ECO 2030 1nd Edition Lecture 11 Outline of Last Lecture I Introduction to Elasticity Outline of Current Lecture II Elasticity III Elasticity examples IV Elasticity of Demand shown on the demand curve Current Lecture Elasticity Elasticity and its application Elasticity measures how a change in one variable affects another Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants A Scenario from the PPT You design websites for local businesses ou charge 200 per website and currently sell 12 websites per month Your costs are rising including the opportunity cost of your time so you consider raising the price to 250 The law of demand says that you won t sell as many websites if you raise your price How many fewer websites How much will your revenue fall or might it increase Price elasticity of demand DELTA Qd DELTA P Price elasticity of demand percent change in Qd percent change in P Example Price elasticity of demand 15 10 1 5 All Changes move in opposite direction Also with elasticity we don t care about minus signs leave them out Midpoint method Elasticity and its application In this case we calculate percent changes differently we use the Midpoint Price elasticity end value Start Value Midpoint x 100 Price Elasticity If the concept of midpoint is confusing you should think of it as the average for example 200 and 400 200 400 2 300 300 the midpoint Also it doesn t matter whether you put the end value or the start value first or last because if you encounter a negative you can simply discard it Note you have to calculate the change in P and in Q so you can get a so you can get change Example change in P 250 200 225 x100 22 2 Change in Q 12 8 10 x 100 40 So price elasticity 40 22 2 1 8 Example 1 Breakfast cereal vs sunscreen The prices of these goods rises by 20 for which good does the demand drop the most Cereal will see the biggest drop in demand because it has so many substitutes that people can easily change to Sunscreen on the other hand has very few substitutes therefore many people will buy it no matter what the price Therefore price elasticity is higher when when substitutes are available Example 2 Blue Jeans vs Clothing the price of both goods rises by 20 for which good does the demand drop the most Again Blue Jeans have many substitutes as do many narrowly defined goods On the other hand there are few substitutes available for broadly defined goods So the price elasticity is highest for narrowly defined goods Blue Jeans than for broadly defined goods Clothing Example 3 Insulin vs Caribbean Cruises The price of both rise by 20 which good will see the biggest fall in demand For anyone who buys insulin it is because they need it so a rise in price will cause little or no decrease in demand A cruise is a luxury not a necessity if the prices rise the demand will fall also there are plenty of substitutes for cruises Therefore the price elasticity is higher for luxuries than for necessities Example 4 Gas in the short run vs Gas in the long run If the price of gas rises by 20 will the demand fall more in the long or short run For most people they have few options that would relieve them from buying gas in the short run so demand for gas in the short run does not fall In the long run people have a better chance of reducing their dependence on gas such as moving closer to work moving near a bus or train station ect So the demand of gas in the long run does fall Therefore the price of elasticity is higher in the long run than in the short run Price of Elasticity Summary The Price Elasticity of demand depends on The extent to which close substitutes are available Whether a good is a necessity or a luxury How broadly or narrowly a good is defined and the time frame elasticity is higher in the long run than in the short run Visualizing Elasticity Perfectly inelastic demand doesn t happen in the real world Price Elasticity of demand Q P 0 10 0 The closest example of this in real world would probably be insulin Inelastic Demand Here the Demand Curve is relatively steep and you can see that a fall in price has a small effect on demand Price Elasticity of demand Q P 10 10 1 An example of this might be textbooks if the price gets too high some student might seek alternatives to buying textbooks Unit Elastic Demand This is when the elasticity 1 because both the fall in price and the increase in demand are the same also rarely happens in the real world Elastic Demand This is when the demand increases more than the price falls Elasticity 10 10 1 This would be an example of anything that has substitutes Perfectly elastic demand This is extreme price sensitivity basically means that you cannot change the price at all Quantity can change by any amount but price always stays the same If you lower the price of a good your demand could increase to infinity however if you increase the price your demand will reach 0