Slide 0In this chapter, look for the answers to these questions:A scenario…ElasticityPrice Elasticity of DemandSlide 6Slide 7Calculating Percentage ChangesSlide 9Slide 10Slide 11A C T I V E L E A R N I N G 1: Calculate an elasticityA C T I V E L E A R N I N G 1: AnswersWhat determines price elasticity?EXAMPLE 1: Rice Krispies vs. SunscreenEXAMPLE 2: “Blue Jeans” vs. “Clothing”EXAMPLE 3: Insulin vs. Caribbean CruisesEXAMPLE 4: Gasoline in the Short Run vs. Gasoline in the Long RunThe Determinants of Price Elasticity: A SummaryThe Variety of Demand Curves“Perfectly inelastic demand” (one extreme case)“Inelastic demand”“Unit elastic demand”“Elastic demand”“Perfectly elastic demand” (the other extreme)Elasticity of a Linear Demand CurvePrice Elasticity and Total RevenueSlide 28Slide 29Slide 30Slide 31A C T I V E L E A R N I N G 2: Elasticity and expenditure/revenueA C T I V E L E A R N I N G 2: AnswersSlide 34APPLICATION: Does Drug Interdiction Increase or Decrease Drug-Related Crime?Policy 1: InterdictionPolicy 2: EducationPrice Elasticity of SupplySlide 39The Variety of Supply Curves“Perfectly inelastic” (one extreme)“Inelastic”“Unit elastic”“Elastic”“Perfectly elastic” (the other extreme)The Determinants of Supply ElasticityA C T I V E L E A R N I N G 3: Elasticity and changes in equilibriumA C T I V E L E A R N I N G 3: AnswersSlide 49How the Price Elasticity of Supply Can VaryOther ElasticitiesSlide 52CHAPTER SUMMARYSlide 54Slide 55© 2007 Thomson South-Western, all rights reservedN. G R E G O R Y M A N K I WPowerPoint® Slidesby Ron Cronovich 5P R I N C I P L E S O FF O U R T H E D I T I O NElasticity and its ApplicationElasticity and its ApplicationCHAPTER 5 ELASTICITY AND ITS APPLICATION2In this chapter, look for the answers to these questions:What is elasticity? What kinds of issues can elasticity help us understand?What is the price elasticity of demand? How is it related to the demand curve? How is it related to revenue & expenditure?What is the price elasticity of supply? How is it related to the supply curve? What are the income and cross-price elasticities of demand?CHAPTER 5 ELASTICITY AND ITS APPLICATION3You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you’re thinking of 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? You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you’re thinking of 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? A scenario…CHAPTER 5 ELASTICITY AND ITS APPLICATION4ElasticityBasic idea: Elasticity measures how much one variable responds to changes in another variable. •One type of elasticity measures how much demand for your websites will fall if you raise your price. Definition: Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants.CHAPTER 5 ELASTICITY AND ITS APPLICATION5Price Elasticity of DemandPrice elasticity of demand measures how much Qd responds to a change in P.Price elasticity of demand=Percentage change in QdPercentage change in PLoosely speaking, it measures the price-sensitivity of buyers’ demand.CHAPTER 5 ELASTICITY AND ITS APPLICATION6Price Elasticity of DemandPrice elasticity of demand equals PQDQ2P2P1Q1P rises by 10%Q falls by 15%15%10%= 1.5Price elasticity of demand=Percentage change in QdPercentage change in PExample:CHAPTER 5 ELASTICITY AND ITS APPLICATION7Price Elasticity of DemandAlong a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as positive numbers. Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as positive numbers. PQDQ2P2P1Q1Price elasticity of demand=Percentage change in QdPercentage change in PCHAPTER 5 ELASTICITY AND ITS APPLICATION8Calculating Percentage ChangesPQD$2508B$20012ADemand for your websitesStandard method of computing the percentage (%) change:end value – start valuestart valuex 100%Going from A to B, the % change in P equals($250–$200)/$200 = 25%CHAPTER 5 ELASTICITY AND ITS APPLICATION9Calculating Percentage ChangesPQD$2508B$20012ADemand for your websitesProblem: The standard method gives different answers depending on where you start. From A to B, P rises 25%, Q falls 33%,elasticity = 33/25 = 1.33From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50CHAPTER 5 ELASTICITY AND ITS APPLICATION10Calculating Percentage ChangesSo, we instead use the midpoint method: end value – start valuemidpointx 100%The midpoint is the number halfway between the start & end values, also the average of those values. It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way!CHAPTER 5 ELASTICITY AND ITS APPLICATION11Calculating Percentage ChangesUsing the midpoint method, the % change in P equals$250 – $200$225x 100%= 22.2%The % change in Q equals12 – 810x 100%= 40.0%The price elasticity of demand equals40/22.2 = 1.8AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : Calculate an elasticityCalculate an elasticityUse the following information to calculate the price elasticity of demand for hotel rooms:if P = $70, Qd = 5000if P = $90, Qd = 300012AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : AnswersAnswersUse midpoint method to calculate % change in Qd(5000 – 3000)/4000 = 50%% change in P($90 – $70)/$80 = 25%The price elasticity of demand equals1350%25%= 2.0CHAPTER 5 ELASTICITY AND ITS APPLICATION14What determines price elasticity?To learn the determinants of price elasticity, we look at a series of examples. Each compares two common goods. In each example:•Suppose the prices of both goods rise by 20%. •The good for which Qd falls