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Week: 3

Elasticity, Consumer
Surplus
&
Producer Surplus

Price Elasticity of Demand
• The responsiveness (or sensitivity) of
consumers to a price change is measured
by a product’s price elasticity of demand.
• The price elasticity of demand is
expressed by Ed
• Types of Ed:
• Elastic Demand
• Inelastic Demand
• Unit Elasticity

Price Elasticity of Demand
• Measuring responsiveness to
price changes
• Elastic demand
• Large change in quantity
purchased for given price
change

• Inelastic demand
• Small change in quantity

Price Elasticity of Demand • Price-elasticity coefficient and formula Ed = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product X .

Price Elasticity of Demand • Calculate percentage change • Restate formula Ed = Change in Quantity Demanded of Original Quantity Demanded of ÷ Change in Price of Original Price of X X X X .

Price Elasticity of Demand • Calculation problem • Starting point matters • Midpoint formula Change in Quantity Change in Price Ed = ÷ Sum of Quantities/2 Sum of Prices/2 .

04 .02 =1 Unit Elasticity Ed = .02 = .02 =2 Inelastic Demand Ed = .02 .Interpretations of Elasticity Elastic Demand Ed = .01 .5 .

Price Elasticity of Demand • Why use percentages? • Unit free measure • Compare responsiveness across products • Elimination of the (-) sign • Extreme cases • Perfectly inelastic demand • Perfectly elastic demand .

The Total Revenue Test • Total Revenue = TR = PxQ • Inelastic demand • P and TR change in same direction • Elastic demand • P and TR change in opposite direction .

The Total Revenue Test • Lower price and elastic demand • Blue gain exceeds gold loss P $3 a 2 b 1 0 D1 10 20 30 40 Q .

The Total Revenue Test • Lower price and inelastic demand • Gold loss Pexceeds blue gain $4 c 3 2 d 1 D2 0 10 20 Q .

The Total Revenue Test • Lower price and unit-elastic demand • Blue gain equals yellow loss P $3 e 2 f 1 0 D3 10 20 30 Q .

00 2.60 1.000] 20.000] 20.00 0.000] 18.000] Elastic Elastic Elastic Unit Elastic Inelastic Inelastic Inelastic .000] 14. ThousandsPrice Per TicketCoefficient (Ed) (1) X (2) Test 1 2 3 4 5 6 7 8 $8 7] 6] 5] 4] 3] 2] 1] 5.000 14.38 0.Elasticity on a Linear Demand Curve (1) Total Quantity of (3) (4) (5) Tickets Demanded Elasticity Total RevenueTotal-Revenue (2) Per Week.20 $8.000] 18.64 0.000] 8.57 1.

Price Elasticity and the TR Curve $8 a 7 b 6 c 5 d 4 e 3 f 2 g 1 Elastic Ed > 1 Unit Elastic Ed = 1 Inelastic Ed < 1 h D Total Revenue (Thousands of Dollars) 0 1 2 3 4 5 6 7 8 Quantity Demanded $2 0 18 16 14 12 10 TR 8 6 4 20 1 2 3 4 5 6 7 8 Quantity Demanded .

Determinants of Elasticity • Substitutability • More substitutes. more elastic demand • Proportion of income • Price relative to income • Luxuries versus necessities • Luxuries are more elastic • Time • More elastic in the long run .

Price Elasticity of Supply Responsiveness to price changes by producers Es = Percentage Change in Quantity Supplied of Product X Percentage Change in Price of Product X .

Price Elasticity of Supply The Market Period • Perfectly inelastic supply P Greatest Price Impact Sm Pm P0 D1 D2 Q0 Q .

Price Elasticity of Supply The Short Run • Inelastic supply P Lower Price Impact Ss Ps P0 D1 D2 Q0Qs Q .

Price Elasticity of Supply The Long Run • Elastic supply P Sl Least Price Impact Pl P0 D1 D2 Q0 Ql Q .

Cross Elasticity of Demand • Responsiveness of sales to change in price of another good Exy = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product Y .

Cross Elasticity of Demand • Substitute goods • Positive sign • Complementary goods • Negative sign • Independent goods • Zero .

Income Elasticity of Demand Ei = Percentage Change in Quantity Demanded Percentage Change in Income • Responsiveness of sales to change in income • Normal goods – positive sign • Inferior goods– negative sign .

Consumer Surplus • Benefit surplus • Maximum willingness to pay (WTP) less than actual price paid Person Max WTP Bob $13 $8 Barb $12 $8 Bill $11 $8 Bart $10 $8 Brent $9 $8 Betty $8 $8 Actual Price CS $5 $4 $3 $2 $1 $0 .

Price (Per Bag) Consumer Surplus Consumer Surplus Equilibrium Price = $8 P1 D Q1 Quantity (Bags) .

Producer Surplus • Benefit surplus • Actual price received more than minimum acceptable price (AP) Person Carlos Courtney Chuck Cindy Craig Chad Min AP Actual Price PS $3 $8 $5 $4 $8 $4 $5 $8 $3 $6 $8 $2 $7 $8 $1 $8 $8 $0 .

Producer Surplus Price (Per Bag) S Producer Surplus Equilibrium Price = $8 P1 Q1 Quantity (Bags) .

Efficiency Revisited Price (Per Bag) • Productive and allocative efficiency S Consumer Surplus Equilibrium Price = $8 P1 Producer Surplus Q1 Quantity (Bags) D .

Efficiency Loss Price (Per Bag) • Deadweight loss S Efficiency Losses P1 D Q2 Q1 Q3 Quantity (Bags) .

Elasticity and Pricing Power • Competitive markets • No pricing power • Firms with market power • Charge different prices • Differences in group elasticities • Business vs. leisure travelers • Discounting for children • College tuition .

Applications of Elasticity • Large crop yields • Inelastic demand • Excise taxes • Inelastic demand • Decriminalization of illegal drugs • Elastic or inelastic demand? .

Key Terms • price elasticity of demand • midpoint formula • elastic demand • inelastic demand • unit elasticity • perfectly inelastic demand • perfectly elastic demand • total revenue (TR) • total-revenue test • price elasticity of supply • market period • short run • long run • cross elasticity of demand • income elasticity of demand • consumer surplus • producer surplus • efficiency losses (deadweight losses) .