EQ: How Do I Calculate Elasticity?

Transcription

1 EQ: What is Elasticity? In economics, we are not merely concerned with which variables affect what other variables (like whether price changes affect quantity demanded by buyers). We are also concerned with the degree to which one variable is affected by another variable: That is, does a large/small change in one variable cause a large/small change in the other This is called the Elasticity of a variable EQ: What is Elasticity? Elasticity in economics is always concerned with percentage of change in one variable due to a percentage of change in another variable. % change in X That is: also written: % change in Y Note 2 things from this: % X % Y You will be doing a bit of math in this chapter Since you are dividing one percentage by another percentage, the % signs cancel each other out EQ: What are the Different Types of Elasticity? We will examine 4 types of elasticity: Price Elasticity of Demand ( % Q D/ % P ) Income Elasticity of Demand ( % Q D/ % Y ) Cross Elasticity of Demand ( % Q D/ % P Y) Price Elasticity of Supply ( % Q S/ % P ) Elasticity of Demand/Supply The first part of the equation shown on the previous slide is always either: % change in Quantity Demanded, or % change in Quantity Supplied EQ: How Do I Calculate Elasticity? All 4 types of elasticity have a similar formula for calculating elasticity: E = Change in Quantity Demanded/Supplied Average Quantity Demanded/Supplied Change in Price/Income Average Price/Income *Demanded/Supplied = either Quantity Demanded or Quantity Supplied **Price/Income = either Change in Price or Change in Income

2 EQ: What is Price Price Elasticity of Demand (ED) is a measure of the relative change in quantity demanded in response to a change in price. Formula: Change in Quantity Demanded Average Quantity Demanded EQ: What is Price Perfectly Inelastic Demand With perfectly inelastic demand, the demand curve is vertical. The quantity demanded is unchanged by a change in price. Change in Price Average Price *See the textbook, chapter 17, for examples on how to calculate Price Elasticity of Demand. EQ: What is Price EQ: What is Price Perfectly Elastic Demand With perfectly elastic demand the demand curve is horizontal. A seller has no ability to change the selling price. Perfectly Inelastic Demand

3 EQ: What is Price Perfectly Elastic Demand Price Quantity Demanded $ What is ED if price changes from $7 to $6? What is ED if price changes from $6 to $5? Q2 Q (Q2 + Q1)/2 ( )/ ED = = 2.60 P2 P (P2 + P1)/2 (6 + 7)/2 6.5 Q2 Q (Q2 + Q1)/2 ( )/ ED = = 1.57 P2 P (P2 + P1)/2 (5 + 6)/2 5.5

4 What is ED if price changes from $5 to $4? What is ED if price changes from $4 to $3? Q2 Q (Q2 + Q1)/2 ( )/ ED = = 1.00 P2 P (P2 + P1)/2 (4 + 5)/2 4.5 Q2 Q (Q2 + Q1)/2 ( )/ ED = =.64 P2 P (P2 + P1)/2 (3 + 4)/2 3.5 What is ED if price changes from $3 to $2? What is ED if price changes from $2 to $1? Q2 Q (Q2 + Q1)/2 ( )/ ED = =.38 P2 P (P2 + P1)/2 (2 + 3)/2 2.5 Q2 Q (Q2 + Q1)/2 ( )/ ED = =.20 P2 P (P2 + P1)/2 (1 + 2)/2 1.5

5 EQ: What Does the PED Number Mean? EQ: What Does the PED Number Mean? Price Elasticity of Demand (ED) is always a positive number (except when it is 0). When making the calculations, use absolute values (change negative signs to positive) The result is a number that is: Greater than 1 (ED > 1) Elastic Perfectly Elastic Elastic Unitary Elastic Inelastic Perfectly Inelastic Equal to 1 (ED = 1) Unitary Elasticity Less than 1 (ED < 1) Inelastic ED = 0 Perfectly Inelastic 10-2 (22 ED = { } ( undefined ) Perfectly Elastic What Factors Affect what PED will be for a Product? Necessity vs. Luxury % of Budget Spent on Product Number of Substitutes Response Time for Price Change Price Elasticity of Demand How Does the PED of a Product Affect Total Revenue for the Seller? Total Revenues 10-3 (4) EQ: What Factors Affect what PED will be for a Product? Determinants of ED: Substitutes More substitutes = More elastic Fewer substitutes = Less elastic % of Buyers Budgets Spent on the Good Higher % of buyers budgets = More elastic Lower % of buyers budgets = Less elastic Luxury vs. Necessity Luxury = More elastic Necessity = Less elastic Response Time for Consumers More time to respond to price changes = More elastic Less time to respond to price changes = Less elastic

6 EQ: How Does the PED of a Product If demand is elastic (ED > 1), then: Price increase will result in a decrease in TR Price decrease will result in an increase in TR If demand is inelastic (ED < 1), then: Price increase will result in an increase in TR Price decrease will result in a decrease in TR If demand is unitary elastic (ED = 1), then: Price increase or decrease will not change TR EQ: How Does the PED of a Product If demand is elastic (ED > 1): When price changes from $7 to $6, demand increases from 20 to 30. Price Elasticity of Demand = 2.60, which is elastic. Before the price change, TR = $7 x 20 = $140 After the price change, TR = $6 x 30 = $180 So, when PED is elastic: A price increase will decrease TR. A price decrease will increase TR. EQ: How Does the PED of a Product If demand is inelastic (ED < 1): When price changes from $3 to $2, demand increases from 60 to 70. Price Elasticity of Demand = 0.38, which is inelastic. Before the price change, TR = $3 x 60 = $180 After the price change, TR = $2 x 70 = $140 So, when PED is inelastic: A price increase will increase TR. A price decrease will decrease TR. EQ: How Does the PED of a Product If demand is unitary elastic (ED = 1): When price changes from $5 to $4, demand increases from 40 to 50. Price Elasticity of Demand = 1, which is unitary elastic. Before the price change, TR = $5 x 40 = $200 After the price change, TR = $4 x 50 = $200 So, when PED is unitary, a change in price will have no effect on Total Revenues.