Price Elasticity Coefficient
Formula
• Ed = % change in quantity demanded of product X
% change in price of product X
Calculating % change
% Change in quantity =
nqd – iqd
initial quantity demanded
Example: % Change in quantity
100,000 nqd - 110,000 iqd = - 10,000
-10,000 = .10 or 10%
100,000
1
Price Elasticity Coefficient
Formula
• Ed = % change in quantity demanded of product X
% change in price of product X
• Change in price = New Price – Initial Price
Initial price
New Price = $4
Initial Price = $3
$4 np - $3 ip = $1 = .33 or 33%
$3 ip
$3
Price Elasticity Coefficient
Formula
• Ed = % change in quantity demanded of product X
% change in price of product X
10% = .30 or 30%
33%
Chapter 6:
Extensions of Supply,
Demand, and
Supply Analysis
Elasticity
• It is all about how things respond to
changes in prices
– Responsive or not responsive
5
Supply and Demand Review
1. Define the Law of Demand
2. Define the Law of Supply
3. What is the difference between a change in
demand and a change in quantity
demanded?
4. What happens if price is above equilibrium?
5. What happens if price is below equilibrium?
6. Define Consumer’s and Producer’s Surplus
7. Identify the rule for double shifts in S&D
8. Explain the results of an excise tax
THE LAW OF DEMAND SAYS...
Consumers will buy more when prices
go down and less when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?
7
Elasticity
Elasticity shows how sensitive quantity is
to a change in price.
Summary of the Chapter
• Paul Salmon Video - Elasticity
9
Goals Of This Chapter
• By the end of this chapter you should be
able to do the
– Elasticity Slide
10
4 Types of Elasticity
1. Elasticity of Demand
2. Elasticity of Supply
3. Cross-Price Elasticity (Subs or Comp)
4. Income Elasticity (Norm or Inferior)
Total Revenue
• Total revenue = total amount the seller
receives from the sale of a product or
service
– In a particular time period
• Formula
TR = P * Q
• TR = total revenue
• P = Price
• Q = quantity
12
Total Revenue
• Formula
TR = P X Q
• TR = total revenue
• P = Price
• Q = quantity
• Example
–Price is $3.50 per gallon
–Quantity = 10 gallons
–$3.5 * 10 = $35 Total Revenue
13
What Happens If--• What happens to total revenue if
– Prices go up?
– Prices go down?
• We know about the Supply and Demand
Curve
– Does not tell us what happens if---
• Brings us to elasticity
14
Elasticity
• Measure of the responsiveness of the
quantity demanded to a good or service
– To change in price
– When all other factors remain the same
1. Elasticity of Demand
Elasticity of Demand• Measurement of consumers
responsiveness to a change in price.
• What will happen if price increase? How
much will it affect Quantity Demanded
Who cares?
• Used by firms to help determine prices
and sales
• Used by the government to decide how
to tax
Elasticity of Demand
• In the previous section, supply and demand
curves were drawn as straight lines.
• This is a simplification,
– we assume rate of change of demand or supply
is the same for all prices in the market.
• At some prices, a small change in price may
– cause a large change in the quantity
demanded.
Name--• In the short run, name
• Products whose price change will not
change demand much
• Products whose price change will change
demand significantly
18
This shown in the diagram as the movement from Pe to Pe1; a
small change in price which causes an even larger percentage
decrease in quantity demanded (from Qe to Qe1.
At other prices, a large
increase in price may see a
much smaller decrease in
demand. This shown in the
diagram as the movement
from Pe2 to Pe3; a large
change in price which causes
a smaller percentage
decrease in quantity
demanded (from Qe2 to Qe3.
Inelastic Demand
Inelastic Demand
INelastic = Quantity is
INsensitive to a change in price.
•If price increases, quantity
20%
demanded will fall a little
•If price decreases, quantity
demanded increases a little.
In other words, people will
continue to buy it.
5%
A INELASTIC demand curve is steep! (looks like an “I”)
Examples:
•Gasoline
•Milk
•Diapers
•Chewing Gum
•Medical Care
•Toilet paper
Inelastic Demand
• If percentage change in price produces a
smaller percentage change in quantity
demanded
22
Inelastic Demand
General Characteristics
of INelastic Goods:
20%
•Few Substitutes
•Necessities
•Small portion of
income
•Required now, rather
than later
•Elasticity coefficient
less than 1
5%
Example: Calculate
24
Elastic Demand
Elastic Demand
Elastic = Quantity is sensitive
to a change in price.
