Summary

1
Review

• Summary
• Elasticity is a general measure of responsiveness
  that can be used to answer various questions.
• The price elasticity of demand the percent
  change in the quantity demanded divided by the
  percent change in the price (dropping the minus
  sign) is a measure of the responsiveness of the
  quantity demanded to changes in the price.

2
Review

• Summary
• The responsiveness of the quantity demanded to
  price can range from perfectly inelastic demand,
  where the quantity demanded is unaffected by the
  price, to perfectly elastic demand, where there
  is a unique price at which consumers will buy as
  much or as little as they are offered. When
  demand is perfectly inelastic, the demand curve
  is vertical when it is perfectly elastic, the
  demand curve is horizontal.
• The price elasticity of demand is classified
  according to whether it is more or less than 1.
  If it is greater than 1, demand is elastic if it
  is exactly 1, demand is unit-elastic if it is
  less than 1, demand is inelastic. This
  classification determines how total revenue, the
  total value of sales, changes when the price
  changes.

3
Review

• Summary
• The price elasticity of demand depends on whether
  there are close substitutes for the good, whether
  the good is a necessity or a luxury, the share of
  income spent on the good, and the length of time
  that has elapsed since the price change.

4
Price Elasticity of Demand

• Some Estimated Price Elasticities of Demand
• Good Price elasticity
• Inelastic demand
• Eggs -0.1
• Beef -0.4
• Stationery -0.5
• Gasoline -0.5
• Elastic demand
• Housing -1.2
• Restaurant meals -2.3
• Airline travel -2.4
• Foreign travel -4.1

Price elasticity of demand lt 1
Price elasticity of demand gt 1
5
Intro to Cross-Price EoD

• Intro
• The cross-price elasticity of demand measures the
  effect of a change in one goods price on the
  quantity of another good demanded.

6
Cross-Price Elasticity

• Cross Price Elasticity of Demand
• If EQX,PY gt 0, then X and Y are gross substitutes
  because as the price of good Y increases, the
  demand for good X increases. This can happen
  from either of two effects.
• Good X substitutes for Good Y. For example, as
  the price of Y apples increases, the demand for
  X oranges increases because consumers
  substitute oranges for apples.
• Good X is needed because it is affordable. For
  example, as the price of Y College education
  increases, freshmen students must economize and
  consume more affordable goods, like X Ramen
  Noodles.
• Since there are two effects, their sum is called
  the gross effect.

7
Cross-Price Elasticity

• Cross Price Elasticity of Demand
• If EQX,PY lt 0, then X and Y are gross complements
  because as the price of good Y increases, the
  demand for good X decreases. This can happen
  from either of two effects.
• Good Y complements Good X. For example, as the
  price of Y bread increases, the demand for X
  butter decreases because consumers need less
  butter when there is less bread.
• Good X is not wanted because it is unaffordable.
  For example, as the price of Y college
  education increases, freshmen students must
  economize and consume fewer unaffordable goods,
  like X Chix Fillet.
• Since there are two effects, their sum is called
  the gross effect.

8
Intro to Income Elasticity EoD

• Intro
• The income elasticity of demand is the percent
  change in the quantity of a good demanded when a
  consumers income changes divided by the percent
  change in income. If the income elasticity is
  greater than 1, a good is income elastic if it
  is positive and less than 1, the good is
  income-inelastic.

change in demand divided by the change in
income
9
Income ElasticityIf EQX,M gt 0, then X is
a normal good. Higher income M implies higher
demand.If EQX,M lt 0, then X is a inferior good.
Higher income M implies lower demand.
Income Elasticity
10
Normal goods have a positive income elasticity of
demand so as consumers income rises more is
demanded at each price i.e. there is an outward
shift of the demand curve Normal necessities have
an income elasticity of demand of between 0 and
1 for example, if income increases by 10 and
the demand for fresh fruit increases by 4 then
the income elasticity is 0.4. Demand is rising
less than proportionately to income. Luxury goods
and services have an income elasticity of demand
gt 1 i.e. demand rises more than proportionate to
a change in income for example a 8 increase in
income might lead to a 10 rise in the demand for
new kitchens. The income elasticity of demand in
this example is 1.25. Inferior Goods Inferior
goods have a negative income elasticity of demand
meaning that demand falls as income rises.
Typically inferior goods or services exist where
superior goods are available if the consumer has
the money to be able to buy it. Examples include
the demand for cigarettes and low-priced own
label foods in supermarkets.
11
Elasticity Applications

• Business Applications of Elasticity
• Pricing and managing cash flows.
• Effect of changes in competitors prices.

• The income elasticity of demand is usually
  strongly positive for
• Fine wines and spirits, high quality chocolates
  and luxury holidays overseas.
• Sports cars
• Consumer durables - audio visual equipment,
  smart-phones
• Sports and leisure facilities (including gym
  membership and exclusive sports clubs).
• In contrast, income elasticity of demand is lower
  for
• Staple food products such as bread, vegetables
  and frozen foods.
• Mass transport (bus and rail).
• Beer and takeaway pizza!
• Income elasticity of demand is negative
  (inferior) for cigarettes and urban bus services.

12
Review

• Cross elasticity of demand measures how sensitive
  purchases of a specific product are to changes
  in
• The price of some other product
• The price of that same product
• Income
• The general price level
• If it is a normal or inferior good
• a. The price of some other product

13
Elasticity Applications

• Example 1 Pricing and Cash Flows
• According to an FTC Report by Michael Ward,
  ATTs own price elasticity of demand for long
  distance services is -8.64.
• ATT needs to boost revenues in order to meet
  its marketing goals.
• If ATT lowered price by 3 percent, what would
  happen to the volume (Hint quantity) of long
  distance telephone calls routed through ATT?

14
Elasticity Applications

• Answer
• Calls would increase by 25.92 percent.

15
Controversy Gambling
Controversy Gambling
16
Controversy Gambling
A lottery is a form of gambling which involves
the drawing of lots for a prize. Some governments
outlaw it, while others endorse it to the extent
of organizing a national or state lottery. At the
beginning of the 20th century, most forms of
gambling, including lotteries and sweepstakes,
were illegal in many countries, including the
U.S.A. and most of Europe. This remained so until
after World War II. In the 1960s casinos and
lotteries began to appear throughout the world as
a means to raise revenue in addition to taxes.
17
Controversy Gambling
Lotteries and gambling are an effective way to
raise revenue because there are few substitutes.
As the government taxes any good, it raises the
price, and so consumers lower demand, which
lowers tax revenue. But with few substitutes,
the demand for gambling is very inelastic, and so
consumers demand is only slightly lower, which
means tax revenue is only slightly
lower. Lotteries and gambling are controversial,
however, if you believe most gamblers are
irrational. If irrational, a gambler could hurt
themselves by saying yes to gambling when they
should have said no.