Chapter 6-1

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Chapter 6-1 Powered By Docstoc
					The Elasticity of Demand

        Chapter 7
     The Concept of Elasticity
• Elasticity is a measure of the
  responsiveness of one variable to another.
• The greater the elasticity, the greater the
  responsiveness.
           Laugher Curve
Q. What’s the difference between an
   economist and a befuddled old man with
   Alzheimer’s?
A. The economist is the one with a
   calculator.
     The Concept of Elasticity
• Elasticity is a measure of the
  responsiveness of one variable to another.
• The greater the elasticity, the greater the
  responsiveness.
            Price Elasticity
• The price elasticity of demand is the
  percentage change in quantity demanded
  divided by the percentage change in price.


     Percentage change in quantity demanded
ED =
            Percentage change in price
      Sign of Price Elasticity
• According to the law of demand, whenever
  the price rises, the quantity demanded
  falls. Thus the price elasticity of
  demand is always negative.

• Because it is always negative, economists
  usually state the value without the sign.
      What Information Price
       Elasticity Provides
• Price elasticity of demand and supply
  gives the exact quantity response to a
  change in price.
Classifying Demand and Supply
     as Elastic or Inelastic
• Demand is elastic if the percentage
  change in quantity is greater than the
  percentage change in price.

                   E>1
Classifying Demand and Supply
     as Elastic or Inelastic
• Demand is inelastic if the percentage
  change in quantity is less than the
  percentage change in price.


                    E<1
           Elastic Demand
• Elastic Demand means that quantity
  changes by a greater percentage than the
  percentage change in price.
         Inelastic Demand
• Inelastic Demand means that quantity
  doesn't change much with a change in
  price.
        Defining elasticities
• When price elasticity is between zero and
  -1 we say demand is inelastic.
• When price elasticity is between -1 and
  - infinity, we say demand is elastic.
• When price elasticity is -1, we say demand
  is unit elastic.
   Elasticity Is Independent of
                Units
• Percentages allow us to have a measure
  of responsiveness that is independent of
  units.
• This makes comparisons of
  responsiveness of different goods easier.
      Calculating Elasticities
• To determine elasticity divide the
  percentage change in quantity by the
  percentage change in price.
      The End-Point Problem
• The end-point problem – the percentage
  change differs depending on whether you
  view the change as a rise or a decline in
  price.
      The End-Point Problem
• Economists use the average of the end
  points to calculate the percentage change.


                     (Q2 - Q1)
                                    ½Q2  Q1 
      Elasticity = (P   2   - P1)
                                    ½P1 + P2 
      Graphs of Elasticities
               B
$26
 24                   C (midpoint)
 22                          A
 20
 18
                                       D
 16
 14                              Elasticity of demand
                                 between A and B = 1.27
  0            10    12      14
  Quantity of software (in hundred thousands)
          Calculating Elasticities: Price
              elasticity of Demand

      P        What is the price elasticity of
               demand between A and B?
                                               Q2–Q1
                                       %ΔQ   ½(Q2+Q1)
           B
                                 ED = %ΔP =    P2–P1
$26                 Midpoint
               C                             ½(P2+P1)
$23
$20                A                 10–14
                                    ½(10+14) -.33
                                 = 26–20 = .26 = 1.27
                               D    ½(26+20)
                                  Q
           10 12 14
                                                    7-18
        Price Elasticity: Supply
• Price elasticity of supply is the
  percentage change in quantity supplied
  divided by the percentage change in
          ES =     % change in Quantity Supplied
                        % change in Price
• This tells us exactly how quantity supplied responds to
  a change in price
• Elasticity is independent of units



                                                            7-19
        Price Elasticity: Supply
• Supply is elastic if the percentage
  change in quantity is greater than the
       Elastic change in ES >
  percentagesupply is whenprice1

• Supply is inelastic if the percentage change in quantity
  is less than the percentage change in price

          Inelastic supply is when ES < 1




                                                             7-20
            Calculating Elasticities: Price
                                   Supply
                elasticity ofelasticity of
                 What is the price
        P                  supply between A and B?

                                                     Q2–Q1
                                  S
                                               %ΔQ ½(Q2+Q1)
                             B
                                         ES = %ΔP = P2–P1
$5.00
        Midpoint                                    ½(P2+P1)
$4.75               C                   485–476
                                       ½(485+476) 0.0187 0.18
            A                         = 5–4.50 = 0.105 =
$4.50
                                        ½(5+4.50)
                                        Q
            476    480.5    485

                                                                7-21
        Graphs of Elasticities

$6.00
 5.50
 5.00                                       B
 4.50                                     C (midpoint)
                                      A
 4.00
 3.50    Elasticity of supply
 3.00    between A and B = 0.18

   0
                                   470 480 490
                  Quantity of workers
 Calculating Elasticity

            Q 2  Q1
   %Q 2 (Q 1  Q 2 )
          1
E      
   % P      P2  P1
           2 (P1  P2 )
           1
 Calculating Elasticity of Demand
      Between Two Points
                     Elasticity of demand       %Q
                                             E
$26                  between A and B:           %P
              B
24                                       10  14      4
                                       2 (14  10 )         .33
                                       1
22     midpoint      C            ED                12         1.27
20                                       26  20       6    .26
                                       2 (26  20 )
                             A         1
                                                      23
18
16                                Demand
14


