5 5 Demand and Elasticity A high cross elasticity of demand [between two goods indicates that they]...
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Transcript of 5 5 Demand and Elasticity A high cross elasticity of demand [between two goods indicates that they]...
5
Demand and ElasticityA high cross elasticity of demand [between two goods
indicates that they] compete in the same market. [This can prevent a supplier of one of the products]
from possessing monopoly power over price.U.S. SUPREME COURT, DUPONT CELLOPHANE DECISION, 1956
● Elasticity: The Measure of Responsiveness
● Price Elasticity of Demand: Its Effect on Total Revenue and Total Expenditure
● What Determines Demand Elasticity?
● Elasticity as a General Concept
● Changes in Demand: Movements Along the Demand Curve vs Shifts in the Demand Curve
● Elasticity: The Measure of Responsiveness
● Price Elasticity of Demand: Its Effect on Total Revenue and Total Expenditure
● What Determines Demand Elasticity?
● Elasticity as a General Concept
● Changes in Demand: Movements Along the Demand Curve vs Shifts in the Demand Curve
ContentsContents
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● The Time Period of the Demand Curve and Economic Decision Making
● Real-World Application: Polaroid versus Kodak
● Appendix: How to Find a Legitimate Demand Curve from the Statistics
● The Time Period of the Demand Curve and Economic Decision Making
● Real-World Application: Polaroid versus Kodak
● Appendix: How to Find a Legitimate Demand Curve from the Statistics
Contents (continued)Contents (continued)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● Elasticity = measure of the responsiveness of one variable to changes in another variable
● Price elasticity of demand =
● Elasticity = measure of the responsiveness of one variable to changes in another variable
● Price elasticity of demand =% quantity
% price
Elasticity: The Measure of ResponsivenessElasticity: The Measure of Responsiveness
FIGURE 5-1(a) The Hypothetical Demand Curves for Film
FIGURE 5-1(a) The Hypothetical Demand Curves for Film
4 3 0
10
$20
Quantity Demanded
Pri
ce p
er P
ack
age
DS
DS
B
A
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 5-1(b) The Hypothetical Demand Curves for Film
FIGURE 5-1(b) The Hypothetical Demand Curves for Film
4 1.5 0
10
$20
Pri
ce p
er P
ack
age
Quantity Demanded
D f
Df b
a
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity: The Measure of ResponsivenessElasticity: The Measure of Responsiveness
● Elastic demand = price elasticity of demand > 1
● Inelastic demand = price elasticity of demand < 1
● Elastic demand = price elasticity of demand > 1
● Inelastic demand = price elasticity of demand < 1
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity: The Measure of ResponsivenessElasticity: The Measure of Responsiveness
● Equation for Price Elasticity of Demand♦ % Quantity % Price
♦ [(Q1 - Q0) / (average of Q1 and Q0)] [(P1 - P0) / (average of P1 and P0)]
● Equation for Price Elasticity of Demand♦ % Quantity % Price
♦ [(Q1 - Q0) / (average of Q1 and Q0)] [(P1 - P0) / (average of P1 and P0)]
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● Percentages calculated in terms of the averages of the prices and quantities
● Minus sign dropped
● Percentages calculated in terms of the averages of the prices and quantities
● Minus sign dropped
Elasticity: The Measure of ResponsivenessElasticity: The Measure of Responsiveness
FIGURE 5-2a Sensitivity of Slope to Units of Measurement
FIGURE 5-2a Sensitivity of Slope to Units of Measurement
2,000 1,500 1,000
D
D
500 0
10 9 8
17 16 15 14 13 12 11
7 6 5 4 3 2 1
$18
(a)
Pizzas per Week
Pri
ce
pe
r P
izza
3,000 2,500 360
280
B
A
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 5-2b Sensitivity of Slope to Units of Measurement
FIGURE 5-2b Sensitivity of Slope to Units of Measurement
2,000 1,500 1,000
D
D
500 0
10 9 8
17 16 15 14 13 12 11
7 6 5 4 3 2 1
$18
(b)
Slices of Pizza per Week
Pri
ce
pe
r P
izza
2,500 3,000 2,880 2,240
A
B
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● The Relationship between Elasticity and Slope♦ Slope depends upon specific units while
elasticity does not.
