ELASTICITYPRICE ELASTICITY OF DEMANDFACTS ABOUT ELASTICITYLOTS OF ELASTICITIES!What’s the percent increase in price here because of the shift in supply?PowerPoint PresentationSlide 7Economists usually use the “midpoint” formula (option C), above) to compute elasticity in cases like this in order to eliminate the ambiguity that arises if we don’t know whether price increased or decreased.Using the Midpoint FormulaWhat’s the percent change in Q due to the shift in supply?Use the midpoint formula again.NOW COMPUTE ELASTICITYSlide 14MORE ELASTICITY COMPUTATIONSSlide 16Now we try different pricesSlide 20ELASTICITY IS NOT SLOPE!TERMS TO LEARNLIKE THIS!Slide 26Slide 27Slide 28Slide 29But total spending is easy to see using a demand curve graph:Slide 31Slide 32Slide 33Slide 34Here’s a convenient way to think of the relative elasticity of demand curves.Examples of elasticityMORE ...Slide 38DETERMINANTS OF DEMAND ELASTICITYOTHER ELASTICITY MEASURESSlide 41Elasticity slide 1ELASTICITYElasticity is the concept economists use to describe the steepness or flatness of curves or functions. In general, elasticity measures the responsiveness of one variable to changes in another variable.Elasticity slide 2PRICE ELASTICITY OF DEMANDMeasures the responsiveness of quantity demanded to changes in a good’s own price.The price elasticity of demand is the percent change in quantity demanded divided by the percent change in price that caused the change in quantity demanded.Elasticity slide 3FACTS ABOUT ELASTICITYIt’s always a ratio of percentage changes.That means it is a pure number -- there are no units of measurement on elasticity.Price elasticity of demand is computed along a demand curve.Elasticity is not the same as slope.Elasticity slide 4LOTS OF ELASTICITIES!THERE ARE LOTS OF WAYS TO COMPUTE ELASTICITIES. SO BEWARE! THE DEVIL IS IN THE DETAILS.MOST OF THE AMBIGUITY IS DUE TO THE MANY WAYS YOU CAN COMPUTE A PERCENTAGE CHANGE. BE ALERT HERE. IT’S NOT DIFFICULT, BUT CARE IS NEEDED.Elasticity slide 5What’s the percent increase in price here because of the shift in supply?pE = $2QESDQpriceS'pE = $2.50CIGARETTE MARKETElasticity slide 6IS IT:A) [.5/2.00] times 100?B) [.5/2.50] times 100?C) [.5/2.25] times 100?Elasticity slide 7From time to time economists have used ALL of these measures of percentage change --including the “Something else”!Notice that the numerical values of the percentage change in price is different for each case:Go to hidden slideElasticity slide 9Economists usually use the “midpoint” formula (option C), above) to compute elasticity in cases like this in order to eliminate the ambiguity that arises if we don’t know whether price increased or decreased.Elasticity slide 10Using the Midpoint FormulaElasticity =% change in p = times 100.% change in p =For the prices $2 and $2.50, the % change in p is approx. 22.22 percent. Pin change %Q in change % Paverage Pin change100 )P P(MEANElasticity slide 11What’s the percent change in Q due to the shift in supply?pE = $2.00QE = 10SDQ (millions)priceS'pE’ = $2.50CIGARETTE MARKETQE’ = 7Elasticity slide 12Use the midpoint formula again.Elasticity =% change in Q =% change in Q =For the quantities of 10 and 7, the % change in Q is approx. -35.3 percent. (3/8.5 times 100) Pin change %Q in change %Q averageQ in change100 )QQ (MEANElasticity slide 13NOW COMPUTE ELASTICITY% change in p = 22.22 percent% change in Q = -35.3 percentE = -35.3 / 22.22 = -1.6 (approx.)Elasticity slide 14But you can do the other options as well:A) If you use the low price, and its corresponding quantity, as the base values, then elasticity = 1.2B) If you use the high price, and its corresponding quantity, as the base values, then elasticity = 2.1 (approx.)C) And the midpoint formula gave 1.6 (approx.)SAME PROBLEM...DIFFERENT ANSWERS!!!SAME PROBLEM...DIFFERENT ANSWERS!!!Elasticity slide 15MORE ELASTICITY COMPUTATIONSQPQUANTITY PRICE0 101 92 83 74 65 56 47 38 29 110 0024681012140 2 4 6 8 10 12 14Compute elasticity between prices of $9 and $8.Compute elasticity between prices of $9 and $8.Elasticity slide 16The % change in Q =The % change in P =Therefore elasticity =USE THE MIDPOINT FORMULA.Go to hidden slideElasticity slide 19Now we try different pricesQPQUANTITYPRICE0 101 92 83 74 65 56 47 38 29 110 0024681012140 2 4 6 8 10 12 14Compute elasticity between prices of $3 and $2.Compute elasticity between prices of $3 and $2.Elasticity slide 20The % change in Q = The % change in P = Therefore elasticity = Go to hidden slideElasticity slide 23ELASTICITY IS NOT SLOPE!QPNote that elasticity is differentat the two points even thoughthe slope is the same. (Slope = -1)Note that elasticity is differentat the two points even thoughthe slope is the same. (Slope = -1)QUANTITY PRICE0 101 92 83 74 65 56 47 38 29 110 0024681012140 2 4 6 8 10 12 14E = -5.67E = -.33Elasticity slide 24TERMS TO LEARNDemand is ELASTIC when the numerical value of elasticity is greater than 1.Demand is INELASTIC when the numerical value of elasticity is less than 1.Demand is UNIT ELASTIC when the numerical value of elasticity equals 1.NOTE: Numerical value here means “absolute value.”Elasticity slide 25LIKE THIS!QPQUANTITY PRICE0 101 92 83 74 65 56 47 38 29 110 0024681012140 2 4 6 8 10 12 14Demand is elastic here.Demand is elastic here.Demand is inelastic here.Demand is inelastic here.Elasticity slide 26There is an important relationship between what happens to consumers’ spending on a good and elasticity when there is a change in price.Spending on a good = P Q.Because demand curves are negatively sloped, a reduction in P causes Q to rise and the net effect on PQ is uncertain, and depends on the elasticity of demand.Elasticity slide 27QPAt P = $9, spending is $9 (= 1 times $9).At P = $8, spending is $16 ( = 2 times $8).When price fell from $9 to $8, spending rose. Q must haveincreased by a larger percent than P decreased. So...QUANTITYPRICE0 101 92 83 74 65 56 47 38 29 110 0024681012140 2 4 6 8 10 12 14Demand is elastic here.Demand is elastic here.Elasticity slide 28QPAt P = $3, spending is $21 (= 7 times $3).At P = $2, spending is $16 ( = 8 times $2).When price fell from $3 to $2, spending fell. Q must haveincreased by a smaller percent than P decreased. So...QUANTITY PRICE0 101 92 83 74 65 56 47 38 29 110 0024681012140 2 4 6 8 10 12 14Demand is inelastic here.Demand is inelastic here.Elasticity slide