•If price increases, quantity
demanded will fall a lot
•If price decreases, quantity
demanded increases a lot.
In other words, the amount
people buy is sensitive to price.
An ELASTIC demand curve is flat!
Examples:
•Soda
•Boats
•Beef
•Real Estate
•Pizza
•Gold
Elastic Demand
General Characteristics
of Elastic Goods:
• Many Substitutes
• Luxuries
• Large portion of
income
• Plenty of time to
decide
• Elasticity coefficient
greater than 1
Price Elasticity Coefficient
Formula
• Ed = % change in quantity demanded of product X
% change in price of product X
Calculating % change
% Change in quantity =
nqd – iqd
initial quantity demanded
Example: % Change in quantity
100,000 nqd - 110,000 iqd = - 10,000
-10,000 = .10 or 10%
100,000
28
Price Elasticity Coefficient
Formula
• Ed = % change in quantity demanded of product X
% change in price of product X
• Change in price = New Price – Initial Price
Initial price
New Price = $4
Initial Price = $3
$4 np - $3 ip = $1 = .33 or 33%
$3 ip
$3
Price Elasticity Coefficient
Formula
• Ed = % change in quantity demanded of product X
% change in price of product X
10% = .30 or 30%
33%
Graph
• Graph the previous example
• Is it elastic or inelastic? WHY?
– Inelastic because change in % change in
quantity demanded is less than % change in
price
• Or a 33% change in price created a 10% drop in
quantity demanded
• Calculated price elastic is < 1 therefore price is
inelastic
You Solve
• Decide the price elasticity of demand for a
slice of pizza at $2.00 by examining a
price decrease from $2.00 to $1.50 per
slice. In this case, the demand pizza
would increase from 7 million slices to 10
million slices. You can use these figures to
calculate the price elasticity of demand
• Ed = % change in quantity demanded of product X
% change in price of product X
• Ed =
• Ed =
(10M – 7M) ÷ 7M (DN-O÷O)
($1.50 - $2.00) ÷ $2.00 (PN-O÷O)
.43
- 0.25
= -1.72
Drop the negative: Ed is > 1 therefore the demand for
pizza slices is elastic
Negative Numbers
• If price increases by 10% and consumers
respond by decreasing purchases by 20%
• the equation computes the elasticity coefficient
as -2.
• The result is negative because an increase in
price (a positive number)
• leads to a decrease in purchases (a negative
number).
• Because the law of demand says it will always
be negative, many economists ignore the
negative sign
Elastic or Inelastic?
Beef1.27
Gasoline.20
Real Estate- 1.6
Medical Care- .31
Electricity.13
Gold2.6
Elastic
What about the
INelastic
demand for insulin for
diabetics?
Elastic
INelastic
What if % change in
INelastic quantity demanded equals
Elastic
% change in price?
Perfectly INELASTIC
(Coefficient = 0)
Unit Elastic (Coefficient =1)
2. Price Elasticity of Supply
Elasticity of Supply• Elasticity of supply shows how sensitive producers
are to a change in price.
Elasticity of supply is based on time limitations.
Producers need time to produce more.
INelastic = Insensitive to a change in price (Steep curve)
• Most goods have INelastic supply in the short-run
Elastic = Sensitive to a change in price (Flat curve)
• Most goods have elastic supply in the long-run
Perfectly Inelastic = Q doesn’t change (Vertical line)
• Set quantity supplied
• Elasticity of supply is influenced by a number of factors.
These include :
• the length of the production period. In the late 1990's,
demand for Australia wines overseas has reached all
time records. Vines take three years to grow to a point
where they yield adequate amounts of fruit. Increases in
demand for Australian wine has seen prices rise (from
Po to P1), and returns to existing grape growers are
excellent. Those who wish to buy grapes face a market
where supply can only increase marginally (from Qo to
Q1), in the short term.
• However, many new stands of vines are being planted,
and in a few years, returns to growers may stabilise, as
supply increases. Prices will fall from P1 to P2 as the
supply of grapes increases from Q1 to Q2.
Elasticity Over Time - Supply
38
Elasticity Over Time - Supply
39
Elasticity Over Time - Supply
40
2.Price Elasticity of Supply
Over Time
Price Elasticity of Supply Over
Time
• How would you graph the supply
elasticity of Gas over time?