♦ If a demand curve has a constant slope (straight-line), the elasticity is not constant.
♦ If a demand curve has a constant elasticity (unit elastic), the slope is not constant.
● The Relationship between Elasticity and Slope♦ Slope depends upon specific units while
elasticity does not.
♦ If a demand curve has a constant slope (straight-line), the elasticity is not constant.
♦ If a demand curve has a constant elasticity (unit elastic), the slope is not constant.
Price Elasticity of Demand and the Shapes of Demand CurvesPrice Elasticity of Demand and the Shapes of Demand Curves
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
TABLE 5-1 Estimates of Price Elasticities
TABLE 5-1 Estimates of Price Elasticities
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 5-3 Demand Curves with Different Elasticities
FIGURE 5-3 Demand Curves with Different Elasticities
Pri
ce
C B
A
C'
A'
B'
$6
4 3
7 5 4 2
1
Straight- line
demand curve
(c)
Quantity Demanded
0
D
D
$0.75 D D
“Perfectly elastic” demand curve
(b)
Quantity Demanded
Pri
ce
0
“Perfectly inelastic” demand curve
(a)
Quantity Demanded
Pri
ce
D
D
90 0
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 5-3(d) Unit Elastic Demand Curve
FIGURE 5-3(d) Unit Elastic Demand Curve
Unit- elastic
demand curve
U' 14 7
D
D
$30
10
20
Quantity Demanded
Pri
ce
0
(d)
S
T
U
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Price Elasticity of DemandPrice Elasticity of Demand
price revenues if the demand curve is elastic
price revenues if the demand curve is inelastic
price 0 revenues if the demand curve is unit elastic
price revenues if the demand curve is elastic
price revenues if the demand curve is inelastic
price 0 revenues if the demand curve is unit elastic
FIGURE 5-4 An Elastic Demand Curve
FIGURE 5-4 An Elastic Demand Curve
5
12
Quantity Demanded
Pri
ce
$6
1
2
3
4
4 0
U
W
D
D
R
T
S
V
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
What Determines Demand Elasticity?What Determines Demand Elasticity?
● Nature of the good
● Availability of close substitutes
● Fraction of income absorbed
● Passage of time
● Nature of the good
● Availability of close substitutes
● Fraction of income absorbed
● Passage of time
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity as a General ConceptElasticity as a General Concept
● Elasticity can be used to measure the responsiveness of anything to anything else.
● Income Elasticity♦ Income elasticity of demand = % quantity
demanded % income
● Price Elasticity of Supply♦ Price elasticity of supply = % quantity of
supply % price
● Elasticity can be used to measure the responsiveness of anything to anything else.
● Income Elasticity♦ Income elasticity of demand = % quantity
demanded % income
● Price Elasticity of Supply♦ Price elasticity of supply = % quantity of
supply % price
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Elasticity as a General ConceptElasticity as a General Concept
● Cross Elasticity of Demand♦ Cross elasticity of demand (for product X to a
change in the price of product Y) = % quantity demanded of X % price of Y
♦ If two goods are substitutes (complements), their cross elasticity of demand is positive (negative).
● Cross Elasticity of Demand♦ Cross elasticity of demand (for product X to a
change in the price of product Y) = % quantity demanded of X % price of Y
♦ If two goods are substitutes (complements), their cross elasticity of demand is positive (negative).
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Changes in Demand: Movements Along vs ShiftsChanges in Demand: Movements Along vs Shifts
price movement along the demand curve
any other factor that affects spending decisions shift between demand curves
price movement along the demand curve
any other factor that affects spending decisions shift between demand curves
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Changes in Demand: Movements Along vs ShiftsChanges in Demand: Movements Along vs Shifts
● Demand Shifters♦ Consumer incomes rise
♦ Tastes change in favor of the good
♦ The price of substitute goods
♦ The price of complementary goods
● Demand Shifters♦ Consumer incomes rise
♦ Tastes change in favor of the good
♦ The price of substitute goods
♦ The price of complementary goods
FIGURE 5-5 Shifts in a Demand Curve
FIGURE 5-5 Shifts in a Demand Curve
D0
D0
(b) Quantity of Sweaters
Pri
ce
D1
D1
S
D0
D0
(a) Quantity of Sweaters in Thousands
Pri
ce
$35
28
60 40
R
U T
D2
D2
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Demand Curve and Economic Decision MakingThe Demand Curve and Economic Decision Making
● The demand curve shows the quantity of demand buyers would hypothetically purchase at different prices during the same time period.
