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? Mankiw Chapter 5 - Elasticit
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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?
Mankiw Chapter 5 - Elasticity
Reminder: Article next weekReminder: Article next weekstart of class, topics: ???start of class, topics: ???
ElasticElastic Elastic DemandElastic Demand Very responsive Very responsive
to price changeto price change Most normal Most normal
goodsgoods Rare purchasesRare purchases Big budgetBig budget Many substitutesMany substitutes
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
InelasticInelastic
Inelastic DemandInelastic Demand Not responsive to Not responsive to
price changeprice change Few substitutesFew substitutes Small part of budgetSmall part of budget Most goods, close to Most goods, close to
needsneeds 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
200
300
400
500
600
700
In RealityIn Reality
A
B
C
7
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.
8
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.
9
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.
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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 measures how much 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 of demand equalsequals
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.
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 value
start valuex 100%
Going from A to B, the % change in P equals
($250–$200)/$200 = 25%
New – Old
Oldx 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 equals
12 – 810
x 100% = 40.0%
The price elasticity of demand equals
40/22.2 = 1.8
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 equals
50%25%
= 2.0
SummarySummary
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%= 0
Price 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%< 1
Price 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%= 1
Price 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%> 1
Price 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=
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
Summarize
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