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ElasticitiesofDemandand Supply
Chapter
5
Copyright © 2002 Addison Wesley
CHAPTER CHECKLIST
1.Define, explain the factors that influence,and calculate the price elasticity ofdemand.2.Define, explain the factors that influence,and calculate the price elasticity of supply.3.Define and explain the factors thatinfluence the cross elasticity of demandand the income elasticity of demand.
LECTURE TOPICS
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The Price Elasticity of Demand
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The Price Elasticity of Supply
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Cross Elasticity and Income Elasticity
5.1 THE PRICE ELASTICITY OF DEMANDPrice elasticity of demand
A measure of the extent to which the quantitydemanded of a good changes when the price of thegood changes.To determine the price elasticity of demand, wecompare the percentage change in the quantitydemanded with the percentage change in price.
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5.1 THE PRICE ELASTICITY OF DEMAND
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Percentage Change in Price
Percent change in price =New price –Initial priceInitial Pricex 100Percent change in price =$5 –$3$3x 100= 66.67 percentSuppose Starbucks raises the price of a latte from $3to $5 a cup. What is the percentage change in price?
5.1 THE PRICE ELASTICITY OF DEMAND
Suppose Starbucks cuts the price of a latte from $5 to$3 a cup. What is the percentage change in price?Percent change in price =New price –Initial priceInitial Pricex 100Percent change in price =$3 –$5$5x 100= –40 percent
5.1 THE PRICE ELASTICITY OF DEMAND
The same price change, $2, over the same interval, $3to $5, is a different percentage change depending onwhether the price rises or falls.We need a measure of percentage change that doesnot depend on the direction of the price change.We use the average of the initial price and the newprice to measure the percentage change.
5.1 THE PRICE ELASTICITY OF DEMAND
The Midpoint Method
x 100Percent change in price =New price –Initial price(New Price + Initial Price) ÷ 2To calculate the percentage change in the price dividethe change in the price by the
average
price and thenmultiply by 100.The average price is at the midpoint between theinitial price and the new price, hence the namemidpoint method.
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5.1 THE PRICE ELASTICITY OF DEMAND
The percentage change in price calculated by the midpointmethod is the same for a price rise and a price fall.x 100Percent change in price =$3 –$5($5 + $3) ÷ 2= 50 percent
5.1 THE PRICE ELASTICITY OF DEMAND
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Percentage Change in Quantity Demanded
x 100Percent changein quantity =New quantity –Initial quantity(New quantity + Initial quantity) ÷ 2x 100Percent changein quantity =5 –15(5 + 15) ÷ 2= –100 PercentIf Starbucks raises the price of a latte, the quantity oflatte demanded decreases.
5.1 THE PRICE ELASTICITY OF DEMAND
Minus Sign
When the price rises, the quantity demanded decreasesalong the demand curve. Price and quantity always changein opposite directions.So to compare the percentage change in the price and thepercentage change in the quantity demanded, we ignorethe minus sign and use the absolute values.
5.1 THE PRICE ELASTICITY OF DEMAND
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Elastic and Inelastic Demand
Elastic demand
Demand is elastic if the percentage change in thequantity demanded exceeds the percentage change inprice.
Unit elastic demand
If the percentage change in the quantity demandedequals the percentage change in price.
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