5
Elasticity and its Application
Economics
PRINCIPLES OF
N. Gregory Mankiw
Premium PowerPoint Slides
by Ron Cronovich
Calculating Percentage Changes
• So, we instead use the midpoint method:
end value – start value
midpoint
x 100%
 The midpoint is the number halfway between the
start & end values, the average of those values.
 It doesn’t matter which value you use as the
“start” and which as the “end” – you get the same
answer either way!
ELASTICITY AND ITS
APPLICATION
2
Calculating Percentage Changes
• Using the midpoint method, the % change
in P equals
$250 – $200
$225
x 100%
= 22.2%
 The % change in Q equals
12 – 8
x 100%
10
= 40.0%
 The price elasticity of demand equals
40/22.2 = 1.8
ELASTICITY AND ITS
APPLICATION
3
ACTIVE LEARNING 1
Calculate an elasticity
Use the following
information to
calculate the
price elasticity
of demand
for hotel rooms:
if P = $70, Qd = 5000
if P = $90, Qd = 3000
4
ACTIVE LEARNING 1
Answers
Use midpoint method to calculate
% change in Qd
(5000 – 3000)/4000 = 50%
% change in P
($90 – $70)/$80 = 25%
The price elasticity of demand equals
50%
= 2.0
25%
5
Price Elasticity and Total Revenue
Price elasticity
of demand
=
Percentage change in Q
Percentage change in P
Revenue = P x Q
• If demand is elastic, then
price elast. of demand > 1
% change in Q > % change in P
• The fall in revenue from lower Q is greater
than the increase in revenue from higher P,
so revenue falls.
ELASTICITY AND ITS
APPLICATION
6
Price Elasticity and Total Revenue
Elastic demand
(elasticity = 1.8)
If P = $200,
Q = 12 and revenue
= $2400.
If P = $250,
Q = 8 and
revenue = $2000.
increased
Demand for
revenue due
your websiteslost
to higher P
revenue
due to
lower Q
P
$250
$200
D
When D is elastic,
a price increase
causes revenue to fall.
ELASTICITY AND ITS
APPLICATION
8
7
12
Q
Price Elasticity and Total Revenue
Now, demand is
inelastic:
elasticity = 0.82
If P = $200,
Q = 12 and revenue
= $2400.
If P = $250,
Q = 10 and
revenue = $2500.
P
$250
$200
D
When D is inelastic,
a price increase
causes revenue to rise.
ELASTICITY AND ITS
APPLICATION
increased
Demand for
revenue
yourdue
websites
lost
to higher P
revenue
due to
lower Q
10
8
12
Q
6
Supply, Demand, and
Government Policies
Economics
PRINCIPLES OF
N. Gregory Mankiw
Premium PowerPoint Slides
by Ron Cronovich
ACTIVE LEARNING 1
Price controls
P
140
Determine
effects of:
A. $90 price
ceiling
130
The market for
hotel rooms
S
120
110
100
90
B. $90 price
floor
80
C. $120 price
floor
60
D
70
50
40
0
Q
50 60 70 80 90 100 110 120 130
10
ACTIVE LEARNING 1
A. $90 price ceiling
The price falls
to $90.
Buyers
demand
120 rooms,
sellers supply
90, leaving a
shortage.
P
140
The market for
hotel rooms
130
S
120
110
100
90
80
Price ceiling
shortage = 30
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
11
ACTIVE LEARNING 1
B. $90 price floor
Eq’m price is
above the floor,
so floor is not
binding.
P = $100,
Q = 100 rooms.
P
140
The market for
hotel rooms
130
S
120
110
100
90
80
Price floor
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
12
ACTIVE LEARNING 1
C. $120 price floor
The price
rises to $120.
Buyers
demand
60 rooms,
sellers supply
120, causing a
surplus.
P
140
130
120
110
The market for
hotel rooms
surplus = 60
S
Price floor
100
90
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
13
ACTIVE LEARNING 2
Effects of a tax
Suppose govt
imposes a tax on
buyers of $30
per room.
Find new
Q, PB, PS,
and incidence of
tax.
