Elasticity and Its Applications

1
Chapter 5

• Elasticity and Its Applications

2
Freeze Frame What A Bounce!
3
wimpy bounce
4
Deriving Market Demand

• Price Moe Larry Curly Total
• 3 0 1 2 3
• 2 1 2 3 6
• 1 2 4 5 11

5
Market Demand
Price
3 2 1
1 2 3 4 5 6 7 8 9 10 11 12
Q
6
EC106 Demand For Milano Cookies

• Price/Cookie Quantity
• 1 .00 015
• .80 037
• .60 060
• .40 119
• .20 240

7
PRICE
ELASTICITY
Start the Show!
OF
DEMAND
8
EC106 Demand For Milano
Price
1 .80 .60 .40 .20
Demand Curve
Supply Curve
Quantity
10 20 30 40 50 60 70 80 90
9
Ch 5 Outline

• Deriving Market Demand Curve
• Price Elasticity of Demand
• Cross Price Elasticity of Demand
• Income Elasticity of Demand
• Price Elasticity of Supply

So far OK, no backsliding
10
Price Elasticity of Demand
Output Effect
Percentage Change in Quantity Demanded
Ed

Percentage Change in Price
Price Effect
11
Ford Bet the Farm on Ed
Price
1000 800 600 400
Demand Curve Elastic
Demand Curve Inelastic
Quantity
10 20 30 40 50 60 70 80 90
12
Outline

• Price Elasticity of Demand (Ch 5)
• Price Ceilings (Ch 6)
• Price Floors
• Apps

Not a Bad Agenda
13
Drug Bust
Pe
Price
New Equilibrium
Pe
Quantity
Qe
14
Perfectly Inelastic Demand
Perfectly Inelastic
Price Effect
P 10 5
TR40
TR20
4 Q
15
Operating Deficit for NYC Subway

• Train Schedules and All Costs Have Been Incurred
  for 1999 Operation --24.5 million
• When Price Lowered from 6 to 4 Still Deficit
• Your Job Reduce Defict

16
Operation Deficit TR lt TC
17
Area of Rectangle
AreaLength x Width A L x W

200 20 X 10
A
Length
20
10
Width
18
Demand For Subway
Price Per Day Pass
10
6
TR 24M
10
4
Millions of Riders Per Day
19
Operating Deficit

• TR - TC 24M - 24.5M
• TR - TC -0.5M
• ..Hence the Operating Deficit

20
Demand For Subway
Price Per Day Pass
10
6
5
TR25M
10
4
5
Millions of Riders Per Day
21
Demand For Subway
Price Per Day Pass
10
6
5
4
TR24
6
10
4
5
Millions of Riders Per Day
22
Demand For Subway
Price Per Day Pass
10
6
4
6
10
4
Millions of Riders Per Day
23
Demand For Subway
Price Per Day Pass
10
6
4
TR24M
6
10
4
Millions of Riders Per Day
24
Demand For Subway
Price Per Day Pass
10
6
5
4
6
10
4
5
Millions of Riders Per Day
25
Demand For Subway
Price Per Day Pass
10
6
5
TR25M
4
6
10
4
5
Millions of Riders Per Day
26
Demand For Subway
Price Per Day Pass
10
6

5
4
6
10
4
5
Millions of Riders Per Day
27
Demand For Subway
Price Per Day Pass
10
6
t
5
4
6
10
4
5
Millions of Riders Per Day
28
Demand For Subway
Price Per Day Pass
10
6
t
24M
5
25M
4
24M
6
10
4
5
Millions of Riders Per Day
29
Demand For Subway
Price Per Day Pass
When Price Falls TR First Rises. Then Falls...
10
6
t
24M
5
25M
4
24M
6
10
4
5
Millions of Riders Per Day
30
Price Elasticity of Demand
Output Effect
Percentage Change in Quantity Demanded
Ed

