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Elasticity
McGraw-Hill/Irwin
price changes
Formula for price elasticity of demand
Ed =
LO1
Change in quantity
=
Sum of quantities/2
Change in price
Sum of prices/2
P2 P1 / (P1 + P2) /2
LO1
Use percentages
Not dollar price change
Compare responsiveness across
LO1
products
Eliminate the minus sign
Easier to compare elasticities
Interpretation of Elasticity of
Demand
Perfectly elastic
LO1
Extreme Cases
P
D1
Perfectly
inelastic
demand
(Ed = 0)
Extreme Cases
P
P0
D2
Perfectly
elastic
demand
(Ed = )
LO2
$4
c
3
D2
0
LO2
10
20
D1
LO2
10
20
30
40
D3
0
LO2
10
20
30
(2)
Price per Ticket
$8
(4)
Total
Revenue
(1) X (2)
(5)
Total
Revenue
Test
$8,000
5.00
14,000
Elastic
2.60
18,000
Elastic
1.57
20,000
Elastic
1.00
20,000
Unit Elastic
0.64
18,000
Inelastic
0.38
14,000
Inelastic
0.20
8,000
Inelastic
7
8
LO2
(3)
Elasticity
Coefficient
(Ed)
High
price
low
price
Price
Elastic
Ed > 1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
h
0 1 2 3 4 5 6 7 8
Total Revenue
(Thousands of Dollars)
Quantity Demanded
$20
18
16
14
12
10
8
6
4
2
TR
0 1 2 3 4 5 6 7 8
Quantity Demanded
LO2
Summary for Ed
Ed > 1, %P , %Qd , TR
Ed = 1, %P , % Qd
, TR
Ed < 1, %P , % Qd
, TR
Determinants of Elasticity of
Demand
Substitutability
LO1
Price Elasticity
of Demand (Ed) Product or Service
Price Elasticity
of Demand (Ed)
Newspapers
.10
Milk
.63
Electricity (household)
.13
Household appliances
.63
Bread
.15
Liquor
.70
MLB Tickets
.23
Movies
.87
Telephone Service
.26
Beer
.90
Cigarettes
.25
Shoes
.91
Sugar
.30
Motor vehicles
1.14
Medical Care
.31
Beef
1.27
Eggs
.32
China, glassware
1.54
Legal Services
.37
Residential land
1.60
Automobile repair
.40
Restaurant meals
2.27
Clothing
.49
2.65
Gasoline
.60
Fresh peas
2.83
LO1
Applications of Ed
LO1
Lecture 5
Objective:
1. Price elasticity of supply and its
determinants.
2. Cross- and income elasticities of demand.
3. The law of diminishing marginal
utility
4. Theory of consumer choice
LO3
LO3
elasticity of supply
Time periods considered
Market period (immediate period)
(see slide 21)
Short Run (fixed and variable i/ps)
(slide 22)
Long Run (slide 23)
P0
D2
D1
Q0
LO3
Ss
Ps
P0
D2
D1
Q0 Qs
LO3
Pl
P0
D2
D1
Q0
LO3
Ql
Applications of Elasticity of
Supply
Antiques
Inelastic supply
Reproductions
More elastic supply
Volatile gold prices
Highly Inelastic supply
LO3
Ex,y =
Percentage change in price of product Y
LO4
Application
Company Change the price? (Yes,
LO4
to changes in income
Normal goods positive sign
Inferior goods negative sign
Percentage change
in quantity demanded
Ei =
Percentage change in income
LO4
LO4
Ex,y and Ei
Cross and Income Elasticities of Demand
Value of
Coefficient
Cross elasticity:
Positive (Ewz > 0)
Negative (Exy < 0)
Description
Quantity demanded of W changes in same
direction as change in price of Z
Type of Good(s)
Substitutes
Income elasticity:
Positive (Ei >0)
Normal or superior
Negative (Ei<0)
Inferior
LO4
price elasticities
Examples:
Business and leisure air travelers
Adult vs. child