P
140
130
The market for
hotel rooms
S
120
110
100
90
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
ACTIVE LEARNING 2
Answers
P
140
Q = 80
PB = $110
PS = $80
Incidence
buyers: $10
sellers: $20
The market for
hotel rooms
130
S
120
PB = 110
100
90
PS = 80
Tax
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
7
Consumers, Producers,
and the Efficiency of Markets
Economics
PRINCIPLES OF
N. Gregory Mankiw
Premium PowerPoint Slides
by Ron Cronovich
ACTIVE LEARNING 1
Consumer surplus
demand curve
P
50
A. Find marginal
$ 45
buyer’s WTP at
40
Q = 10.
35
B. Find CS for
30
P = $30.
25
Suppose P falls to $20.
20
How much will CS increase
15
due to…
10
C. buyers entering
5
the market
D. existing buyers paying 0
lower price
0
5
10
15
20
Q
25
17
ACTIVE LEARNING 1
Answers
A. At Q = 10, marginal
buyer’s WTP is $30.
B. CS = ½ x 10 x $10
= $50
P falls to $20.
C. CS for the
additional buyers
= ½ x 10 x $10 = $50
D. Increase in CS
on initial 10 units
= 10 x $10 = $100
demand curve
P
50
$ 45
40
35
30
25
20
15
10
5
0
0
5
10
15
20
Q
25
18
ACTIVE LEARNING 2
Producer surplus
A. Find marginal
seller’s cost
at Q = 10.
B. Find total PS for
P = $20.
Suppose P rises to $30.
Find the increase
in PS due to…
C. selling 5
additional units
D. getting a higher price
on the initial 10 units
supply curve
P
50
45
40
35
30
25
20
15
10
5
0
0
5
10
15
20
Q
25
19
ACTIVE LEARNING 2
Answers
A. At Q = 10,
marginal cost = $20
B. PS = ½ x 10 x $20
= $100
P rises to $30.
C. PS on
additional units
= ½ x 5 x $10 = $25
D. Increase in PS
on initial 10 units
= 10 x $10 = $100
supply curve
P
50
45
40
35
30
25
20
15
10
5
0
0
5
10
15
20
Q
25
20
8
Application:
The Costs of Taxation
Economics
PRINCIPLES OF
N. Gregory Mankiw
Premium PowerPoint Slides
by Ron Cronovich
ACTIVE LEARNING 1
Answers to A
CS
= ½ x $200 x 100
= $10,000
PS
= ½ x $200 x 100
= $10,000
Total surplus
= $10,000 + $10,000
= $20,000
The market for
airplane tickets
P
$ 400
350
300
S
250
P = 200
150
D
100
50
Q
0
0
25
50
75 100 125
22
ACTIVE LEARNING 1
Answers to B
CS
= ½ x $150 x 75
= $5,625
P
$ 400
350
300
PS = $5,625
PB = 250
Tax revenue
= $100 x 75
= $7,500
200
Total surplus
= $18,750
DWL = $1,250
A $100 tax on
airplane tickets
S
PS = 150
D
100
50
Q
0
0
25
50
75 100 125
23
9
Application:
International Trade
Economics
PRINCIPLES OF
N. Gregory Mankiw
Premium PowerPoint Slides
by Ron Cronovich
ACTIVE LEARNING
1
Analysis of trade
Without trade,
PD = $3000, Q = 400
P
Plasma TVs
S
In world markets,
PW = $1500
Under free trade,
how many TVs
will the country
import or export?
$3000
$1500
Identify CS, PS, and
total surplus without trade,
and with trade.
D
200
400
600
Q
25
ACTIVE LEARNING
1
Answers
Under free trade,
 domestic
consumers
demand 600
 domestic
producers
supply 200
 imports = 400
P
Plasma TVs
S
$3000
$1500
D
imports
200
600
Q
26
ACTIVE LEARNING
1
Answers
Without trade,
CS = A
PS = B + C
Total surplus
=A+B+C
With trade,
CS = A + B + D
PS = C
Total surplus
=A+B+C+D
P
Plasma TVs
S
gains from
trade
A
$3000
B
$1500
C
D
imports
D
Q
27