Percentage Change in Price
Price Effect
31
P
Ed gt 1, Demand Elastic
10
8 6 3 1
TR 16
TR 24
2 4
10
Q
32
P
10
8 6 3 1
TR 16
2 4
10
Q
33
P
Price Effect
10
Ed gt 1, Demand Elastic
8 6 3 1
TR 16
Lower Price, TR Rises
TR 24
Output Effect
2 4
10
Q
34
Elasticity and Total Revenue
ED gt 1 then
P P
TR
and
TR
and
35
Price Elasticity of Demand
Difference in Q
Average Q
Ed

Difference in P
Average P
36
Change From 10 to 12
12 - 10



X 100
10
2
X 100

10

20
37
Price Elasticity of Coefficient
Percentage Change in Quantity Demanded
Ed

Percentage Change in Price
38
Looking at Top of Ed Formula
Qd
Percent Change in Quantity Demanded
X 100

Qd
Looking at Bottom of Ed Formula
P
Percent Change in Price

X 100
P
39
Price Elasticity of Demand
Qd
X 100
Qd
Ed

P
X 100
P
40
Price Elasticity of Demand
Qd
Qd
Ed

P
P
41
P
10
8 6 3 1
2 4 7 9
10
Q
42
Price Elasticity of Demand
Qd
(4 - 2)
Qd
?

Ed


(6 - 8)
P
P
?
43
P
10
Which Is Base Point? Left point or Right Point?
8 6 3 1
2 4 7 9
10
Q
44
P
10
Use Midpoint (Called Arc or Midpoint Formula)_
8 6 3 1
7

2 3 4 7 9
10
Q
45
P
10
8 6 3 1
2 4 7 9
10
Q
46
Price Elasticity of Demand
Diff Q
(4 - 2)
Ave Q
(42)/2
Ed


(6 - 8)
Diff P
Ave P
(68)/2
47
Price Elasticity of Demand
Difference in Q
Average Q
Ed

Difference in P
Average P
48
P
10
8 6 3 1
2 4 7 9
10
Q
49
Price Elasticity of Demand
Difference in Q
(4 - 2)
Average Q
(42)/2
Ed


(6 - 8)
Difference in P
Average P
(68)/2
50
Time for Calculator...
(4 - 2)
.667
3
2.33
Ed



(6 - 8)
-.286
7
finally, drop that MINUS
51
P
10
8 6 3 1
2 4 7 9
10
Q
52
P
10
8 6 3 1
TR 21
2 4 7 9
10
Q
53
P
10
8 6 3 1
TR 21
TR 9
2 4 7 9
10
Q
54
P
10
8 6 3 1
Price Effect
TR 21
TR 9
2 4 7 9
10
Q
Output Effect
55
Price Elasticity of Demand
Output Effect
Percentage Change in Quantity Demanded
Ed

Percentage Change in Price
Price Effect
56
Elasticity and Total Revenue
ED lt 1 then
P P
TR
and
TR
and
57
Linear Demand Curves Have Three Elasticity Ranges

• Ed gt 1 (Demand Elastic),
• P falls, TR rises
• Ed 1 (Demand Unit Elastic),
• P falls, TR stays same
• Ed lt 1 (Demand Inelastic),
• P falls, TR falls

58
Snack Time
59
Milano Cookie

• A Pepperidge Farm Special

60
EC106 Demand For Milano Cookies

• Price/Cookie Quantity
• 2 .00 03
• 1.80 07
• 1.60 12
• 1.40 17
• 1.20 22
• 1.00 30

61
EC106 Demand For Milano
Price
2.00 1.80 1.60 1.40 1.20 1.00
Demand Curve
Supply Curve
Quantity
5 10 15 20 25 30
62
EC106 Demand For Milano Cookies

• Price/Cookie Quantity TR
• 2 .00 03 6.00
• 1.80 07 12.60
• 1.60 12 19.20
• 1.40 17 23.80
• 1.20 22 26.40
• 1.00 30 30.00

