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    LESSON 3. ELASTICITY-1

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    Economics

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    © All Rights Reserved
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    7 views50 pages

    Lesson 3. Elasticity-1

    Uploaded by

    C J A S
    Economics

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    © All Rights Reserved
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    of 50
    Elasticity: A Measure of Response Can anything be so elegant as to have few wants, and to serve them one's self? -Ralph Waldo Emerson Slide 1 of 50 Elasticity can measure numerous things In this presentation, we'll look at four concepts related to elasticity. They include: Cross Elasticity Each of these concepts refers to how sensitive changes in one variable are to changes in another variable. We'll use these symbols as shorthand Slide 2 of 50 So far, we have always looked at 45 degree demand curves In reality, demand curves can change in slope depending on how sensitive Price quantity demand is to price. That sensitivity is referred to as elasticity of demand! ‘Guantty Slide 3 of 50 A demand curve that is more (esas sinene horizontal is referred to as ‘elastic’ Price Examples of goods that have elastic demand include: Restaurant food Vacation air travel Luxury goods P, i Have you ever i changed travel dates or Small changes in i destinations to save price result in big | : money on vacation air fare? Probably so because as a vacation air traveler, you were sensitive to price. changes in quantity demanded Slide 4 of 50 A demand curve that is more Seas vertical is referred to as ‘inelastic’ Even big Examples: Price changes in price Milk & Salt TesplbIn only Business air travel small changes in ‘ quantity Habit forming goods P. demanded. Doctor/Medical Visits 2 P, Consultants are business air travelers. When they book plane tickets, they Q, a Quantity | usually don’t care about ae er price. They want to be on +- time for the meeting! ‘Slide 5 of 50 Real world example of an Eel inelastic price elasticity of demand in lin —_Inelastic! _. Slide 6 of 50 Price Elasticity of Demand- the —— technical definition Price elasticity of demand (also simply called elasticity of demand) — The rate of response of quantity demanded due to a change in price. in this presentation) or e, (as it is in your course reading material. It is commonly referred to as E, (as it is E Slide 7 of 50 Price Elasticity of Demand- the technical definition seen graphically Price | pelea When we talk about price elasticity of demand, we are asking how sensitive changes in quantity demand are... ..-to changes in price. Qy2, Oat Quantity Slide 8 of 50 Individual exercises 1) Identify one item that you bere are mine: routinely buy that you would be : willing to pay a lot more for if you had to. am insensitive to the price of ESPN. If it doubled, I'd still pay. My demand for ESPN is inelastic! Don't tell them that! 2) Now identify one item that you would not buy if the price were to go up even only alittle. | like pineapples but they are $5 and they are a lot of work. | only buy them on sale. | am very sensitive to price- my demand for pineapples is very elastic! Slide 9 of 50 Different elasticity of demand scenarios When demand is very elastic, consumers are quite sensitive to price. When itis very inelastic, they care much less about price...they are willing to pay more. © St. Taany” ouantiy” Ganiy” Elastic Inelastic Unit Elastic This means a one Note how the horizontal demand Note how the unit change in price curve looks like the vertical demand (ie. 1%) results in a middle flat part of curve looks like an ‘one unit change in the “E” for elastic! LP teriieeeic: | Quantity demand (ie. 1%) Slide 10 of 50 Elasticity of Demand Why is this important? Understanding elasticity is important for economists because it lets us measure what the impact that a price change had, is having, or will have on the amount of product that is demanded. | Let's look at a case study on the next few slides to see how this can be applied. Slide 11 of 50 | Elasticity of Demand Case study: the Dulles Greenway The Dulles Greenway is a 14 mile road that opened in 1995. It allowed people to avoid all the stoplights on Route 7 as they made their way into Tyson's Corner, the nation’s tenth largest employment center. They thought people would be willing to pay a big toll to avoid stoplights on alternate routes. Slide 12 of 50 aay Elasticity of demand, misread Instead of attracting 30,000 cars $3.00 per day, they attracted about 10,000. $250 5 At least at first, the roadway lost money in what must have been a $2.00 painful learning experience about Sigel eee Ree elasticity of demand! 