Elasticity adding (quantitative) meat to the bones of supply and demand.

Elasticityadding (quantitative) meat to the

bones of supply and demand

Suppose the price of gas rises by 10% over the next month. By how much will Ohio drivers cut back on their purchases of gasoline?

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a) 0 percent (no cut back)b) 1 to 5 percentc) 6 to 10 percentd) 11 to 20 percente) More than 20 percent

a) 0 percent (no cut back)b) 1 to 5 percentc) 6 to 10 percentd) 11 to 20 percente) More than 20 percent

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Price Elasticity of Demand Measures the price sensitivity of buyers

Ed = $

Gasoline

$3.50

$3.00

280 300

D

D%ΔQ%ΔP

%ΔQ

%ΔP

Midpoint Formula

Ed = =

Ed = -[.07/.15] = -0.47

avg

12

avg

12

PPP

QQQ

3.25

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Degree of Sensitivity Elastic: |Ed| > 1 Unit: |Ed| = 1 Inelastic: |Ed| < 1

$

Gasoline

$3.50

$3.00

280 300

D

%ΔQ

%ΔP

a) -1.81; elasticb) -0.55; inelasticc) -0.50; elasticd) -2.00; inelastic

a) -1.81; elasticb) -0.55; inelasticc) -0.50; elasticd) -2.00; inelastic

When the price of milk is $2 per gallon, consumers buy 500 gallons. When the price rises to $3 per gallon, consumers buy only 400 gallons. What is the elasticity of demand and how would you classify it?

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Ed =

Ed = -.22/.40 = -0.55

2)/2.5(3400)/450(500

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Determinants of Elasticity Number of substitutes

The greater the # substitutes, the greater the elasticity The narrower the definition of the market, the greater the

elasticity

Ex:

Item’s share of consumer budget The greater the share of budget, the greater the elasticity

Ex: Ehousing > Esalt

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gasoline

$

P0

Q0

P1

Q1 Q2

short run

long run

Determinants of Elasticity

Time The longer the time horizon, the greater the elasticity

Gasoline Demand: ELR > ESR

Perfectly Inelastic

Ed =

Examples?

Perfectly Elastic

Ed =

Examples?

$

Q

$

Q

D1

P1

P2

Q1

D1P1

0

∞

Extreme Cases of Price Elasticity

Good Price elasticity

Inelastic demand

Eggs - 0.10 Beef - 0.40 Stationery - 0.50 Gasoline - 0.50

Elastic demand

Housing - 1.20 Restaurant meals - 2.30 Airline travel - 2.40 Foreign travel - 4.10

Good Price elasticity

Inelastic demand

Eggs - 0.10 Beef - 0.40 Stationery - 0.50 Gasoline - 0.50

Elastic demand

Housing - 1.20 Restaurant meals - 2.30 Airline travel - 2.40 Foreign travel - 4.10

Some Estimated Price Elasticities of Demand

a) enrollment will fall by 6.25% and tuition revenues will increase.

b) enrollment will fall by 4% and tuition revenues will increase.

c) enrollment will fall by 6.25% and tuition revenues will decrease.

d) enrollment will fall by 4% and tuition revenues will decrease.

a) enrollment will fall by 6.25% and tuition revenues will increase.

b) enrollment will fall by 4% and tuition revenues will increase.

c) enrollment will fall by 6.25% and tuition revenues will decrease.

d) enrollment will fall by 4% and tuition revenues will decrease.

Suppose that the price elasticity of demand for a Marietta College education is estimated to be E = -0.80. Based on this information, if the college were to raise tuition by 5%, then:

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Elasticity and Total Revenue

Elastic Demand P x Q = TR

P x Q = TR

Inelastic Demand P x Q = TR

P x Q = TR

$

Computers

$1000

$800

200 300

D

TR = $200,000

TR = $240,000

400 500

$600

$400

E = - 1.82

E = - 0.55

TR = P x Q

a) enrollment will fall by 6.25% and tuition revenues will increase.

b) enrollment will fall by 4% and tuition revenues will increase.

c) enrollment will fall by 6.25% and tuition revenues will decrease.

d) enrollment will fall by 4% and tuition revenues will decrease.

a) enrollment will fall by 6.25% and tuition revenues will increase.

b) enrollment will fall by 4% and tuition revenues will increase.

c) enrollment will fall by 6.25% and tuition revenues will decrease.

d) enrollment will fall by 4% and tuition revenues will decrease.

Suppose that the price elasticity of demand for a Marietta College education is estimated to be E = -0.80. Based on this information, if the college were to raise tuition by 5%, then:

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1 2 3 4 5

a) The demand was elastic.b) The demand was inelastic.c) The demand was perfectly elastic.d) The demand was perfectly

inelastic.

a) The demand was elastic.b) The demand was inelastic.c) The demand was perfectly elastic.d) The demand was perfectly

inelastic.

In August, 1990, East German taxicab drivers were on strike demanding lower cab fares. What must the drivers have believed about the price elasticity of demand for taxi rides?

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a) -0.71b) -1.40c) +1.40d) +0.71

a) -0.71b) -1.40c) +1.40d) +0.71

According to recent studies at M.I.T. and the University of Michigan, a 10% increase in the price of cigarettes leads to a 14% drop in sales to teenagers. What is the elasticity of demand for cigarettes among teenagers?

Would you expect it to be this high for older smokers? Explain.

Would you expect it to be this high for older smokers? Explain.

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1-1

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0.71

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1 2 3 4 5

price

D1

S1

4.00

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3.40

t = $1

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Cigarette Tax Revisited

Assume that ED = -0.60

ED = = -0.60

%ΔQD = - 6.0%

cigarettesWhat happens to total consumer expenditures?What happens to total consumer expenditures?

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ΔQ% D

What happens to tax revenue if demand becomes more elastic?What happens to tax revenue if demand becomes more elastic?

%ΔQD = - 6%

%ΔP = 10%

Other Demand Elasticities

Cross-Price Elasticity

Exy =

Income Elasticity

EI =

Substitutes: Exy > 0

Complements: Exy < 0

Normal Goods: EI > 0

Inferior Goods: EI < 0

Y

X

ΔP%

ΔQ%

IΔ%

ΔQ%

Examples of cross-price elasticities

Commodity With respect to price of

Cross-Price elasticity

Beef Pork 0.28

Butter Margarine 0.67

Electricity Natural gas 0.20

Natural gas Fuel oil 0.44

Clothing Footwear - 0.01

Dairy products Meat products - 0.15

Entertainment Food - 0.72

Examples of income elasticities

Commodity Income elasticity

Automobiles 2.46

Furniture 1.48

Restaurant Meals 1.40

Water 1.02

Tobacco 0.64

Gasoline 0.48

Margarine -0.20

Pork -0.20

Public transportation -0.36

In Marietta, the price elasticity of demand for bus rides is ED = -0.5, the income elasticity of demand for bus rides is EI = -0.1, and the cross elasticity of demand for bus rides

with respect to gasoline is Exy = 0.2.

a) Is the demand for bus rides elastic or inelastic with respect to the price of a bus ride? How do you know?

b) Would an increase in bus fares increase the bus company's total revenue? Explain your answer.

c) Describe the relationship between bus rides and gasoline. Explain your answer.

d) If the price of gasoline increases by 10 percent with no change in the price of a bus ride, by what percentage will the number of bus rides change?

e) If incomes in Marietta increase by 5 percent with no change in the price of a bus ride, by what percentage will the number of bus rides change?

f) In Marietta, is a bus ride a normal good or an inferior good? Why?