Bellringer Bellringer Which of the following goods do you Which of the following goods do you think the government would be most think the government would be most likely to be concerned its price and likely to be concerned its price and why? why?
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BellringerBellringerWhich of the following goods do you think the Which of the following goods do you think the government would be most likely to be concerned government would be most likely to be concerned its price and why?its price and why?
Brainstorm with partnerBrainstorm with partner 3 products people stop buying 3 products people stop buying as much
when the price rises.when the price rises.In other words, a 10% rise in price will In other words, a 10% rise in price will
cause more than a 10% DROP in cause more than a 10% DROP in quantity demandedquantity demanded
ElasticElastic Elastic DemandElastic Demand Very responsive to Very responsive to
price changeprice change Most normal goodsMost normal goods Many substitutesMany substitutes TimelinessTimeliness luxuryluxury Big budgetBig budget
Why important to Why important to think about as a think about as a firm?firm?
Price/month
Quantity
D-nice apartments
1000
500
100
1000 5000 10,000
Brainstorm with partnerBrainstorm with partner 3 products people 3 products people DON’TDON’T stop buying stop buying as
much when the price rises.when the price rises.In other words, a 10% rise in price will In other words, a 10% rise in price will NOTNOT
cause more than a 10% DROP in cause more than a 10% DROP in quantity demandedquantity demanded
InelasticInelastic Inelastic DemandInelastic Demand Not responsive to Not responsive to
price changeprice change Few substitutesFew substitutes Small part of budgetSmall part of budget goods, close to needsgoods, close to needs Ex: lifesaversEx: lifesavers Why does Why does
government often government often control prices of control prices of inelastic goods?inelastic goods? Illegal drugs?Illegal drugs?
Price/dose
Quantity
D-dialysis100
1 2 3
200300
400
500
600
700
In RealityIn Reality
A
B
C
Gasoline, per gallon market
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EXAMPLE 1:EXAMPLE 1:Breakfast cereal vs. SunscreenBreakfast cereal vs. Sunscreen The prices of both of these goods rise by 20%. The prices of both of these goods rise by 20%.
For which good does For which good does QQdd drop the most? Why? drop the most? Why? Breakfast cereal has close substitutes Breakfast cereal has close substitutes
((e.ge.g., pancakes, waffles, leftover pizza), ., pancakes, waffles, leftover pizza), so buyers can easily switch if the price rises.so buyers can easily switch if the price rises.
Sunscreen has no close substitutes, Sunscreen has no close substitutes, so consumers would probably not so consumers would probably not buy much less if its price rises. buy much less if its price rises.
Lesson: Lesson: Price elasticity is higher when close substitutes are available.
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EXAMPLE 2:EXAMPLE 2:“Blue Jeans” vs. “Clothing”“Blue Jeans” vs. “Clothing” The prices of both goods rise by 20%. The prices of both goods rise by 20%.
For which good does For which good does QQdd drop the most? Why? drop the most? Why? For a narrowly defined good such as For a narrowly defined good such as
blue jeans, there are many substitutes blue jeans, there are many substitutes (khakis, shorts, Speedos). (khakis, shorts, Speedos).
There are fewer substitutes available for broadly There are fewer substitutes available for broadly defined goods. defined goods. (There aren’t too many substitutes for clothing, (There aren’t too many substitutes for clothing, other than living in a nudist colony.) other than living in a nudist colony.)
Lesson: Lesson: Price elasticity is higher for narrowly defined Price elasticity is higher for narrowly defined goods than broadly defined ones. goods than broadly defined ones.
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EXAMPLE 3:EXAMPLE 3:Insulin vs. Caribbean Insulin vs. Caribbean CruisesCruises The prices of both of these goods rise by 20%. The prices of both of these goods rise by 20%.
For which good does For which good does QQdd drop the most? Why? drop the most? Why? To millions of diabetics, insulin is a necessity. To millions of diabetics, insulin is a necessity.
A rise in its price would cause little or no A rise in its price would cause little or no decrease in demand. decrease in demand.
A cruise is a luxury. If the price rises, A cruise is a luxury. If the price rises, some people will forego it. some people will forego it.
Lesson: Lesson: Price elasticity is higher for Price elasticity is higher for luxuries than for necessities. luxuries than for necessities.
SummarySummary
Closure in your notesClosure in your notesGood/serviceGood/service Elastic/Inelastic Elastic/Inelastic Reasoning?Reasoning?Ground beefGround beefIphoneIphonetattoostattoosDeodorantDeodorantInsulinInsulinVacation to Costa RicaVacation to Costa Rica
Notebook paperNotebook paperDesigner ClothingDesigner ClothingDinner @ Red LobsterDinner @ Red LobsterCough dropsCough dropsMP3 music downloadsMP3 music downloadsCollege textbooksCollege textbooks
BellringerBellringer1. Which of the would economists label “elastic” 1. Which of the would economists label “elastic” demand?demand?2. What circumstances would change the elastic 2. What circumstances would change the elastic demands to a more inelastic demand?demands to a more inelastic demand?