63
P
10
8 6 3 1
2 4 7 9
10
Q
64
Price Elasticity of Demand
Difference in Q
(9-7)
Average Q
(97)/2
Ed


(1-3)
Difference in P
Average P
(13)/2
65
Price Elasticity of Demand
Diff Q
(9-7)
Ave Q
8
Ed


(1-3)
Diff P
2
Ave P
66
Price Elasticity of Demand
Diff Q
(9-7)
Ave Q
8
Ed


(1-3)
Diff P
Ave P
2
67
Time for Calculator...
(2)
8
Ed
.25


(-2)
2
68
Time for Calculator...
Qd
.25
Qd
Ed



-
.250
-1
P
P
finally, drop that MINUS
69
Calculate Price Elasticity as Price Falls from
6 to 4 and Quantity Demanded Rises from 4
to 6
70
P
10
8 6 3 1
We're Using the Midpoint Formula
2
2 4 7 9
10
Q
8
71
P
Price Effect lt Output Effect
10
Edgt1 Price , TR
6 4
5
4 6
Q
5
72
P
Price Effect Output Effect
10
Ed 1 Price , TR
6 4
5
4 6
Q
5
73
P
10
Price Effect gt Output Effect
6 4
Edlt1 P TR
5
4 6
Q
5
74
P
10
Edgt1 Price , TR
6 4
5
Edlt1 Price , TR
4 6
Q
5
75
Linear Demand Curves Have Three Elasticity Ranges

• Ed gt 1 (Demand Elastic),
• P falls, TR rises
• Ed 1 (Demand Unit Elastic),
• P falls, TR stays same
• Ed lt 1 (Demand Inelastic),
• P falls, TR falls

76
Calculate Price Elasticity as Price Falls from
6 to 4 and Quantity Demanded Rises from 4
to 6
77
Demand For Subway
Price Per Day Pass
10
6
5
TR25M
4
6
10
4
5
Millions of Riders Per Day
78
Demand For Subway
Price Per Day Pass
When Price Falls TR First Rises. Then Falls...
10
6
t
24M
5
25M
4
24M
6
10
4
5
Millions of Riders Per Day
79
Drug Bust
300Pe
Price
New Equilibrium
100Pe
Quantity
60 100 Qe
80
Demand For Subway
Price Per Day Pass
When Price Falls TR First Rises. Then Falls...
10
6
t
24M
5
25M
4
24M
6
10
4
5
Millions of Riders Per Day
81
P
Edgt1 Demand Elastic
10

Q
82
P
10
Edlt1 Demand Inelastic

Q
83
Ranges of Elasticity . . . (Figure 5-1)

• Perfectly Inelastic Consumers are extremely
  unresponsive to price changes.
• Perfectly Elastic Consumers are extremely
  responsive to price changes.
• Unit Elastic Response is equal to change in
  price.

84
Perfectly Inelastic Demand
Perfectly Inelastic
P 10 5
4 Q
85
Price Elasticity of Demand
Difference in Q
Average Q
Ed

Difference in P
Average P
86
Price Elasticity of Demand
Qd
Qd
Ed

0
P
P
87
Perfectly Elastic Demand
P 10
Perfectly Elastic
2 4 Q
88
Price Elasticity of Demand
Qd
Qd
Ed

oo
P
P
89
Demand Elastic for Good When

• Many Substitutes (e.g., Luxuries)
• Very Narrowly Defined
• Longer the Time Period
• Large Share of Budget
• Example Demand for Gas During OPEC Energy Crisis
  1973-74

90
By What Does Qd change?

• Given Ed 2
• Given Price Rises 10
• Ed Change Qd / Change P
• 2 x / 10
• 2 x 10 x
• 20 x
• So Qd FALLS by 20

Color Code
91
By What Does Qd change?

