Elasticity allows us to analyze supply and demand with buyers and sellers is a measure of how much respond to changes in market conditions THE ELASTICITY OF DEMAND Quantity demanded divided by the percent change in price Price Elasticity of Demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good Price elasticity of demand is the percentage change in given a percent change in Computing the Price Elasticity of Demand The price elasticity of demand is computed as quantity the percentage change in price divided by the percentage change in Price elasticity of demand Percentage change in quantity demanded Percentage change in price 1 The Midpoint Method A Better Way to Calculate Percentage Changes and Elasticities The formula is preferable when midpoint calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change Price elasticity of demand Q 2 Q1 Q 2 Q1 2 P2 P1 P2 P1 2 The Midpoint Method A Better Way to Calculate Percentage Changes and Elasticities Example If the price of an ice cream cone increases from 2 00 to 2 20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand using the midpoint formula would be calculated as 10 8 22 10 8 2 2 32 2 20 2 00 9 5 2 00 2 20 2 The Variety of Demand Curves Demand Quantity demanded does not respond strongly to price changes Price elasticity of demand is Demand Quantity demanded responds strongly to changes in price Price elasticity of demand is 2 The Price Elasticity of Demand and Its Determinants Availability of Close Substitutes Necessities versus Luxuries Definition of the Market Time Horizon The Price Elasticity of Demand and Its Determinants Demand tends to be more elastic close is the number of close substitutes luxury if the good is narrowly the more defined the market greater the the time period The Variety of Demand Curves Product Elasticity Product Elasticity Salt 0 1 Automobiles 1 2 Water 0 2 Foreign Travel 1 8 Coffee 0 3 Restaurant Meal 2 3 Cigarettes 0 3 Air Travel 2 4 Shoes 0 7 Movies 3 7 Housing 1 0 Coffee Brand 5 6 3 The Variety of Demand Curves inelastic Perfectly Quantity demanded does not respond to price changes Elastic Demand Perfectly Quantity demanded changes infinitely with any change in price Unit Elastic Quantity demanded changes by the same percentage as the price The Variety of Demand Curves Because the price elasticity of demand measures how much quantity demanded responds to the price it is closely related to of the demand curve The Price Elasticity of Demand Elasticity equals zero a Perfectly Inelastic Demand Price Demand 5 4 1 An increase in price 0 100 Quantity 2 leaves the quantity demanded unchanged 4 The Price Elasticity of Demand b Inelastic Demand Elasticity Is less than one Price 5 4 1 A 22 increase in price Demand 90 0 Quantity 100 2 leads to an 11 decrease in quantity demanded The Price Elasticity of Demand one c Unit Elastic Demand Elasticity Equals Price 5 4 Demand 1 A 22 increase in price 80 0 Quantity 100 2 leads to a 22 decrease in quantity demanded The Price Elasticity of Demand than one d Elastic Demand Elasticity Is Greater Price 5 4 Demand 1 A 22 increase in price 0 50 100 Quantity 2 leads to a 67 decrease in quantity demanded 5 The Price Elasticity of Demand Infinity e Perfectly Elastic Demand Elasticity Equals Price 1 At any price above 4 quantity demanded is zero 4 Demand 2 At exactly 4 consumers will buy any quantity Quantity 0 3 At a price below 4 quantity demanded is infinite Total Revenue and the Price Elasticity of Demand Total Revenue is the amount paid by buyers and received by sellers of a good Computed as the price of the good times the quantity sold TR P x Q Exercise A cigarette company is thinking of raising its price by 10 Price elasticity of demand for the cigarettes is known as 0 3 1 What will happen to the quantity demanded for the cigarettes 2 Will the cigarette company s total revenue rise or fall 6 Inelastic Demand ED 0 3 1 Price 10 Quantity Demanded 3 As price increases total revenue will increase P x Q TR Elastic Demand ED 2 4 1 Price 10 Quantity Demanded 24 As price increases total revenue will increase P x Q TR Income Elasticity of Demand Income Elasticity of Demand measures how much the quantity demanded of a good responds to a change in consumers income It is computed as the percentage change in quantity demanded divided by the percentage income change in i 7 Computing Income Elasticity Income elasticity of demand Percentage change in quantity demanded Percentage change in income Income Elasticity Types of Goods Normal Goods Inferior Goods Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods Income Elasticity Goods consumers regard as necessities tend to be income Examples include food fuel clothing utilities and medical services Goods consumers regard as luxuries tend to be income Examples include sports cars furs and expensive foods 8 THE ELASTICITY OF SUPPLY is a measure of how much Price Elasticity of Supply the quantity supplied of a good responds to a change in the price of that good Price elasticity of supply is the percentage quantity change in resulting from a price percent change in Computing the Price Elasticity of Supply The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price Percentage change in quantity supplied Price elasticity of supply Percentage change in price Determinants of Elasticity of Supply Ability of sellers to change the amount of the good they produce Beach front land is inelastic Books cars or manufactured goods are elastic Time period Supply is more elastic in the long run 9 The Price Elasticity of Supply a Perfectly Inelastic Supply Elasticity Equals Zero Price Supply 5 4 1 An increase in price 100 0 Quantity 2 leaves the quantity supplied unchanged The Price Elasticity of Supply Less than one less than one b Inelastic Supply Elasticity Is Price Supply 5 4 1 A 22 increase in price 0 100 110 Quantity 2 leads to a 10 increase in quantity supplied The Price Elasticity of Supply Equals c Unit Elastic Supply Elasticity Equals one Price Supply 5 4 1 A 22 increase in price 0 100 125 Quantity 2 leads to a 22 increase in quantity supplied 10 The Price Elasticity of Supply greater than one d Elastic Supply Elasticity Is Price Supply 5 4 1 A 22 increase in price 100 0 Quantity 200 2