• Lets see
42
3. Cross-Price Elasticity of Demand
• Cross-Price elasticity shows how sensitive a product
is to a change in price of another good
• It shows if two goods are substitutes or complements
% change in quantity of product “b”
% change in price of product “a”
P increases 20%
coefficient is negative (shows inverse
relationship) then the goods are complements
• If coefficient is positive (shows direct relationship)
then the goods are substitutes
•
(test) If
Q decreases 15%
Think
• Pizza and Burgers are elastic and substitutes
of each other
• If the price of pizza declines
• 1. What happens to the sale of pizza?
• 2. What happens to the sale of burgers?
• 2. Soda is a compliment to pizza. What
happens to the sale of soda?
• Lets Graph
4. Income-Elasticity of Demand
• Income elasticity shows how sensitive a product is to
a change in INCOME
• It shows if goods are normal or inferior
% change in quantity
% change in income
Income increases 20%, and quantity decreases 15%
then the good is a… INFERIOR GOOD
•
(test) If coefficient is negative (shows inverse
relationship) then the good is inferior
• If coefficient is positive (shows direct relationship)
then the good is normal
Ex: If income falls 10% and quantity falls 20%…
Total Revenue Test
Uses elasticity to show how changes in price will
affect total revenue (TR).
(TR = Price x Quantity)
Elastic Demand• Price increase causes TR to decrease
• Price decrease causes TR to increase
Inelastic Demand• Price increase causes TR to increase
• Price decrease causes TR to decrease
Unit Elastic• Price changes and TR remains unchanged
Ex: If demand for milk is INelastic, what will happen to
expenditures on milk if price increases?
Is the range between A and B, elastic,
inelastic, or unit elastic?
10 x 100 =$1000 Total Revenue
5 x 225 =$1125 Total Revenue
A
50%
B
125%
Price decreased and TR increased,
so…
Demand is ELASTIC
You Should Now Get This
• Elastic and Inelastic Demand Baby
– Winner 2013 Econ video contest
48
Total Revenue Test
Total Revenue Test
}
inelastic
} unit elastic
}elastic
Elasticity Practice
53
• Graph the following chart
• Calculate the Ed using the top set of numbers
and prices rising
Answers -Graph
• This is what your graph should look like
Answers - Ed
• Ed = % change in quantity demanded of product X
% change in price of product X
% Change in quantity =
nqd – iqd
initial quantity demanded
% Change in price =
New Price – Initial Price
Initial price
Ed =
(90 – 100) ÷ 100
($2 - $1.00) ÷ $1.00
• Ed =
-.10 = -.1
1
Drop the negative: Ed is < 1 therefore the demand for is
INelastic
• Calculate the TR and determine if Total
Revenue increased or decreased with a price
increase
• What is gain or loss on
price move?
Answers
• $3 * 70 = $210
• $2 * 90 = $180
• Total Revenue increased $30
What Happens If --• Graph the following chart
• Calculate the Ed using the bottom two numbers
and prices rising
Answers - Ed
• Ed = % change in quantity demanded of product X
% change in price of product X
% Change in quantity =
nqd – iqd
initial quantity demanded
% Change in price =
New Price – Initial Price
Initial price
Ed =
(40 – 70) ÷ 70
($4 - $3.00) ÷ $3.00
• Ed =
-.4285
.3333
or 42.85% = 1.28
or 33.33%
Drop the negative: Ed is > 1 therefore the demand for is elastic
Ed & TR Test “quiz”
Practice Problem
• See handout
Consumer and Producer
Surplus
• Consumer Surplus
– Difference between maximum price willing
to pay and the actual price producers charge
– Think of it as a “willing to pay” curve
63
Marginal Benefit & Surplusses
• Marginal Benefit
– What you gain when you get one more unit
– Measured by what you are willing to give up
– Everyday life we say “getting value for our
money”
– There is a difference between value and price
Value vs. Price
• Value is what we get
• Price is what we pay
• Everyday idea of value is marginal benefit
OR
• The measure of the maximum price what
consumers are willing to pay for another
unit of a good or service
Pizza Sales Per Slice
Consumer Surplus
P
Consumer
surplus from
10th slice of
pizza
2
Willing to pay
1.5
Market Price
$1
.5
Amount Paid
D
10
20
30
40
Voluntary Exchange
In the free-market, buyers and sellers
voluntarily come together to seek mutual
benefits.
67
Voluntary Exchange
In the free-market, buyers and sellers voluntarily
come together to seek mutual benefits.
68
Voluntary Exchange
In the free-market, buyers and sellers voluntarily
come together to seek mutual benefits.