• Given Ed 2
• Given Price Rises 10
• Ed Change Qd / Change P
• 2 x / 10
• 2 x 10 x
• 20 x
• So Qd FALLS by 20

Color Coded!
92
Examine whether the supply or demand curve shifts.
SA
Price
4.00
DA
Quantity
2000
93
Applications of Elasticity

• Good News for Farming Bad News For Farmers?
• University agronomists discover a more
  productive wheat variety

94
Consider which direction the curve shifts.
SA
Price
SB
Technology causes an increase in supply.
4.00
DA
Quantity
2000
95
Use Supply-and-Demand diagram to see how the
market changes.
SA
Price
SB
4.00
2.60
DA
Quantity
2000
2400
96
Compute Elasticity
(2400 - 2000) / (2200)
ED
(2.60 - 4.00) / (3.30)
ED
0.43 (Inelastic)
97
Observe the Change in Total Revenue
SA
Price
SB
TRSA 8,000
4.00
2.60
TRSB 5,760!
DA
Quantity
2000
2400
98
P
10
Ed of Curved Line at Point Same as Straight Line
Tangent to Curved Line at that Point
6 4
4 6
Q
99
CROSS
PRICE
ELASTICITY
OF
DEMAND
100
Px
10
Substitutes XCoke YPepsi
6 4
Py20
Py10
4 6
Qx
101
Cross Price Elasticity of Demand
Shift Effect
Percentage Change in Quantity Demanded of X
Cd

Percentage Change in Price of Y
Cross Price Effect
102
Px
10
Complements X Pizza Y Beer
6 4
Py10
Py20
2 4
Qx
103
Cross Price Elasticity

• Cd gt 0 Substitutes
• Cd 0 Unrelated Goods
• Cd lt 0 Complements

Cd
104
Cd Used in Antitrust Cases

• DuPont has 90 of Cellophane Market
• Antitrust Case initiated
• DuPont claims wax paper, tin foil substitutes for
  Cellophane
• Does Dupont hope that Cd gt 0?
• What does Justice department hope that Cd equals?
  

105
A Bar is a bar is a bar?

• Are the taverns of Erie County, PA all
  substitutes for one another?
• What differentiates them
• drinks sold
• bartenders
• customers
• darts/pool
• dancing/music

106
Income
ELASTICITY
DEMAND
OF
107
Income Elasticity of Demand
Shift Effect
Percentage Change in Quantity Demanded
Yd

Percentage Change in Income
Cross Price Effect
108
Px
10
Normal Good
6 4
I100G
I50G
4 6
Qx
109
Px
10
Inferior Good
6 4
I50G
I100G
2 4
Qx
110
Income Elasticity

• Yd gt 0 Normal
• Yd lt 1 Necessity
• Yd gt 1 Luxury
• Yd 0 Income Neutral
• Yd lt 0 Inferior

Yd
111
Example of Income Elasticity

• During a recession, the sales of which would be
  hurt most?
• Barber services
• Fast Food Restaurants
• Luxury Cars
• Salvation Army Stores

Lets See...
112
PRICE
ELASTICITY
OF
SUPPLY
SUPPLY
113
P
Elasticity of Supply
10
6 4
4 6
Q
114
Price Elasticity of Supply
Percentage Change in Quantity Supplied
Es

Percentage Change in Price
115
P
Elasticity of Supply
10
6 4
4 6 10
Q
116
Elasticity of Supply

• Es oo Perfectly Elastic (Horizontal)
• Es gt 1 Elastic (Flat Slope)
• Es 1 Unit Elastic
• Es lt 1 Inelastic (Steep Slope)
• Es 0 Perfectly Inelastic (Vertical)
• Yd lt 0 Inferior

Es
117
P
Elasticity of Supply
10
6 4
Es1
Eslt1
Es0
4 6
Q
118
P
Elasticity of Supply
10
6 4
Esgt1
Es00
Es1
4 6
Q
119
Quick Quiz!

• Define the price elasticity of demand.
• Explain the relationship between total revenue
  and elasticity of demand

120
Supply Elastic for Good When

• Longer the Time Period
• Example Supply of Strawberries in Erie
• This minute -This Hour - Today

121
Price Elasticity of Supply
Price

• The percentage change in quantity supplied
• resulting from a one (1) percent change in
  price.