2 $150 ~ ~ a 2 : $1.00 i i $0.50 -- - $0.00 + + o 10,000 20,000 30,000 40,000 50,000 60,000 Demand (Annual Dally Traffic) Slide 13 of 50 Factors that determine elasticity of demand + Availability of close substitutes — Example: margarine and butter are close substitutes so they are more elastic « Necessity versus Luxury — Doctor's costs are not likely to respond as much to price increases as the cost of 60” plasma TV * Definition of Market — Elasticity of demand for any market will depend on how the market is defined. Broad definitions, such as food will have fewer substitutes and will be more ~*~) eo inelastic. Conversely, snow peas, will have many substitutes and will be more elastic. * Time Horizon — Goods tend to be more elastic over time as markets f adjust to changes in price / ) Slide 14 of 50 How can time impact elasticity? Over time, what could we do? Change our behavior so we demanded less gas. Typical car in 1960 Typical car just 12 years later Weighed up to 5,000 pounds Weighed only 2,600 pounds 10 MPG 35 MPG We are seeing another broad and dramatic change in our fleet now. A movement to electric and hybrid cars! Slide 15 of 50 Calculating elasticity of demand Price Elasticity of Demand Note: this ratio will always be negative. If a BIG change in price For this first le, 50% /1% i results in a SMALL change in ors veal = quantity demand, then price . elasticity of demand for that For this second example, -1%/50% is good is low- it is INELASTIC! actually -.02. Since we know the sign will always be negative, we ignore it. Slide 16 of 50 Here are some possible price elasticity of demand scenarios Price Elasticity = Percent Change in Quantity Demanded of Demand Percent Change in Price Increase in. Decrease in Elasticity of Graphical price Quantity Demand — Demand Elasticity Example q 0% ‘Any Quantity infinite Perfectly Elastic + & heey: 20% 40% 20 Elastic 4 1% 1% 10 Unit Elastic | hs 7 aon isk ee ul Any Increase 0% 00 Perfectly inelastic 7 Slide 17 of 50 Examples of some elasticity's for selected goods Source: Mackinge Conter Yor Puble Pokey errs Salt Matches Toothpicks . Airline travel (business) o1 Gasoline, short-run 02 Coffee 0.25] Legal senices, short-run 0.4 Tobacco products 0.45 Physician services 06 Gasoline, long-run O7 ‘Approximately Unitary Elasticity Movies 09 Shellfish, consumed at home 09 Tires 1.0) Oysters, consumed at home TA Private education ml Housing, owner occupied, long-run 1.2) Radio and television receivers 1.2 Elastic ‘Automobiles, short-run 15) Restaurant meals 23 Airline travel (non-business) 24 Fresh green peas 2.8 Chevrolet automobiles 4 Fresh tomatoes a6 Slide 18 of 50 A closer look at the demand curve Elasticity's differ at different points along the demand curve Slide 19 of 50 aay The demand schedule and curve Let's start with the demand schedule and curve shown here: Quantity ated TE Tr) Oo} a|olalS Bla|o]s|nJo ~ ‘Quantity Demanded Slide 20 of 50 Price Elasticity Percent Change in Quantity Demanded Calculating Elasticity “sosmn” - Percent Change Price Abaine price falls from $9 to $8, what is the elasticity of demand? + Step 1: Calculate the parcent change in Quantity Demanded (Qd) = Quantity demanded increases from 1 to 2. = The percent change in Qd = change/first or 1/1=100% * Step 2: Calculate the percent change in Price — The price decreased by 1 = The percent change in price = changeffirst or (4)9 or 11.19%. * Step 3: Calculate Elasticity — Divide the percent change in Qd by the percent change in price - Ed=100%/11%=9. + Step 4: interpret the results —————___ — This is elastic! (itis greater than one) Note: we dropped the negative sign. Since the demand curve represents a negative relationship, this figure is always negative. The negative sign is understood and is therefore ignored! Slide 