Micro L10 Elasticity of Demand

8/8/2019 Micro L10 Elasticity of Demand

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Elasticity of Demand and Supply

Price Elasticity of Demand (Ep)

Calculating Percentage Change Significance of Price Elasticity of Demand (Ep)

Determinants of Price Elasticity of Demand (Ep)

For Next Time


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Price Elasticity of Demand A measure of the extent to which the quantity

demanded of a good changes when the price of the

good changes, ceteris paribus. We know if we raise a price, the Qd will decline, but

we dont know how much.

Elasticity answers the how much question.

In Business, we want to know the relationshipbetween Qd and Price

Ep = % Change in Quantity Demanded

% Change in Price


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Price of Latte

Suppose a retail gourmet coffee outlet is selling itspremium Latte for $3/cup. The store generally is

selling 15 cups of Latte per hour, and the storemanager is thinking seriously of raising the price to$5/cup. He knows he will lose some sales but thinksthat most of his customers are willing to pay more.Help him quantify his decision by determining how

many fewer cups he can sell and still generate morerevenue per hour.


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Calculating Percentage Change

Percentage Change measures how much a value haschanged from one time period to another

For Example, if a firms sales for the current monthamounted to $100 million and the previous month,the same firms sales were $90 million. What wasthe percentage change?

There are two methods of calculating the percentagechange

Simple Method

Midpoint Method


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Simple Method

Percentage Change = Current Value-Previous Value

Previous Value

or, = $100m - $90 m = $10m = 11.1%

$90m $90m

Very Common Usage, especially in the business world


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Midpoint Method

Percentage Change = Current Value Previous Value

(Current Value + Previous Value)/ 2

Or, = $100m -$90m = $10m = 10.5%

($100m + $90m)/2 $95m

The midpoint method is the better method because itgives similar results whether we are measuringforward or backward


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Price Elasticity of Demand

From Formula Ep = % Change in Qd

% Change in Price

If Price Elasticity of Demand > 1, demand is elastic

If Price Elasticity of Demand = 1, demand is unitelastic

If Price Elasticity of Demand < 1, demand isinelastic


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Demand Elasticity Elastic Demand When % Change in Quantity

Demanded > % Change in Price

Unit Elastic Demand When % Change in QuantityDemanded = % Change in Price

Inelastic Demand When % Change in QuantityDemanded < % Change in Price

Perfectly Elastic Demand When Quantity Demanded

Changes by a very large percentage in response toan almost zero Change in Price

Perfectly Inelastic Demand When the QuantityDemanded remains constant as Price changes


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18-10Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Perfectly Elastic Demand Curve

Quantity

D

14

8

6

4

2

10 15 20 25 305

12

10

The elasticity of a perfectly elastic demand curve is infinity


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Perfectly Inelastic Demand Curve

Quantity

D

30

25

20

15

10

5

5 10 15 20 25

The elasticity of a perfectly inelastic demand curve is 0


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Relativity Elasticity of Demand Curves

Quantit


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Elasticity of Straight Line Demand Curve

Quantit

9

7

V er elastic

e = .

Slightl elastic

Unit elastic

Slightl inelastic

Ver

inelastic

e = . 9

e = .

7 9


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Significance of Price Elasticity of Demand

Profit maximization requires that business set a pricethat will maximize the firms profit

Elasticity tells the firm how much control it has overusing price to raise profit

If Ep > 1, then the % Change in Qd > % Change isPrice and demand is said to be elastic

An increase in price will reduce total revenue

A decrease in price will increase total revenue


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Significance of Price Elasticity of Demand

If Ep < 1, then the % change in Qd < % change inprice, and demand is said to be inelastic

An increase in price will increase total revenue A decrease in price will decrease total revenue

If Ep = 1, then the % change in Qd = % change inPrice, and demand is said to be unit elastic

An increase in price will have no impact on total revenue

A decrease in price will have no impact on total revenue


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Price Elasticity of Demand Influences Substitute Product Availability (key determinant)

-- Luxury or Necessity (Ep for luxury items is >)-- How narrowly it is defined (coffee is inelastic but latte

may have more substitutes and therefore is more elastic)

-- Time elapsed since price change (>time, >elasticity;more time to find substitutes or manage consumption)

Income Effects-- The greater the proportion of income spent

on the good, greater a price change impactsQuantity Demanded


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Advertising

Purpose Product Differentiation (Branding)

To make the demand for a product greater

To make the demand for a product more inelastic

D D



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Elasticity Thoughts

Demand Curve Slope and Elasticity (Steeper the slope, lower theelasticity)

A Units-Free Measure (% Change Absolute Value)

Elasticity Along a Linear Demand Curve-- Slope is constant but elasticity varies

Elasticity and Total Revenue-- Price and Total Revenue change in opposite directions, demand is elastic

-- Price Change leaves Total Revenue unchanged, demand is unit elastic-- Price and Total Revenue change in same direction, demand is inelastic


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Price Elasticity of Supply

A measure of the extent to which the

quantity supplied of a good changes whenthe price of the good changes, and all otherinfluences on sellers plans remain the same(cateris paribus)


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Price Elasticity of Supply Perfectly Elastic Supply When the quantity supplied

changes by a very large percentage in response to analmost zero increase in price

Elastic Supply When the % change in the quantitysupplied > the % change in the price

Unit Elastic Supply When the % change in thequantity supplied = the % change in price

Inelastic Supply When the % change in thequantity demanded is < the % change in price

Perfectly Inelastic Supply When the quantitysupplied remains the same as the price changes


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Influences on Price Elasticity of

Supply

Production Possibilities page 124

-- Opportunity Costs

constant or gently rising opportunity costs

= elastic price elasticity

-- Fixed Production = inelastic price elasticity

-- Time Elapse longer time, > priceelasticity


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Influences of Price Elasticity of

Supply

Storage Possibilities

The better the storability, the more elastic isthe price elasticity of supply


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Computing Price Elasticity of Supply

Percentage change in quantity supplied

Percentage change in price

If Price Elasticity of Supply > 1, Supply is elastic

If Price Elasticity of Supply = 1, Supply is unit elastic

If price elasticity of supply< 1, Supply is inelastic


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Cross Elasticity of Demand

A measure of the extent to which the demandfor a good changes when the price of a

substitute or complement changes, ceterisparibus

% Change in Quantity Demanded

% Change in Price of one of its

substitutes or complements


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Income Elasticity of Demand

A measure of the extent to which thedemand for a good changes whenincome changes, ceteris paribus

% Change in Quantity Demanded

% Change in Income


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Income Elasticity of Demand

If income elasticity of demand > 1 thedemand for the good is income elastic

If income elasticity of demand is between

0 and 1, the demand is income inelastic

* If income elasticity of demand < 0 the

demand is negative income elastic


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For Next Time

Define the term Price Elasticity of Supply. Whatdoes this concept tell us?

What are the main determinants of supply elasticity?How do they impact supply?

If government taxes a product (excise tax), how canwe determine how much of the tax will be passed onto the buyer and how much will have to be paid bythe seller?

Micro L10 Elasticity of Demand

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