● It does not show the quantity actually bought at different prices at different times.
● The demand curve shows the quantity of demand buyers would hypothetically purchase at different prices during the same time period.
● It does not show the quantity actually bought at different prices at different times.
Expected Demand at Various Six-Month Prices
Expected Demand at Various Six-Month Prices
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Real-World Application: Polaroid versus KodakReal-World Application: Polaroid versus Kodak
● In 1989, Polaroid vs Kodak—copyright infringement
● Key issue: how much profit Polaroid lost?● Price elasticity of demand
♦ growth in instant camera sales due to ■Kodak competition (lower price) OR■Kodak’s reputation (Polaroid might have benefited
from Kodak increasing potential number of customers)
● In 1989, Polaroid vs Kodak—copyright infringement
● Key issue: how much profit Polaroid lost?● Price elasticity of demand
♦ growth in instant camera sales due to ■Kodak competition (lower price) OR■Kodak’s reputation (Polaroid might have benefited
from Kodak increasing potential number of customers)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Real-World Application: Polaroid versus KodakReal-World Application: Polaroid versus Kodak
● Cross elasticity of demand♦ After 1980, decline in sales due to
■decreasing cost of 35-mm photography ● then Kodak not to blame
■Kodak’s infringement● Kodak damages due increase
● Cross elasticity of demand♦ After 1980, decline in sales due to
■decreasing cost of 35-mm photography ● then Kodak not to blame
■Kodak’s infringement● Kodak damages due increase
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Real-World Application: Polaroid versus KodakReal-World Application: Polaroid versus Kodak
● Third issue: How much could Polaroid’s total revenue increased if Kodak not infringe?♦ Polaroid claimed lots! $9 billion or more
♦ Kodak claimed neighborhood of $450 million (very close to judge’s verdict)
● Third issue: How much could Polaroid’s total revenue increased if Kodak not infringe?♦ Polaroid claimed lots! $9 billion or more
♦ Kodak claimed neighborhood of $450 million (very close to judge’s verdict)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Finding a Legitimate Demand CurveFinding a Legitimate Demand Curve
● In the real world we usually only observe historical price-quantity combinations, so it is often difficult to distinguish between movement along a demand curve and shifts between demand curves.
● In the real world we usually only observe historical price-quantity combinations, so it is often difficult to distinguish between movement along a demand curve and shifts between demand curves.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Finding a Legitimate Demand CurveFinding a Legitimate Demand Curve
● Prices and quantities observed at different times in the real world may result from shifting demand curves and not movement along a demand curve.
● Prices and quantities observed at different times in the real world may result from shifting demand curves and not movement along a demand curve.
TABLE 5-2 Historical Data on Price and Quantity
TABLE 5-2 Historical Data on Price and Quantity
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Finding a Legitimate Demand CurveFinding a Legitimate Demand Curve
● Simply connecting the points may not give a good estimate of a demand curve.
● Simply connecting the points may not give a good estimate of a demand curve.
FIGURE 5-6 Plot of Historical Data on Price and Quantity
FIGURE 5-6 Plot of Historical Data on Price and Quantity
Ave
rag
e P
rice
Quantity Demanded in Thousands
98 97 96 95 94 93 92 91 90 0
7.00
7.20
7.40
7.60
7.80
8.00
$8.20
T
T
S
April
Jan.
March
R
May
Feb.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 5-7 Plot of Historical Data and True Demand Curves
FIGURE 5-7 Plot of Historical Data and True Demand Curves
T
T
98
M M
F
F
Av
era
ge
Pri
ce
Quantity Demanded in Thousands
97 96 95 94 93 92 91 90 0
7.00
7.20
7.40
7.60
7.80
8.00
$8.20
J
J
Jan.
March
Feb. R W
S
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
TABLE 5-3 Annual Rainfall in St. Louis, 1993-2001
TABLE 5-3 Annual Rainfall in St. Louis, 1993-2001
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.