ECON 1 1st Edition Lecture 7Outline of Last Lecture I. Supply and Demand cont. II. EquilibriumOutline of Current Lecture II. Chapter 5: Elasticity and its ApplicationsCurrent LectureQuestions:1. What is elasticity? How can it help?2. What is the price elasticity of demand? Of Supply? Scenario:- You design websites for local businesses. Charge $200 per site, and currently sell 12 websites per month.o Your costs are rising; consider raising price to $250.o Law of demand says you won’t sell as many website if you raise your price?o How many fewer websites? How much will your revenue fall, or might it increase? Elasticity: - Measures how much the change of one variable responds to changes in another variable.o Ex. One type of elasticity measures how much demand for your websites will fall if you raise your price.- A numerical measure of the responsiveness of Qd or Qs to one of its determinants. Elasticity of Demand:-There is an inverse relationship between price and quantity demanded.How much does quantity demanded change when price changes?- Elastic: A demand curve is elastic when an increase in price reduces the quantity demanded a lot (vice versa).- Inelastic: A demand curve is inelastic when the same increase in price reduces quantity demanded just a little.Elastic= large change in quantity, just goes down. Big decrease in quantity demanded if demand is elastic.Inelastic: large change in price, very steep. Causes small decrease in quantity demanded if demand is inelastic. The more responsive quantity demanded is to a change in price, the more elastic is the demand curve. Elasticity Rule: - Elasticity is not the same as slope but if two linear demand (supply) curves run through acommon point, then at any given quantity the curve that is flatter is more elastic. Determinants of the Elasticity of Demand:1. Availability of Substitutesa. Fewer subs make it harder for consumers to adjust Q when P changes, so demand is inelastic. i. Ex. Gasb. Many subs? Switching brands when prices change is easy, so demand is elastic.i. Ex. Soda, if you only wanted the caffeine and sugarc. When the patent expires on a brand name drug and 5 generic drugs come on the market, what happens to elasticity of demand? It rises!d. Breakfast cereal vs. Sunscreeni. The prices of both of these goods rise by 20%. For which good does Qd drop the most? 1. Cereal has close substitutes, so buyers can easily switch if the price rises. 2. Sunscreen has no close substitutes, so consumers would probably not buy much less if its price risesPrice elasticity is higher when close substitutes are available.2. Time Horizona. Less time to adjust means lower elasticity.b. Over time, consumers can adjust their behavior by finding subs (making demand more elastic).c. Ex. Gasoline in short vs. long runi. Qd drops more in the long run because people need time to find alternatives and adjust to changes.Price elasticity is higher in the long run than in the short run. 3. Category of product (Narrow vs. Broad)a. The classification of the good matters.b. The less specific the classification, the fewer substitutes there are (makes demand inelastic) and vice versac. Ex. the elasticity of demand is higher for “lettuce” (more specific) than for “food” (broad).i. More specific equals more substitutesii. More broad equals fewer substitutes. d. Ex. Blue jeans vs. Clothingi. Clothing=Broad, inelasticii. Blue jeans=Specific, elastic. e. Price elasticity higher for narrowly defined goods than broadly defined ones. 4. Necessities vs. Luxuriesa. The nature of the good to the consumer can also affect the elasticity of demandb. For necessities, we do not change Q much when P changes.i. Inelastic demandsc. For luxuries, we are more sensitive to P changesi. Elastic demands 5. Insulin vs. Caribbean Cruisesa. Cruise equals luxury.b. The quantity that would drop the most is the cruises.6. Purchase Sizea. We are less sensitive to price changes when the good feels cheap.b. We are more sensitive to price changes when the good feels expensive.Price Elasticity of Demand- Price Elasticity Demand (Ed): measures how much Qd responds to a change in price (P).o Measures price-sensitivity of buyers’ demando Ed= % change in Qd/ % change in Price- Ex. If price of oil increases by 10%, the Qd falls by 5%o Long elasticity of demand for oil is?  -5% divided by 10% equals -0.5- Along a demand curve, price and quantity move in opposite directions, which would make price elasticity negative. Elasticity of demand is always negative, so we typically drop the negative sign and use absolute value instead.- Ed<1, D curve is inelastic- Ed>1, elastic- Ed=1, unit elasticLESS ELASTIC MORE ELASTICFewer subs More SubsShort run (less time) Long run (more time)Necessities LuxuriesSmall part of budget Less part of budgetCalculating percentage changes:- midpoint method:o End value – start value/(end value + start value) divided by 2 Variety of demand curves: - Rule of thumb:o The flatter the curve, the bigger the elasticityo The steeper, the smaller the elasticityFive different classifications of Demand curve1. Perfectly inelastica. Demand curve is verticalb. Consumers’ price sensitivity: nonec. Elasticity: 0d. P changes but Quantity demanded stays the same. 2. Inelastic demand a. Elasticity: <1b. Demand curve is relatively steep3. Unit elastica. D Curve: Intermediate slopeb. Consumers’ price sensitivity: intermediatec. Elasticity: 14. Elastic demanda. D curve: relatively flatb. Consumers’ price sensitivity: relatively highc. Elasticity: >15. Perfectly elastic demanda. D curve: horizontalb. Consumers’ price sensitivity: extremec. Elasticity: infinityd. Price changes by zero and Quantity demanded changes by any %. PRODUCT PRICE ELASTICITYEggs .1Healthcare .2Rice .5Housing .7Beef 1.6Restaurant meals 2.3Mountain dew 4.4Price Elasticity of Demand using the Midpoint Formula:1. Ex. Initial price: $10 and Qd=100. When price rises to $20, the Qd is 90.a. Pecent change in Qd: 90-100/(90+100)/2= -10.5b. Percent change in Price: 20-10/(20+10)/2= 66.6%c. Ed: -10.5/66.6= -.15 or .15Elasticity of Demand and Total Revenue - A firm’s revenues are equal to price per unit times quantity sold.- Revenue = Price x Quantity- The elasticity of demand directly influences revenues when the price of the good