.62
• Newspapers 0.38

41
Income Elasticity and Florida Sales Tax Reform

• Income elasticity of sales tax revenue currently
  is about 0.60.
• Regressive tax
• Sales tax revenues do not keep up with demand for
  public services
• After sales tax base broadened by tax reform,
  income elasticity of sales tax revenue would be
  about 0.7.