micro economics chapter 06

Price Elasticity of Demand• Measures buyers’ responsiveness to price changes • Formula for price elasticity of demand E d = Percentage Change in Quantity Demanded of Product X Percenta

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Price Elasticity of Demand

• Measures buyers’ responsiveness to price changes

• Formula for price elasticity of demand

E d =

Percentage Change in Quantity

Demanded of Product X

Percentage Change in Price

of Product X

Price Elasticity of Demand

Formula

• Eliminate the minus sign

• Easier to compare elasticities

Price Elasticity of Demand

• Elastic demand, Ed > 1

• Sensitive to price changes

• Large change in quantity for small price change

• Inelastic demand, Ed < 1

• Insensitive to price changes

• Small change in quantity for large price change

• Unit elastic demand, Ed = 1

– Equal changes in quantity and price

Extreme Cases

D 1

P

Perfectly inelastic demand

Perfectly inelastic demand (Ed = 0)

0

Extreme Cases

Perfectly elastic demand

P

D2

Perfectly elastic demand (Ed = ∞)

0

Price Elasticity of Demand

• Can not use slope to determine

elasticity

• Can use slope to determine relative elasticity

Total Revenue Test

• Total Revenue = Price X Quantity

• Inelastic demand

• P and TR move in the same direction

• Elastic demand

• P and TR move in opposite directions

• Unit elastic demand

• TR doesn’t change when P changes

Total Revenue Test

Table 6.1 Price Elasticity of Demand for Movie Tickets as Measured by the

Elasticity Coefficient and the Total-Revenue Test

(1) Total Quantity of

Tickets Demanded per

Week, Thousands Price per Ticket (2)

(3) Elasticity Coefficient (E d )

(4) Total Revenue (1) X (2)

(5) Total Revenue Test

Summary of Price Elasticity of

Demand

Table 6.2 Price Elasticity of Demand: A Summary

Absolute Value

of Elasticity

Coefficient Demand Is: Description

Impact on Total Revenue of a: Price Increase Price Decrease

Greater than 1

(Ed > 1) Elastic or relatively

elastic

Qd changes by a larger

percentage than does price

Total Revenue decreases Total Revenue increases

Equal to 1

(Ed = 1) Unit or unitary elastic Qthe same d changes by

percentage as does price

Total revenue

is unchanged Total revenue is unchanged

Less than 1

(Ed < 1) Inelastic or relatively

inelastic

Qd changes by a smaller

percentage than does price

Total revenue increases Total revenue decreases

Determinants of Elasticity of

Demand

• Substitutability

• More substitutes, demand is more elastic

• Proportion of Income

• Higher proportion of income, demand is more elastic

• Luxuries vs Necessities

• Luxury goods, demand is more elastic

• Time

• More time available, demand is more elastic

Price Elasticity of Demand

Table 6.3 Selected Price Elasticities of Demand

Product or Service

Price Elasticity

of Demand (E d ) Product or Service of Demand (E Price Elasticity d )

Electricity (household) 13 Household appliances 63

Applications of E d

• Large Crop Yields

• Inelastic demand, lower total revenue

• Excise Taxes

• Inelastic demand, more total revenue

• Decriminalization of Illegal Drugs

• Inelastic demand, more total revenue

• Decrease street crime

Price Elasticity of Supply

• Measures sellers’ responsiveness to price changes

• Elastic supply (Es > 1 ), producers are responsive to price changes

• Inelastic supply (Es < 1), producers are not responsive to price changes

Percentage Change in Quantity

Percentage Change in Price

Es =

Price Elasticity of Supply

• Time is primary determinant of elasticity of supply

• Time periods considered

• Immediate Market period

• Can’t adjust any resources

• Short Run

• Able to adjust some resources

• Long Run

• Able to adjust all resources

Applications of Elasticity of

Supply

• Antiques

• Inelastic supply

• Reproductions

• More elastic supply

• Volatile gold prices

• Inelastic supply

Cross Elasticity of Demand

• Measures responsiveness of sales to change in the price of another good

• Substitutes – positive sign

• Complements – negative sign

• Independent goods - zero

Percentage change in quantity demanded of product X

Ex,y =

Percentage change in price of product Y

Income Elasticity of Demand

• Measures responsiveness of buyers

to changes in income

• Normal goods – positive sign

• Inferior goods – negative sign

Percentage change

in quantity demanded

Ei =

Percentage change in income