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APPALACHIAN ECO 2030 - Price Elasticity of Demand

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ECO 2030 1nd Edition Lecture 11Outline of Last Lecture I. Introduction to ElasticityOutline of Current Lecture II. ElasticityIII. Elasticity examplesIV. Elasticity of Demand shown on the demand curveCurrent LectureElasticity: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 determinantsA 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’tsell 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 = percentchange in Qd/percent change in PExample: Price elasticity of demand = 15% / 10% = 1.5● All Changes move in opposite direction○ Also, with elasticity we don'tcare about minus signs, leavethem 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 % changeExample: change in P = ($250-$200)/($225)x100 = 22.2%Change in Q = (12-8)/(10) x 100 = 40%So price elasticity = 40/22.2 = 1.8Example 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 causelittle 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 ishigher in the long run than in theshort run Visualizing Elasticity:● Perfectly inelastic demand (doesn't happenin the real world) Price Elasticity of demand = (ΔQ)/(ΔP) = 0%/10% = 0 The closest example of thisin real world wouldprobably be insulin. ● Inelastic Demand:Here the Demand Curve is relatively steep andyou can see that a fall in price has a smalleffect on demand. Price Elasticity of demand = (ΔQ)/(ΔP) = <10%/10% = <1An example of this might be textbooks, if theprice gets too high some student might seekalternatives to buying textbooks.● Unit Elastic DemandThis is when the elasticity = 1 because both thefall in price and the increase in demand are thesame. (also rarely happens in the real world)● Elastic DemandThis is when the demand increases more thanthe price falls.Elasticity = >10%/10% = >1This would be an example of anything that has substitutes ● Perfectly elastic demandThis is extreme price sensitivity, basically meansthat you cannot change the price at all, Quantity canchange by any amount but price always stays thesame.If you lower the price of a good, your demand couldincrease to infinity, however if you increase theprice, your demand will reach


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