Price Elasticity of Demand

Transcription

1 Chapter 6 Elas%city Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2 Price Elasticity of Demand Measures buyers responsiveness to price changes Elas%c demand Sensi%ve to price changes Large change in quan%ty Inelas%c demand Insensi%ve to price changes Small change in quan%ty LO1 6-2

3 Price Elasticity of Demand Formula Formula for price elas%city of demand E d = percentage change in quan%ty demanded of product X percentage change in price of product X LO1 6-3

4 Price Elasticity of Demand Formula Use the midpoint formula Ensures consistent results Change in quan%ty E d = Sum of quan%%es/2 Change in price Sum of prices/2 LO1 6-4

5 Price Elasticity of Demand Formula Use percentages Unit free measure Compare elas%ci%es across products Eliminate the minus sign Easier to compare elas%ci%es LO1 6-5

6 Interpretation of Elasticity of Demand E d > 1 demand is elas%c E d = 1 demand is unit elas%c E d < 1 demand is inelas%c Extreme cases E d = 0 demand is perfectly inelas%c E d = demand is perfectly elas%c LO1 6-6

7 Extreme Cases P D 1 Perfectly inelas%c demand (Ed = 0) 0 Perfectly inelas%c demand LO1 6-7

8 Extreme Cases P Perfectly elas%c demand (Ed = ) D 2 0 Perfectly elas%c demand LO1 6-8

9 Total Revenue Test Total Revenue = Price X Quan%ty Total Revenue Test Inelas%c demand P and TR move in the same direc%on Elas%c demand P and TR move in opposite direc%ons LO2 6-9

10 Total Revenue Test Lower price and elas%c demand Blue gain exceeds orange loss P $3 2 a 1 b D Q LO2 6-10

11 Total Revenue Test Lower price and inelas%c demand Orange loss exceeds blue gain P $4 c d LO2 D Q 6-11

12 Total Revenue Test Lower price and unit elas%c demand Blue gain equals orange loss P $3 e 2 1 f D Q LO2 6-12

13 Total Revenue Test Price Elas%city of Demand for Movie Tickets as Measured by the Elas%city Coefficient and the Total Revenue Test (1) Total Quan%ty of Tickets Demanded per Week, Thousands (2) Price per Ticket (3) Elas%city Coefficient (E d ) (4) Total Revenue (1) X (2) (5) Total- Revenue Test $ ] ] ] ] ] ] ] $ 8,000 14,000 18,000 20,000 20,000 18,000 14,000 8,000 ] ] ] ] ] ] ] Elas%c Elas%c Elas%c Unit- elas%c Inelas%c Inelas%c Inelas%c LO2 6-13

14 Elasticity and Total Revenue Price $8 7 a 6 b 5 c 4 d 3 e 2 f 1 g h Quan%ty demanded D Elas%c E d > 1 Unit elas%c E d = 1 Inelas%c E d < 1 LO2 Total revenue (Thousands of dollars) $ Quan%ty demanded TR 6-14

15 Summary of Price Elasticity of Demand Price Elas%city of Demand: A Summary Absolute Value of Elas%city Coefficient Demand Is: Descrip%on Greater than 1 (E d > 1) Elas%c or rela%vely elas%c Q d changes by a larger percentage than does price Impact on Total Revenue of a: Price Increase Total Revenue decreases Price Decrease Total Revenue increases Equal to 1 (E d = 1) Unit or unitary elas%c Q d changes by the same percentage as does price Total revenue is unchanged Total revenue is unchanged Less than 1 (E d < 1) Inelas%c or rela%vely inelas%c Q d changes by a smaller percentage than does price Total revenue increases Total revenue decreases 6-15

16 Determinants of Price Elasticity of Demand Subs%tutability More subs%tutes, demand is more elas%c Propor%on of income Higher propor%on of income, demand is more elas%c LO3 6-16

17 Determinants of Price Elasticity of Demand Luxuries versus necessi%es Luxury goods, demand is more elas%c Time More %me available, demand is more elas%c LO3 6-17

