Economics 1: Principles of microeconomicsMonday, April 23, 2012Lecture 7Review:-Elasticity: 'responsiveness'-Price elasticity of demandEd = % ∆QD% ∆ P = Q 2−Q 1Q 2+Q1P 2− P 1P 2+ P1Preview:-Classification of products by elasticity-Determinants of elasticity-Applications-Income elasticity-Cross elasticity-Supply elasticityEd = If |Ed| > 1, %ΔQ > %ΔP --> Elastic demand; Q is tends to be responsive to PIf |Ed| < 1, %ΔQ < %ΔP --> Inelastic demand; Q is not as responsive to PIf |Ed| = 1, %ΔQ = %ΔP --> Unit(ary) "1" elasticTotal Revenue (TR) = Price (P) x Quantity (Q)If |Ed| = 1, %ΔQD = %ΔP --> Price Δ's do not effect TRIf |Ed| > 1, %ΔQD > %ΔP --> Price increase will cause TR to decrease(Elastic) --> Price decrease will cause TR to increaseIf |Ed| < 1, %ΔQD < %ΔP --> Price increase will cause TR to increase(Inelastic) --> Price decrease will cause TR to decreaseDeterminants of Ed:# and closeness of substituteso If you increase costs and competitors don't increase costs --> more elasticEconomics 1: Principles of microeconomicsMonday, April 23, 2012Lecture 7o Less elastic demand curve if only one selling pottery at a fairo Ed = (-) 2.00 for cigarettes if only Marlboro increases prices, a smoker can go somewhere else to get cigso A more narrowly defined product, more elastic demand it will beTime elapsed after the price changeo Longer the time gas prices stay at a high price, the easier it is to find substituteso Longer the time for prices to decrease, the more uses you will find for it% of income devoted to the product o Makes it more elastico If prices of matches doubles, life is not that affectedo If rent on an apartment doubles, you have to make more changes to accommodateS.I.T.o Substituteso Incomeo TimeIncome Elasticity (Ey)Ey = % ∆Q% ∆Y = Q 2−Q 1Q 2+Q1Y 2−Y 1Y 2+Y 1From negative infinity to zero: inferior goodFrom zero to positive infinity: normal goodNormal good: increase in income, increase in QInferior good: increase in income, decrease in QEy = 1.2 --> normal goodWhen Y increase by 1% --> Q increases by 1.2%Ey = 1.2% = % ∆Q% ∆Y = +3% ---> 1.2 = % ∆Q3 % --> 3.6%Useful in determining where you want to do your marketing.Cross Elasticity of DemandEx = % ∆QA% ∆ PBEconomics 1: Principles of microeconomicsMonday, April 23, 2012Lecture 7Increase in price of Coca-Cola will increase the quantity of PepsiFrom negative infinity to zero: complementsFrom zero to positive infinity: substitutesEx > 0 --> substitutesEx < 0 --> complementsIncrease in peanut butter, quantity goes down and you buy less jelly.You can use this in determining who really is a competitor.-> When you raise your prices and others around you do, then they are your competitorsSupply Elasticity of DemandEs = % ∆QS% ∆ PSupply today4.00 Supply in 5
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