21 of 50 Calculating Elasticity "Scemn” = kun sem fenneet— Assume price falls from $8 to $7, what is the elasticity? i, + Step 1: Calculate the percent change in Quantity Demanded (Qd) — Quantity demanded increases from 2 to 3. — The percent change in Qd = change/first or 1/2=50% + Step 2: Calculate the percent change in Price — The percent change in price = changeffirst or (-1)/B or -12.5% + Step 3: Calculate Elasticity — Divide the percent change in Qd by the percent change in price — Ed =50%/12.5% =4 + Step 4: Interpret the results — This is elastic! (it is greater than one) Slide 22 of 50 Calculating Elasticity "Scemn” = kun sem fenneet— Assume price falls from $2 to $1, what is the elasticity? i, + Step 1: Calculate the percent change in Quantity Demanded (Qd) — Quantity demanded increases from 8 to 9. — The percent change in Qd = change/first or 1/B=12.5% + Step 2: Calculate the percent change in Price — The percent change in price = changeffirst or (-1)/2 or 50% + Step 3: Calculate Elasticity — Divide the percent change in Qd by the percent change in price — Ed = 12.5%/50% = .25 + Step 4: Interpret the results — This is inelastic! (it is less than one) Slide 23 of 50 Lets look more closely at the demand curve Price Elasticity ned Percent Change in Price ange in Quantity Demanded of Dem: his portion of the demand curve is elastic. Slide 24 of 50 [Betiearsimerienel Lets look more closely at the demand curve Price Elasticity. __Percent Change in Quantity Demanded of Demand, Percent Change in Price is portion of the demand curve is inelastic. Slide 25 of 50 [Betiearsimerienel Lets look more closely at the demand curve Price Elasticity | __ Percent Change in Quantity Demanded of Demand, Percent Change in Price Percent change in quantity demand = (6-5)/5 = 20% Price Percent change in price = (4-5)/5 = 20% 20% / 20% = 1.0. This is unit elastic! a a ‘Quantity Demanded Slide 26 of 50 Elasticity of Demand Note an annoying problem when calculating E, * Elasticities will change in the same portion of the demand curve depending on whether prices are increasing or decreasing Slide 27 of 50 Calculating elasticity, este Porere again Price Elasticity _ __ Percent Change in Quantity Demanded of Demand Percent Change in Price Assume Bice falls from $9 to $8, what is the elasticity? + Step 1: Calculate the percent change in nity Demanded (4a) — Quantity demanded increases by 1. — The percent change in Qd = change/first or 1/1=100% + Step 2: Calculate the percent change in rice — The price decreased by 1 - a, he permet change in price = changeffirst or or 11.1% . step 3: Calculate Elasticity — Divide the percent change in Qd by the i +t s—¥ percent change in price ‘ty ment — Ed=100%/11%=9 + Step 4: Interpret the resus Note: We previously — This is elastic! (itis greater than one) of : determined that E, is 9 Slide 28 of 50 Calculating Elasticity, srcecssicry _ __ reicencnangei cuantty bemanded the other direction Ae embnG? tises from $8 to $9, what is the elasticity + Step 1: Calculate the percent change in luantity Demanded (a0) = Quantity demanded decreases by 1 ~The porgent change in Ga = changa/st or . 2: Calculate the percent change in Be = The price increased by 1 — The percent change in price = changeffirst or (1)/8 or 12.5% * Step 3: Calculate Elasticity — Divide the percent change in Qd by the percent change in price — Ed =-50%/12.5% = oS + Step 4: Interpret the results — This is elastic! (itis greater than one) of Demand Percent Change in Price Note: We now determine that E, is 4...along the same part of the demand ! curve: Slide 29 of 50 Calculations of elasticity will change depending on direction We should be careful... As we just saw a price decrease from $9 to $8 gave us an Ed of 9...very elastic. But an increase in price from $8 to $9 gave us an Ed of 4...still elastic but not as much as before. Using the midpoint formula can help solve this problem. Slide 30 of 50 The midpoint formula As you'll probably note, the midpoint formula gets around this problem by taking an average of these starting points using the formula below. _ change in quantity | change in price “ sum of quantities/2 © sum of prices/2 Ey Let's try an example. Slide 31 of 50 The midpoint formula — «.=

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