B
A
Quantity
122
Ranges of Elasticity

• Perfectly Elastic infinite
• Relatively Elastic gt1
• Unitary or Unit 1
• Relatively Inelastic lt1
• Perfectly Inelastic 0

123
Elasticity of Supply illustrated
Perfectly Inelastic
Perfectly Elastic
124
Determinants of Elasticity of Supply

• Flexibility or ability of sellers to change the
  amount of the good they produce.
• Beachfront land verses books, cars, manufactured
  goods, etc.
• More elastic in the long run.

125
Computing Elasticity Coefficient
Percentage Change in Quantity Supplied
Elasticity of Supply

Percentage Change in Price

• Computed as the percentage change in the quantity
  supplied divided by the percentage change in
  price.

126
Quick Quiz!

• Define the elasticity of supply.
• Explain why the price elasticity of supply might
  be different in the long run than in the short
  run.

127
Apply Comparative Statics (Chapter 4)

• Does supply or demand shifts?
• Shift Left or Right?
• Do Pe and Qe change?

This chapter is going slowly! Thank God its
about to end!!!! Yes it will end!
128
Conclusion

• Elasticity is defined as. . .
• Price Elasticity of demand is. . .
• Income Elasticity of demand is. . .
• Price Elasticity of supply is. . .
• What are the relationships between elasticity and
  total revenue or total consumer expenses?

129
Thats All on Elasticity for Today!!!
On Elasticity
130
Price Elasticity of Demand Simplified
Difference in Q
Average Q
Ed

Difference in P
Average P
131
Price Elasticity of Demand Business Traveler
Difference in Q
(1900-2000)
Average Q
(19002000)/2
Ed


(250-200)
Difference in P
Average P
(250200)/2
132
Time for Calculator...
(-100)
-.051
1950
Ed


(50)
.222
finally, drop that MINUS
225
Ed
0.23 Inelastic
133
P
10
Price Effect gt Output Effect
6 4
Edlt1 P TR
5
4 6
Q
5
134
Total Revenue Before After

• Initially, TR 2000 x 200 400,000
• After, TR 1900 x 250 475,000
• When P rose, TR rose
• Demand Inelastic!

135
Price Elasticity of Demand Simplidied
Difference in Q
Average Q
Ed

Difference in P
Average P
136
Price Elasticity of Demand Vacationer
Difference in Q
(600-800)
Average Q
(600800)/2
Ed


(250-200)
Difference in P
Average P
(250200)/2
137
Time for Calculator...
(-200)
-.285
700
Ed


(50)
.222
finally, drop that MINUS
225
Ed
1.28 Inelastic
138
P
Price Effect lt Output Effect
10
Edgt1 Price , TR
6 4
5
4 6
Q
5
139
Total Revenue Before After

• Initially, TR 800 x 200 160,000
• After, TR 600 x 250 150,000
• When P rose, TR fell
• Demand Elastic!

Ya dont say!
140
Elasticity of Demand Income10,000
Difference in Q
(-8)
Average Q
(36)
Ed
1.00


(2)
Difference in P
Average P
(9)
141
Elasticity of Demand Income12,000
Difference in Q
(-5)
Average Q
(47.5)
Ed
0.47


(2)
Difference in P
Average P
(9)
142
Income Elasticity Price 12
Difference in Q
(6)
Average Q
(27)
Yd
1.22


(2,000)
Difference in Income
Average of Income
(11,000)
143
P
10
Normal Good
12 4
I12G
I10G
24 30
Q
144
Income Elasticity Price 16
Difference in Q
(4)
Average Q
(10)
Yd
2.20


(2,000)
Difference in Income
Average of Income
(11,000)
145
Thats All on Elasticity for Today!!!
On Elasticity
146
AN IN-CLASS EXERCISE

• Did elasticity group exercise today
• Ch 5 Problem 3 Worked Okay
• Develop this in future!
• Fairly positive reception