Econ 201 1st Edition Lecture 9Outline of Last Lecture I. Price Elasticity of DemandII. Midpoint MethodIII. Interpreting the Price Elasticity of DemandOutline of Current LectureI. ElasticityII. Determinants of ElasticityIII. Cross price elasticityIV. Income elasticityCurrent LectureElasticityInterpreting the Price Elasticity of Demand-Total revenue: price times quantity demanded (sold).TR = P × Q-The total revenue at any given price is equal to the area of a rectangle whose height is the price and whose width is the quantity demanded at that price.-When demand is inelastic, the price effect dominates the quantity effect. Total revenue will rise.-When demand is elastic, the quantity effect dominates the price effect. Total revenue will fall.-Examples:What happens if salt prices go up? TR will likely rise.What happens if airfare goes up? TR will likely fall.-When demand is unit-elastic, the quantity effect equals the price effect, so the total revenue will not change-Practice Question: The elasticity of demand for eggs has been estimated to be 0.1. If egg producers raisetheir prices by 10 percent, what will happen to their total revenue?a) it will increase-Practice Question: If price falls from $60 to $40, and quantity sold goes from 12 to 6, total revenue changes by _______, so demand is _______.d) $120, elastic-Practice Question: If a fashionable clothing store raised its prices by 25%, what does that tell you about the store’s estimate of the elasticity of demand for its products?b) They think it’s inelasticDeterminants of Elasticity of Demand-The price elasticity of demand is influenced by:These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.1. The number of substitutes the good has2. Necessity vs. Luxury3. The importance of the good in one’s budget4. Time period1. The availability of close substitutes is very important.- Fewer substitutes makes it harder for consumers to adjust Q when P changes, so demand is inelastic.- Many substitutes? Switching brands when prices change is EASY, so demand is elastic.2. Whether the good is a necessity or a luxury also affects the elasticity of demand.- For necessities, we do not change Q much when P changes. (eggs)- For luxuries, we are more sensitive to P changes. (boats)3. The share of income spent on the good matters.- We are less sensitive to price changes when the good feels cheap.- We are more sensitive to price changes when the good feels expensive.4. The length of time elapsed since the price change matters.- Less time to adjust means lower elasticity.- Over time consumers can adjust their behavior by finding substitutes (making demand more elastic).-Price discrimination occurs when a firm separates the people with less elastic demand from those with more elastic demand.Cross-Price Elasticity of Demand-The cross-price elasticity of demand measures how sensitive the quantity demanded of good A is to theprice of good B.-Cross-price elasticity of demand = (% change in quantity of A demanded) / (% change in price of B)� = (% ∆��)/(%∆��)-For substitutes, cross-price elasticity of demand is positive.Ex. An increase in the price of one brand of cookies will increase the demand for other brands.-For complements, cross-price elasticity of demand is negative.Ex. An increase in the price of milk causes a decrease in demand for Oreos.-Practice Question: The price of good B increases by 4%, causing the quantity demanded of good A to decrease by 6%. The cross-price elasticity of demand is _____, and the goods are ______.Answer: –1.5; complementsIncome Elasticity of Demand-The income elasticity of demand measures how sensitive the quantity demanded of a good is to changes in income.Income elasticity of demand = (% change in quantity demanded) / (% change in income)-The income elasticity of demand can be used to distinguish normal from inferior goods.- For normal goods, income elasticity is positive.- For inferior goods, income elasticity is negative.-Normal goods can be income-elastic or not.- For income-elastic goods, income elasticity is greater than 1.- For income-inelastic goods, income elasticity is positive but less than 1.-Practice Question: Tonya consumes 10 boxes of ramen noodles a year when her yearly income is $40,000. After her income falls to $30,000 a year, she consumes 40 boxes of ramen noodles a year. Calculate her income elasticity of demand for ramen