Economics 111.3 Winter 14

February 3rd, 2014Lecture 10

Ch. 4Ch. 6 (up to p. 138)

Total Revenue Test, or relations between seller’s Total Revenue and elasticity

• If demand is elastic, a 1 percent price cut increases the quantity bought by more than 1 percent and the seller’s Total Revenue increases.

• If demand is inelastic, a 1 percent price cut increases quantity bought by less than 1 percent and the seller’s Total Revenue decreases.

If demand is unit elastic, a 1 percent price cut increases quantity bought by 1 percent and the seller’s Total Revenue does not

change.P*Q= constant

Study question• The demand for a product is unit elastic

throughout. If consumers purchase 8,000 units when the price is $5, how many units will they purchase if the price is $4?

Study Question: True or False

• If the elasticity of demand curve for buckwheat is |1.25| at all prices higher than current price, we would expect that when bad weather reduces the size of the buckwheat crop, total revenue of buckwheat producers will fall

PRICE ELASTICITIES OF DEMANDA relationship isdescribed as

When itsmagnitude is Which means that

Unit elastic

Inelastic

Perfectly inelasticor completely inelastic

Perfectly elasticor infinitely elastic

Infinity The smallest possible increase in price causes an infinitely large decrease in quantity demanded.

Less than infinity but greater than 1

Greater than zerobut less than 1

Elastic

1

Zero

The percent decrease in the quantity demanded exceeds the percent increase in price.

The percent decrease in the quantity demanded equals the percent increase in price.

The percentage decrease in the quantity demanded is less than the percent increase in price.The quantity demanded is the same at all prices.

The cross elasticity of demandThe cross elasticity of demand measures the responsiveness of the demand for a good to a change in the price of a substitute or complement good.

CROSS ELASTICITIES OF DEMANDA relationship isdescribed as

When itsmagnitude is

Which means that

Perfect substitutes

Infinity The smallest possible increase in price of one good causes an infinitely large in the demand of the other good.

Positive, lessthan infinity

Substitutes If the price of one good increases, the quantity demanded of the other good also increases.

Independent Zero The demand for one good remains constant, regardless of the price of the other good.

Complements Less than zero The demand for one good decreases when the price of the other good increases.

Study question• Suppose the demand curve for a product is

given by Q=10-2P+PS, where P is the price of the product and PS is the price of a substitute good. The price of the substitute good is $2.00.

• Suppose P=$1.001. What is the price elasticity of demand?2. What is the cross-price elasticity of

demand?

Income Elasticity of Demand• It measures how much the quantity

demanded of a good responds to a change in consumers’ income.

• It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

Income elasticity of demand: some observations city• Types of Goods

– Normal Goods– Inferior Goods

• Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

• Goods consumers regard as necessities tend to be income inelastic– Examples include food, fuel, clothing, utilities, and

medical services.• Goods consumers regard as luxuries tend to be income

elastic.– Examples include sports cars, furs, and expensive foods.

Food

INCOME ELASTICITIES OF DEMAND:

A relationship is described as

When its magnitude is

Which means that

Income elastic(normal good)

Greater than 1

The percent increase in the quantity demanded is greater than the percentage increase in income.

Income inelastic(normal good)

Less than 1 but greater than zero

The percent increase in the quantity demanded is less than the percentage increase in income.

Negative income elastic(inferior good)

Less than zeroWhen income increases, quantity demanded decreases.