Krugman and Wells Chapter 6OverviewExample 1: daily sandwich demandExample 1: daily sandwich demandExample 2: recession and groceriesExample 2: recession and groceriesExample: rent controlsExample: rent controlsElasticityElasticity: the general formPrice Elasticity of Demand (PED)Price Elasticity of Demand (PED)Example: vaccine demand (6.1)One complication…Resolution: use average in denom.Summary: use these formulasExample PED’s from the real worldPED and RevenuePrice effect and quantity effect…Example 1: daily sandwich demandPED and RevenueWhat factors determine PED?Elasticity: the general formCross-Price Elas. of Demand (CPED)What determines CPED?Income Elasticity of Demand (IED)What determines IED?Price Elasticity of Supply (PES)What determines PES?Table 6.3 provides a summary…Sample Problem Set ProblemKrugman and Wells Chapter 6 Steven J. Haider EC201 Spring 2015Overview  Chaps. 3-5: lay out how competitive markets work  Chap 3: shifting S & D  Chap 4: welfare Chap 5: price and quantity controls  This chapter: how much do prices and quantities change?  Depends on the slopes of S and D and how much they shift We measure these features with elasticities  Note: I cover the same material in the chapter, but take a pretty different tack… p2 Caution: if you are uncomfortable with math, this week may look daunting. Let us help you! It isn’t that bad.p3 Example 1: daily sandwich demand  At $5, you sell 250 for daily revenue of $1250  At $6, you sell 220 for daily revenue of $1320  Maybe no close substitutes nearby?  At $5, you sell 250 for daily revenue of $1250  At $6, you sell 50 for daily revenue of $300  Maybe another sandwich shop nearby? You are a pastrami shop owner on Grand River. You’re thinking about raising your price from $5 to $6. Should you? Q P D1 250 Q P D2 250 5 6 220 50p4 Example 1: daily sandwich demand  At $5, you sell 250 for daily revenue of $1250  At $6, you sell 220 for daily revenue of $1320  Maybe no close substitutes nearby?  At $5, you sell 250 for daily revenue of $1250  At $6, you sell 50 for daily revenue of $300  Maybe another sandwich shop nearby? You are a pastrami shop owner on Grand River. You’re thinking about raising your price from $5 to $6. Should you? Q P D1 250 Q P D2 250 5 6 220 50p5 Example 2: recession and groceries  Milk  Quantity drops a little  Recession causes income to decline and milk is a normal good  Perhaps small shift in demand--milk is central to the diet of many  Dove ice cream bars  Quantity drops a lot  Recession causes income to decline and Dove bars are a normal good  Perhaps large shift in demand--pretty easy to do without If you are a grocer, it may be very useful to know how buying patterns change over the business cycle. Q P D1 Q P D1 4 D2 D2p6 Example 2: recession and groceries  Milk  Quantity drops a little  Recession causes income to decline and milk is a normal good  Perhaps small shift in demand--milk is central to the diet of many  Dove ice cream bars  Quantity drops a lot  Recession causes income to decline and Dove bars are a normal good  Perhaps large shift in demand--pretty easy to do without If you are a grocer, it may be very useful to know how buying patterns change over the business cycle. Q P D1 Q P D1 4 D2 D2p7 Example: rent controls  A binding price ceiling is implemented  Large decline in apartments rented  Perhaps lots of alternative uses for land, including conversions to condos  A binding price ceiling is implemented  Small decline in apartments rented  Perhaps apartments/land are not suitable for other uses Q P D Q P D What would happen if a city council adopted a rent control policy? S Sp8 Example: rent controls  A binding price ceiling is implemented  Large decline in apartments rented  Perhaps lots of alternative uses for land, including conversions to condos  A binding price ceiling is implemented  Small decline in apartments rented  Perhaps apartments/land are not suitable for other uses Q P D Q P D What would happen if a city council adopted a rent control policy? S SElasticity  The responsiveness of one variable to another  Ultimately, economics is trying to make predictions about how the world works: “how much” is an important part of this  The words are meant to be descriptive  Two pictures of me trying equally hard to stretch a 1-foot blue hose p9 Inelastic: garden hose, stretches a little Elastic: surgical tubing, stretches a lotElasticity: the general form  Elasticities we will work with in EC201  (Own) Price Elasticity of Demand  Cross-Price Elasticity of Demand  Income Elasticity of Demand Price Elasticity of Supply  Basic formula (∆ means “change” or “difference)  Example p10 P%Q% Demand of ElasticityPriceDBA∆∆=A%B%BofElasticityA∆∆=p11 Price Elasticity of Demand (PED)  Measures the responsiveness of quantity demanded to price changes  Very much related to the slope of the demand curve Absolute statements about responsiveness  Elastic: PED>1. . . . . %∆P causes big %∆Q  Unit: PED=1. . . . . . . %∆P causes equal %∆Q  Inelastic: PED<1. . . . %∆P causes small %∆Q P ∆P=10% ∆Q=0% PED=0 Perfectly Inelas. Q ∆Q=4% PED=.4 Inelastic ∆Q=10% PED=1 Unit Elastic ∆Q=20% PED=2 Elastic ∆Q=∞ PED=∞ Perfectly Elas. Remember pastrami example!p12 Price Elasticity of Demand (PED)  Measures the responsiveness of quantity demanded to price changes  Very much related to the slope of the demand curve Absolute statements about responsiveness  Elastic: PED>1. . . . . %∆P causes big %∆Q  Unit: PED=1. . . . . . . %∆P causes equal %∆Q  Inelastic: PED<1. . . . %∆P causes small %∆Q P ∆P=10% ∆Q=0% PED=0 Perfectly Inelas. Q ∆Q=4% PED=.4 Inelastic ∆Q=10% PED=1 Unit Elastic ∆Q=20% PED=2 Elastic ∆Q=∞ PED=∞ Perfectly Elas. Just like stretching the hose Q “stretches” a lot with a given Δp (the “force”)—elastic Q “stretches” a little with a given Δp (the “force”)—inelasticp13 Example: vaccine demand (6.1)  What is the price