Elasticity: Measuring Responsiveness

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ElasticityMeasuring Responsiveness

• Dr. D. Foster - Microeconomics

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Elasticity

• A measure of responsiveness . . .
• Price elasticity of demand.
• Income elasticity of demand.
• Cross price elasticity of demand.
• Price elasticity of supply.

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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• Responsive if ?D gt 1 and demand is elastic.
• Unresponsive if ?D lt 1 and demand is inelastic.
• Note Technically, calculated ?D is always lt0.

? percentage change in
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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• Perfectly elastic
• ?D ?
• Perfectly inelastic
• 
  ?D 0

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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• Along a straight line, changing elasticity!!

Elastic
Inelastic
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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• We talk about demand curves that are relatively
  elastic vs. relatively inelastic . . .

Inelastic
Elastic
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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• Elasticity tells us how TR will change with a
  change in the price . . .
• If elastic, ?P will ?TR (output effect
  dominates) (conversely, a ?P will ?TR)
• If inelastic, ?P will ?TR (price effect
  dominates) (conversely, a ?P will ?TR)

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Elasticity Questions

• A. What do execs at Pepsi expect TR to do when
  they have a sale on their soft drink? Why?
• B. You manage a concert hall that seats 500.
  Consider the following demand information
• What do youcharge?

At a price of Amount sold is
10 500
15 400
20 200
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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• How to calculate this . . .
• Easy if the ? is given for both.
• Find the ? from the base.
• Find the ? from the average.

?D 5/97.5 .10/1.05 .538
What is elasticity if price rises by 10 and
quantity demanded falls by 5?
What is elasticity if price rises from 1 to
1.10 and quantity demanded falls from 100 to 95?
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Price Elasticity of Demand

• Determinants of elasticity . . .
• The degree of substitutes available more
  substitutes more elastic
• Amount of budget spent on this good higher
  proportion spent more elastic
• Relative importance of this good more of a
  luxury more elastic
• Time to respond to price change more time
  more elastic

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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• What happens when electricity prices rise?

.05
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Elasticity

• A measure of responsiveness . . .
• Price elasticity of demand P and QD
• Income elasticity of demand
• Cross price elasticity of demand
• Price elasticity of supply

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Income Elasticity of Demand

• How responsive is the QD to a ? in Income?
• May be a Normal good (gt0) or an inferior good
  (lt0)
• ?Y E(Qd,I) ?QD/ ?Income

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Elasticity Questions

• 1. If the price of butter goes up 50 and the
  quantity demanded falls by 10, what is the price
  elasticity of demand? Is this elastic or
  inelastic? Why?
• 2. If the price of the Rolling Stones CD,
  Semi-Serious, is reduced from 20 to 18, and the
  quantity demanded (say, on a per month basis)
  rises by 10, what is the price elasticity of
  demand? Is this elastic or inelastic? Why?

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Elasticity Questions

• 3. If the price of gas goes up by 30 and the
  quantity demanded falls from 1,000,000
  gallons/day to 900,000 gallons/day, what is the
  price elasticity of demand? Is this elastic or
  inelastic? Why? If the price, then, falls back
  by 30, would you predict the response by
  consumers will be elastic or inelastic? Why?
• 4. A popular pair of Nike shoes, the Paris
  Hilton Liteweights, is reduced in price from 80
  to 40, while the quantity demanded rises from
  10,000 pairs/week to 20,000 pairs/week. What is
  the price elasticity of demand? Is this elastic
  or inelastic? Why?

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Elasticity Questions

• 5. DishTV has lowered its subscription TV prices
  by 10 and its subscription base rose by 15.
• (a) What is the price elasticity of demand for
  DishTV? Is this elastic or inelastic? Why?
• (b) If DirecTV sees its subscription base fall
  by 8, what is the cross price elasticity of
  demand for DirecTV? For DishTV?
• (c) If incomes rise by 3 and subscription base
  for DishTV rises by 9, what is the income
  elasticity of demand for DishTV?

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Elasticity Questions

• 6. Consider this demand curve. As it is a
  straight line, there is an elastic portion, an
  inelastic portion and point of unitary
  elasticity. Identify where, along this demand,
  the total revenue would be maximized.

• Total revenue equalsprice times quantity.

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Elasticity Questions

• 7. Consider Demand (DA) with equilibrium at
  point A.

A .50 per unit tax is placed on this good . .
. a) Does S show the new supply? Yes. Do you
know why? b) What is the change in total revenue
as you move to the new equilibrium at A? c) What
is the price elasticity of demand? d) What is the
value of the taxes collected?
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Elasticity Questions

• 8. Consider Demand (DB) with equilibrium at
  point B.

A .50 per unit tax is placed on this good . .
. a) Does S show the new supply? Yes. Do you
know why? b) What is the change in total revenue
as you move to the new equilibrium at B? c) What
is the price elasticity of demand? d) What is the
value of the taxes collected?
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ElasticityMeasuring Responsiveness

• Dr. D. Foster - Microeconomics