Principles of Microeconomics ECON 1101 Spring 2010 Department of Economics University of Minnesota Notes On Price Elasticity of Demand Lectures Internet Office Hours M W F 9 05pm 9 55pm Rm WilleyH 175 http www econ umn edu amin0066 HMH 3 105 M 10 45am 1 00pm Instructor Minesh D Amin Email amin0066 umn edu Tel 612 624 9345 Fax This handout will begin by first giving a short review of material we covered in lecture dealing with the price elasticity of demand PED Then we will take a look at three examples of calculating PED First will be the question and after that will be a solution to the problems I would advise you to first try to work out the examples before you check the answers 1 Review of Price Elasticity of Demand The definition of Price Elasticity of Demand PED is Price Elasticity of Demand Percentage Change in Quantity Demanded QD Percentage Change in Price P In order to calculate the PED we need two points on the demand curve QD1 P1 and QD2 P2 In order to calculate the PED we use the midpoint formula QD2 QD1 QD1 QD2 2 PED P2 P 1 P1 P 2 2 Once we have calculated the PED between two points on the demand curve we can say if demand between those points is elastic inelastic or unit elastic as follows Demand is elastic at a certain point if PED 1 Demand is unit elastic at a certain point if PED 1 Demand is inelastic at a certain point if 0 PED 1 2 Notes On Price Elasticity of Demand There are a number of factors that can determine if a demand curve will be more elastic or more inelastic We covered this material on Wednesday February 17th Four Factors Affecting PED 1 Availability of close substitutes 2 Definition of Market 3 Amount of time 4 Necessities vs luxuries When calculating different elasticities it is very important to keep in mind what information you need to calculate a certain elasticity and what information you have available Also sometimes there is information that is not relevant to certain elasticities Be sure you are aware of what information is necessary and what information is not The following examples emphasize this point The answers to these example problems are at the end of this handout 2 Examples of Price Elasticity of Demand Example 1 You are given market data that says when the price of pizza is 4 the quantity demanded of pizza is 60 slices and the quantity demanded of cheese bread is 100 pieces When the price of pizza is 2 the quantity demanded of pizza is 80 slices and the quantity demanded of cheese bread is 70 pieces Can the Price Elasticity of Demand be calculated for either good If so calculate the PED Example 2 Consider the markets for widgets and cogs You study survey data and observe that if widgets cost 5 then 100 widgets are demanded You also observe that if widgets cost 3 then 150 cogs are demanded and if widgets cost 4 then 100 cogs are demanded If cogs cost 2 then 125 cogs are demanded Can the Price Elasticity of Demand be calculated for either good If so calculate the PED Example 3 Consider the market for widgets and cogs again You study survey data and observe that if widgets cost 5 then 100 widgets are demanded and 60 cogs are demanded You also observe that if widgets cost 3 then 200 widgets are demanded and 100 cogs are demanded If cogs cost 2 then 125 cogs are demanded Can the Price Elasticity of Demand be calculated for either good If so calculate the PED Department of Economics University of Minnesota Minneapolis MN 55454 3 Principles of Microeconomics ECON1101 Solution to Example 1 Can the Price Elasticity of Demand be calculated for either good If so calculate the PED In order to calculate PED we need two quantity price pairs for one good two points along a certain goods demand curve We are given this information for pizza We are never given this information for cheese bread We have two quantity price pairs for pizza Specifically QD1 P1 60 4 and QD2 P2 80 2 Then plugging these numbers into the above formula we obtain QD2 QD1 80 60 20 QD1 QD2 60 80 140 20 20 3 3 2 2 2 70 PED 2 70 2 7 P2 P 1 2 4 2 3 P1 P 2 4 2 6 2 2 2 Given this data the PED is 3 7 NOTE This tells us that given these two points this demand curve for pizza is inelastic We know this because the PED is between 0 and 1 Solution to Example 2 Can the Price Elasticity of Demand be calculated for either good If so calculate the PED In order to calculate PED we need two quantity price pairs for one good two points along a certain goods demand curve We are not given this information for either widgets or cogs We cannot calculate PED for either good in this case Department of Economics University of Minnesota Minneapolis MN 55454 4 Notes On Price Elasticity of Demand Solution to Example 3 Can the Price Elasticity of Demand be calculated for either good If so calculate the PED In order to calculate PED we need two quantity price pairs for one good two points along a certain goods demand curve We are given this information for widgets We are never given this information for cogs We have two quantity price pairs for pizza Specifically QD1 P1 100 5 and QD2 P2 200 3 Then plugging these numbers into the above formula we obtain QD2 QD1 200 100 100 QD1 QD2 100 200 300 100 100 4 4 2 2 2 150 PED 2 150 2 3 P 2 P1 3 5 2 4 P 1 P2 5 3 8 2 2 2 Given this data the PED is 4 3 NOTE This tells us that given these two points this demand curve for widgets is elastic We know this because the PED is less then 1 Department of Economics University of Minnesota Minneapolis MN 55454