  0
                10      12       14
      Quantity of software (in hundred thousands)
Calculating Elasticity of Supply
    Between Two Points
$6.00
 5.50                               Elasticity of supply
 5.00                         B     between A and B: E  %Q
 4.50
                      A
                          C                                    %P
 4.00                                    485  475        10
 3.50                                  2 ( 485  475 )
                                       1
                                                               .021
                                  ES                   480        .2
 3.00                                      5  4.50      .50   .105
                                         2 (5  4.50 )
                                         1
                                                         4.75

   0
                  470 480 490
        Quantity of workers
 Calculating Elasticity at a Point
• Let us now turn to a method of calculating
  the elasticity at a specific point, rather than
  over a range or an arc.
 Calculating Elasticity at a Point
• To calculate elasticity at a point, determine
  a range around that point and calculate
  the arc elasticity.
Calculating Elasticity at a Point

 $10                   (28 - 20)
   9                              ½28  20 
   8      E at A   =
                           (5 - 3)
                                               0.66
                                   ½5 + 3 
   7
   6                   C
   5
                           A
   4
                               B
   3
   2
   1
                   20 24 28            40   Quantity
      Calculating Elasticity at a Point

         To calculate elasticity at a point determine
$10      a range around that point and calculate
  9      the arc elasticity.
  8
  7                                     28  20       8
                                      2 (28  20 )
  6                                   1
                   C       E at A                  24  .33  .66
  5
                       A                  53         2    .5
  4
                                        2 (5  3)
                           B            1
                                                      4
  3
  2
  1
               20 24 28             40
        Quantity
 Elasticity and Demand Curves
• Two important points to consider:
  – Elasticity is related (but is not the same as)
    slope.
  – Elasticity changes along straight-line demand
    and supply curves.
Calculating Elasticity at a Point

$10   Demand
  9                                      Supply
  8                EA = 2.33
               A
  7
  6
                                  D
  5                                   ED = 0.86
  4
  3                  C E = 0.75         EB = 0.11
  2                     C
                                           B
  1
      6   12 18 24 30 36 42 48 54 60 Quantity
 Elasticity and Demand Curves
• Two important points to consider:
  – Elasticity is related (but is not the same as)
    slope.
  – Elasticity changes along straight-line demand
    and supply curves.
  Elasticity Is Not the Same as
               Slope
• The steeper the curve at a given point, the
  less elastic is supply or demand.
• There are two limiting examples of this.
  Elasticity Is Not the Same as
               Slope
• When the curves are flat, we call the
  curves perfectly elastic.

• The quantity changes enormously in
  response to a proportional change in price
  (E = ).
  Elasticity Is Not the Same as
               Slope
• When the curves are vertical, we call the
  curves perfectly inelastic.

• The quantity does not change at all in
  response to an enormous proportional
  change in price (E = 0).
Perfectly Inelastic Demand
           Curve

                  Perfectly inelastic
                  demand curve




 0
       Quantity
Perfectly Elastic Demand Curve




                    Perfectly elastic
                    demand curve



   0
         Quantity
               Demand Curve
             Shapes and Elasticity
• Perfectly Elastic Demand Curve
   – The demand curve is horizontal, any change in price can and
     will cause consumers to change their consumption.

• Perfectly Inelastic Demand Curve
   – The demand curve is vertical, the quantity demanded is totally
     unresponsive to the price. Changes in price have no effect on
     consumer demand.

• In between the two extreme shapes of demand curves
  are the demand curves for most products.
  Demand Curve
Shapes and Elasticity
     Elasticity Changes Along
       Straight-Line Curves
• Elasticity is not the same as slope.
• Elasticity changes along straight line
  supply and demand curves–slope does
  not.
        Elasticity Along a Demand Curve
            Ed = ∞
                                    Elasticity declines along
   $10                            demand curve as we move
     9                              toward the quantity axis
     8               Ed > 1
     7
     6
Price




                                  Ed = 1
     5
     4
     3                                         Ed < 1
     2
     1                                                  Ed = 0
        0    1   2   3   4    5     6      7   8   9 10 Quantity
The Price Elasticity of Demand Along a
     Straight-line Demand Curve
    Substitution and Elasticity
• As a general rule, the more substitutes a
  good has, the more elastic is its supply
  and demand.
     Substitution and Demand
• The less a good is a necessity, the more
  elastic its demand curve.

• Necessities tend to have fewer substitutes
  than do luxuries.
    Substitution and Demand
• Demand for goods that represent a large
  proportion of one's budget are more elastic
  than demand for goods that represent a
  small proportion of one's budget.
     Substitution and Demand
• Goods that cost very little relative to your
  total expenditures are not worth spending
  a lot of time figuring out if there is a good
  substitute.

• It is worth spending a lot of time looking for
  substitutes for goods that take a large
  portion of one’s income.
     Substitution and Demand
• The larger the time interval considered, or
  the longer the run, the more elastic is the
  good’s demand curve.
  – There are more substitutes in the long run
    than in the short run.
  – The long run provides more options for
    change.
         Determinants of the
      Price Elasticity of Demand
• The degree to which the price elasticity of
  demand is inelastic or elastic depends on:
  – How many substitutes there are
  – How well a substitute can replace the good or
    service under consideration
  – The importance of the product in the
    consumer’s total budget
  – The time period under consideration

				
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