69
Voluntary Exchange
In the free-market, buyers and sellers voluntarily
come together to seek mutual benefits.
70
Example of Voluntary Exchange
Ex: You want to buy a truck so you go to the local
dealership. You are willing to spend up to $20,000 for a
new 4x4. The seller is willing to sell this truck for no less
than $15,000. After some negotiation you buy the truck
for $18,000.
Analysis:
Buyer’ Maximum- $20,000
Sellers Minimum- $15,000
Price- $18,000
Consumer’s Surplus-$2,000
Producer’s Surplus- $3,000
71
Voluntary Exchange Terms
Consumer Surplus is the difference
between what you are willing to pay
and what you actually pay.
CS = Buyer’s Maximum – Price
Producer’s Surplus is the difference
between the price the seller received
and how much they were willing to sell
it for.
PS = Price – Seller’s Minimum
72
Consumer and Producer’s Surplus
P
Calculate the :
1. Consumer Surplus
2. Producer Surplus
3. Total Surplus
$10
S
8
6
$5
4
CS
PS
2
1
D
2 4 6 8 10
Q
75
Calculating Consumer Surplus
In Dollars
Max
Willing to
pay
Actual
price
(E)
Calculate
CS
$9
$5
9–5=
$4
$8
$5
8–5=
$3
$7
$5
7–5=
$2
$6
$5
6–5=
$1
$5
$5
5–5=
$0
Sum = CS
= $10
76
Calculating Producer Surplus
In Dollars
Min Price
charged
Actual
price
(E)
Calculate
PS
$2
$5
5–2=
$3
$3
$5
5-3=
$2
$4
$5
5-4=
$1
$5
$5
5–5 =
$0
Sum = PS
= $6
77
Surpluses
• Could be calculated in Quantity
78
Summary
Consumption
Inefficiency
Production
Inefficiency
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
$20
$15
$8
George
$12
Ann
$7
Q. If dinner sells for $10, what is the value of Dons’
consumer surplus?
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
$20
$15
$8
George
$12
Ann
$7
Q. If dinner sells for $10, what is the value of Dons’
consumer surplus?
A. Willing to pay is $15. Market price is $10.
Willing to pay ($15) – Actual Price ($10) = $5
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
$20
$15
$8
George
$12
Ann
$7
Q. If dinner sells for $11, what is the TOTAL value of
consumer surplus?
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
$20
$15
$8
George
$12
Ann
$7
Q. If dinner sells for $11, what is the TOTAL value of
consumer surplus?
A. 20 – 11 = 9, 15 – 11 = 4, 12 – 11 = 1
9 + 4 + 1 = $14 consumer surplus
• For a given linier demand curve, the
value of consumer surplus does what as
market price increases?
• For a given linier demand curve, the
value of consumer surplus does what as
market price increases?
• Decreases as market price increases
(1)
Price
(2)
QA
(3)
(4)
QB
(5)
(6)
QC
(7)
$10
9
8
7
6
100
111
125
143
167
$_____
_____
_____
_____
_____
100
130
170
220
280
$_____
_____
_____
_____
_____
100
110
120
130
140
$_____
_____
_____
_____
_____
5
200
_____
350
_____
150
_____
15.
A marketing firm has done a study of market demand for
DVDs of three different movies. Calculate the total revenue for each
movie in columns 3, 5, and 7.
Without calculating the price elasticity of demand, indicate
whether demand for each movie is elastic, inelastic or unit-elastic. For
which movie would a reduction in price produce the greatest increase
in revenue?
86
(1)
Price
(2)
QA
(3)
(4)
QB
(5)
(6)
QC
(7)
$10
100
$1000
100
$1000
100
$1000
9
111
999
130
1170
110
990
8
125
1000
170
1360
120
960
7
143
1001
220
1540
130
910
6
167
1002
280
1680
140
840
5
200
1000
350
1750
150
750
Without calculating the price elasticity of demand, indicate whether demand for
each movie is elastic, inelastic or unit-elastic. For which movie would a
reduction in price produce the greatest increase in revenue?
Applying the total revenue test, we see that total revenues remain
approximately constant for movie A, meaning that demand is unit-elastic. Total
revenues for movie B are increasing as price decreases, meaning that demand
for movie B is elastic. Total revenues for movie C are decreasing as price
decreases, meaning the demand for movie C is inelastic. [text: E pp. 77-80;
MA pp. 77-80; MI pp. 77-80]
87