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How to calculate Price Elasticity of How to calculate Price Elasticity of DemandDemand
Price elasticity of demandPrice elasticity of demand measures how much measures how much QQdd responds to a change in responds to a change in PP..
Price elasticity of demand =
Percentage change in Qd
Percentage change in P
Loosely speaking, it measures the price-sensitivity of buyers’ demand.
Price Elasticity of Price Elasticity of DemandDemand
Price elasticity Price elasticity of demand equalsof demand equals
P
Q
D
Q2
P2
P1
Q1
P rises by 10%
Q falls by 15%
15%10%
= 1.5
Price elasticity of demand =
Percentage change in Qd
Percentage change in P
Example:
Price Elasticity of Price Elasticity of DemandDemand
Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as positive numbers.
P
Q
D
Q2
P2
P1
Q1
Price elasticity of demand =
Percentage change in Qd
Percentage change in P
Calculating Percentage Calculating Percentage Changes %Changes %
P
Q
D
$250
8
B
$200
12
A
Demand for iphones
Standard method of computing the percentage (%) change:
end value – start valuestart value
x 100%
Going from A to B, the % change in P equals
($250–$200)/$200 = 25%
New – OldOld
x 100%
Calculating Percentage Calculating Percentage ChangesChanges
D
$250
8
B
$200
12
A
Demand for iphones
Problem: The standard method gives different answers depending on where you start. From A to B,
P rises 25%, Q falls 33%,elasticity = 33/25 = 1.33
From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50
P
Q
Calculating Percentage Calculating Percentage ChangesChanges
So, we instead use the So, we instead use the midpoint methodmidpoint method: :
end value – start valuemidpoint
x 100%
The midpoint is the number halfway between the start & end values, the average of those values.
It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way!
Calculating Percentage Changes Using the midpoint method, the % change Using the midpoint method, the % change
in in PP equals equals$250 – $200
$225x 100% = 22.2%
The % change in Q equals12 – 8
10x 100% = 40.0%
The price elasticity of demand equals
40/22.2 = 1.8Elastic demand for this good
Real World ElasticitiesReal World ElasticitiesMetal 1.5Metal 1.5 Oil .91 Oil .91Furniture 1.26Furniture 1.26 Electric power .92 Electric power .92Cars 1.14Cars 1.14 Tobacco .61 Tobacco .61Transportation 1.03Transportation 1.03 Housing .55 Housing .55Coca-Cola 3.8Coca-Cola 3.8 Books .34 Books .34Mountain Dew 4.4Mountain Dew 4.4 Food .12 Food .12 Non-business plane tickets 1.5Non-business plane tickets 1.5 Eggs (US) .1 Eggs (US) .1
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11 Calculate an elasticityCalculate an elasticityUse the following information to calculate the price elasticity of demand for hotel rooms:
if P = $70, Qd = 5000
if P = $90, Qd = 3000
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11 AnswersAnswersUse midpoint method to calculate % change in Qd
(5000 – 3000)/4000 = 50%
% change in P
($90 – $70)/$80 = 25%
The price elasticity of demand equals50%25%
= 2.0
Q1
P1
D
““Perfectly inelastic demand”Perfectly inelastic demand” (one extreme case)(one extreme case)
P
Q
P2
P falls by 10%
Q changes by 0%
0%10%
= 0Price elasticity
of demand
=% change in Q% change in P
=
Consumers’ price sensitivity:
D curve:
Elasticity:
vertical
none
0
D
““Inelastic demand”Inelastic demand”
P
QQ1
P1
Q2
P2
Q rises less than 10%
< 10%10%
< 1Price elasticity
of demand
=% change in Q% change in P
=
P falls by 10%
Consumers’ price sensitivity:
D curve:
Elasticity:
relatively steep
relatively low
< 1
D
““Unit elastic demand”Unit elastic demand”
P
QQ1
P1
Q2
P2
Q rises by 10%
10%10%
= 1Price elasticity
of demand
=% change in Q% change in P
=
P falls by 10%
Consumers’ price sensitivity:
Elasticity:
intermediate
1
D curve:intermediate slope
D
““Elastic demand”Elastic demand”
P
QQ1
P1
Q2
P2
Q rises more than 10%
> 10%10%
> 1Price elasticity
of demand
=% change in Q% change in P
=
P falls by 10%
Consumers’ price sensitivity:
D curve:
Elasticity:
relatively flat
relatively high
> 1
D
““Perfectly elastic demand”Perfectly elastic demand”
P
Q
P1
Q1
P changes by 0%
Q changes by any %
any %0%
= infinity
Q2
P2 =Consumers’ price sensitivity:
D curve:
Elasticity:infinity
horizontal
extreme
Price elasticity
of demand
=% change in Q% change in P
=
Summarize
One Final Test of elasticityOne Final Test of elasticity Revenue TestRevenue Test TR = Price X QdTR = Price X Qd
If in Price causes an Total Revenue then D is inelastic (consumers don’t change Qd)
If in Price causes in Total Revenue then D is elastic (consumers do change Qd)
elastic
inelastic
EX 1
EX 2
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