18 Price Elasticity of Demand Selected Price Elas%ci%es of Demand Product or Service Price Elas%city of Demand (E d ) Product or Service Price Elas%city of Demand (E d ) Newspapers.10 Milk.63 Electricity (household).13 Household appliances.63 Bread.15 Liquor.70 MLB Tickets.23 Movies.87 Telephone Service.26 Beer.90 Cigarebes.25 Shoes.91 Sugar.30 Motor vehicles 1.14 Medical Care.31 Beef 1.27 Eggs.32 China, glassware 1.54 Legal Services.37 Residen%al land 1.60 Automobile repair.40 Restaurant meals 2.27 Clothing.49 Lamb and mubon 2.65 Gasoline.60 Fresh peas

19 Applications of Price Elasticity of Demand Large crop yields Inelas%c demand, lower total revenue Excise taxes Inelas%c demand, more total revenue Decriminaliza%on of illegal drugs Inelas%c demand, more total revenue LO3 6-19

20 Price Elasticity of Supply Measures sellers responsiveness to price changes Elas%c supply, producers are responsive to price changes Inelas%c supply, producers are not as responsive to price changes LO4 6-20

21 Price Elasticity of Supply Formula for price elas%city of supply E s = percentage change in quan%ty supplied of Product X percentage change in price of product X LO4 6-21

22 Price Elasticity of Supply E s > 1 supply is elas%c E s = 1 supply is unit elas%c E s < 1 supply is inelas%c Addi%onally, E s = 0 supply is perfectly inelas%c LO4 6-22

23 Price Elasticity of Supply Time is primary determinant of elas%city of supply Time periods considered Immediate market period Short run Long run LO4 6-23

24 E s : The Immediate Market Period Perfectly inelas%c supply P S m P m P 0 Q 0 D 1 D 2 Q LO4 6-24

25 The Short Run Short run supply is more elas%c than in the immediate market period P S s P s P 0 LO4 Q 0 Q s D 1 D 2 Q 6-25

26 The Long Run Long run supply is even more elas%c than in the short run P S L P l P 0 LO4 Q 0 Q l D 1 D 2 Q 6-26

27 Applications of Elasticity of Supply An%ques Inelas%c supply Reproduc%ons More elas%c supply Vola%le gold prices Inelas%c supply LO4 6-27

28 Cross Elasticity of Demand Formula for cross elas%city of demand E x,y = percentage change in quan%ty demanded of product X percentage change in price of product Y LO5 6-28

29 Cross Elasticity of Demand Measures responsiveness of purchases of one good to change in the price of another good Subs%tute goods if elas%city is posi%ve Complement goods if elas%city is nega%ve Independent goods if elas%city is 0 LO5 6-29

30 Cross Elasticity of Demand Applica%ons of cross elas%city of demand Should a company change a price? Should the government allow a merger? LO5 6-30

31 Income Elasticity of Demand Formula for income elas%city of demand E i = percentage change in quan%ty demanded percentage change in income LO5 6-31

32 Income Elasticity of Demand Measures responsiveness of buyers to changes in their income Normal goods if elas%city is posi%ve Inferior goods if elas%city is nega%ve LO5 6-32

33 Income Elasticity Insights High income elas%ci%es Most affected by a recession Low or nega%ve income elas%city Not affected that much by a recession LO5 6-33

34 Cross and Income Elasticities Cross and Income Elas%ci%es of Demand Value of Coefficient Descrip%on Type of Good(s) Cross elas%city: Posi%ve (E wz > 0) Quan%ty demanded of W changes in same direc%on as change in price of Z Subs%tutes Nega%ve (E xy < 0) Income elas%city: Posi%ve (E i >0) Nega%ve (E i <0) Quan%ty demanded of X changes in opposite direc%on from change in price of Y Quan%ty demanded of the product changes in same direc%on as change in income Quan%ty demanded of the product changes in opposite direc%on from change in income Complements Normal or superior Inferior LO5 6-34

35 Elasticity and Pricing Power Charge different prices to different buyers based on price elas%ci%es Business air travelers Children discounts College tui%on 6-35