Econ Notes: Chapter 5 and 6A scenario…- You design websites for local businesses. You Charge $200 a person per website, and currently sell 12 websites per month.- Your costs are rising (including the opportunity cost of your times), so you consider raising the price to $250.- The law of demand says that you won’t sell as many websites if you raise yourprice. How many fewer websites? How much will your revenue fall, or might increase? Elasticity Basic idea:- Elasticity measures how much one variable responds to in another variableo One type of elasticity measures how much demand for you will fall if you raise your priceDefinition:- Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinantsPrice Elasticity of Demand- Percentage change in Qd/ Percentage in P- Price elasticity of demand measures how much Qd responds to a change in P- Loosely speaking, it measurers the price- sensitivity of buyers’ demand- **pure number- Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticity’s positive numbers - Standard of computing the percentage change:o (End value-start value/start value) x 100%o Going from A to B the % change in P ewaula  (250-200/200)=25- Problem: The standard methods gives different answers depending on where you start.o From A to B: P rised 25%, Q falls%, elasticity=33/25=1.33o From B to A: P rises 20%, Q rises 50%, elasticity+ 50/20Calculating Percentage changes- So we instead use the midpoint method: (end value-start value/midpoint)x100- The midpoint is the number halfway between the start and end value, the average of those values.- It does not matter which value you use as the “start” and which as the “end”—you get the same answer wither way. - Using the mid-point methods, the % change in P equalso 250-200/225 =22.2%- The % change in Q equalso 12-8/10=40%- The price elasticity of demand equalso 40/22.2=1.8%Use the following information to calculate to price elasticity of demand for hotel rooms:P=70, Qd=5000P=90,Qd=3000** see notes dates 9/23/13The Variety of Demand Curves- The price elasticity of demand is closely related to the slop of the demand curve but it is not equal to the slope of the demand curve. The reason for this is because slope is a ration of two changes and elasticity is a ration of two % changes.- Rule of thumb:o The flatter the curve, the bigger the elasticity. The stepper the curve, the smaller the elasticity. - Five different classification of D curve“Elastic Demand”- D curve: relatively flat- Consumers’ price sensitive: relatively high- Elasticity:>1“Inelastic demand”- D curve: Relatively steep- Consumers’ price sensitivity: relatively low- Elasticity: <1“Unit elastic demand”- D curve: - Consumers’ price sensitivity: - Elasticity: 1“Perfectly inelastic demand”(one extreme case)- D curve: vertical- Consumers’ price sensitivity: none- Elasticity: 0o Ex. Insulin (diabetics)“Perfectly elastic demand”(the other extreme)- D curve: horizontal- Consumers’ price sensitivity: extreme- Elasticity: infinityo Price changes Q goes to zeroo Fisher men---collect more fish but can only sell at market price. What determines price elasticity?To learn the determinants of price elasticity, we look at a serious of example. Each compares two common goods.In each example:- Suppose the prices of both goods rise by 20%- The good for which Qd falls the most (in percent) has the higher price elasticity of demand. Which good is it? why?Breakfast cereal vs. Sunscreen- The prices of both of these goods rise 20%. For which good does Qd drop the most? Why?o Breakfast cereal has close substitutes (Ex. Pancakes, Eggo waffles, oatmeal)o Sunscreen has no close substitutes, so consumer would probably not buy much less it its price rises. - Lessons: Price elasticity is higher when close substitutes are available. (Cereal has elastic demand curve)“Lucky Brand Jeans” vs. “Clothing”- The process of both good rises 20%. For which good does Qd drop the most? Why?o For narrowly defined good such as Lucky Brand jeans, there are many substitutes (khakis, shorts)o There are fewer substitutes available for broadly defined goods(there aren’t too many substitutes for clothing, other than living in a nudist colony.)- Lesson: Price elasticity is higher for narrowly defined goods than broadly defines ones. Insulin vs. Cruises- The process of both good rises 20%. For which good does Qd drop the most? Why?o To millions of diabetic, insulin is a necessity A rises in its price would cause no decrease in Qdo A cruise is a luxury.- Lesson: Price elasticity is higher for luxuries than for necessities. o Luxury- elastic o Necessity- inelastic Gas in Short Run vs. Gas in the Long Run- The process of both good rises 20%. For which good does Qd drop the most? Why?o There’s not much people can do in the short run, other than ride the bus or carpoolo In the long run, people can buy smaller cars or live closer to where they work.- Lesson: Price elasticity is higher in the long run than the short runo Long Run can find more alternatives. The Determinants of Price Elasticity: A SummaryThe price elasticity of demand depends on:- The extent to which close substitutes are available- Whether the good is a necessity or a luxury- How broadly or narrowly the good is defined- The time horizon- elasticity is higher in the long run than the short runGovernment Policies That Alter the Private Market Outcome- Price Controlso Price Ceiling: a legal maximum on the price of a g/s (Ex. Rent Control)o Price Floor: a legal minimum on the price of a g/a (Ex. Minimum wage)- Taxeso The Govt can make buyers or sellers pay a specific amount on each unit bought/sold. Example 1: Market for Apartments- Eq’m without price control- A price ceiling above the eq’m price is not binding- has no effect on the market outcome. o Ceiling above eq’m it has no effect on the market (will remain in eq’m)o The eq’m is above the ceiling and therefore illegalo The ceiling is a binding constraint on the price causes a shortage. - In the long run supply and demand are more price-elastico People wont go into the apartment market b/c won’t make any money.o Over time shortage gets worseShortage and Rationing- With a shortage, sellers must ration the goods among buyers.- Some rationing mechanisms: (1) Long limes (2) Discrimination according to sellers’