prepared by: jamal husein c h a p t e r 3 © 2005 prentice hall business publishingsurvey of...
TRANSCRIPT
© 2005 Prentice Hall Business Publishing© 2005 Prentice Hall Business Publishing Survey of Economics, 2/eSurvey of Economics, 2/e O’Sullivan & SheffrinO’Sullivan & Sheffrin
Prepared by: Jamal Husein
C H A P T E R
33
Elasticity: A Measure of Responsiveness
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 2
The Concept of ElasticityThe Concept of ElasticityThe Concept of ElasticityThe Concept of Elasticity
How large is the response of producers and consumers to changes in price?changes in price? Before business firms and the government decide to change prices and taxes, they must anticipate the magnitude of response by those affected.
ElasticityElasticity is a measure of the responsiveness of people to changes in economic variables.
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 3
Popular Elasticity MeasuresPopular Elasticity MeasuresPopular Elasticity MeasuresPopular Elasticity Measures
Price elasticity of demand ( Ed )Price elasticity of demand ( Ed ) Price elasticity of supply ( Es )Price elasticity of supply ( Es ) Income elasticity of demand Cross elasticity of demand for
related goods
Popular measures of elasticity include:
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 4
Price Elasticity of DemandPrice Elasticity of DemandPrice Elasticity of DemandPrice Elasticity of Demand
Price elasticity of demandPrice elasticity of demand( Ed )( Ed ) measures the response of consumers to changes in price.
Elasticity of Demand
% Change in quantity demanded
% Change in Price== Ed
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 5
Computing Price Elasticity of DemandComputing Price Elasticity of DemandComputing Price Elasticity of DemandComputing Price Elasticity of Demand
% .Q
8 5 1 0 0
1 0 0
1 5
1 0 00 1 5 o r 1 5 %
%$ 2. $ 2 .
$ 2 .
$ 0.
$ 2 .P
2 0 0 0
0 0
2 0
0 010%
%
%.
Q
P
1 5 %
1 0 %1 5 0
Elasticity of Demand
% Change in quantity demanded
% Change in Price== Ed
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 6
Using the Midpoint Formula to Compute Using the Midpoint Formula to Compute Price Elasticity (Appendix )Price Elasticity (Appendix )Using the Midpoint Formula to Compute Using the Midpoint Formula to Compute Price Elasticity (Appendix )Price Elasticity (Appendix )
The midpoint formula is a more accurate measure of percentage changes.
p ercentage change = ab so lute va lue
average va lue
%( ) / .
Q
8 5 1 0 0
1 0 0 8 5 2
1 5
9 2 516.22%
%$ 2. $ 2 .
($ 2 . $ 2 . ) /
$ 0.
$ 2 .P
2 0 0 0
0 0 2 0 2
2 0
1 09.52%
%
%
.
..
Q
P
1 6 2 2 %
9 5 2 %1 7 0
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 7
Interpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of Elasticity
Response to Price Changes
Responsive
Unresponsive
Proportional
Value of
Elasticity
Ed > 1
Ed < 1
Ed = 1
Demand Elasticity
Elastic
Inelastic
Unitary elastic
Magnitudes of Change
%QD > %P
%QD < %P
%QD = %P
Type of Elasticity
Elastic
Inelastic
Substitutes Available
Many
Few
The main determinant The main determinant of demand elasticity is of demand elasticity is the availability of the availability of substitutes for the substitutes for the good in question.good in question.
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 8
Interpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of Elasticity
The price elasticity for water (0.20) suggests that a 10% increase in the price of water would decrease the quantity demanded by only 2%.
The elasticity for specific brands of coffee (5.6) suggests that a 10% increase in the price of a specific brand would decrease its quantity demanded by 56%.
Estimated price elasticities of demand for selected products
ProductPrice elasticity
of demandSalt 0.1
Water 0.2
Coffee 0.3
Cigarettes 0.3
Shoes and footwear 0.7
Housing 1.0
Automobiles 1.2
Foreign travel 1.8
Restaurant meals 2.3
Air travel 2.4
Motion pictures 3.7
Specific brands of coffee
5.6
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 9
Using the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demand
Applications: College EducationApplications: College Education Suppose a university increases tuition
from $4,000 to $4,400 (a 10% increase in price) and wants to predict how many fewer students will enroll as a result of the high price. The Ed of higher education
is 1.4.
percentage change in quantity demanded = 1.4 × 10% = 14%
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 10
Using the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demand
Predicting Changes in Quantity demandedPredicting Changes in Quantity demanded Suppose you run a campus film series,
and you know that Ed is 2.0. If you decide to increase price by 15%, you can use the following rearranged formula to predict Changes in Quantity demanded
percentage change in quantity demanded = 2 × 15% = 30%
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 11
Using the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demand
Predicting Changes in Quantity demandedPredicting Changes in Quantity demanded How would a tax on beer affect highway
deaths? The Ed for beer among adults is 1.3. If a state imposes a beer tax that increases beer price by 20%, what would happen to the number of highway deaths among young adults?
percentage change in quantity demanded = 1.3 × 20% = 26%
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 12
Elasticity and Total Revenue (TR)Elasticity and Total Revenue (TR)Elasticity and Total Revenue (TR)Elasticity and Total Revenue (TR) Elasticity of demand determines if an
increase in price will cause the firm’s revenue to increase or decrease.
Total Revenue = Price x Quantity sold
Total Revenue = Price x Quantity sold An increase in the price have two opposing effects
The good news about an increase in price is that a higher price will increase the revenue obtained from each unit sold.
The bad news is that at a higher price, fewer units are sold. Elasticity of demand tells us whether Elasticity of demand tells us whether the good news dominates over the bad news.the good news dominates over the bad news.
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 13
Predicting Changes in Total RevenuePredicting Changes in Total RevenuePredicting Changes in Total RevenuePredicting Changes in Total Revenue
Along the elastic range of the demand curve, an increase in price leads to a decrease in total revenue.
This graph shows the relationship between elasticity along a linear demand curve and total revenue. Note the following:
Along the inelastic range, an increase in price leads to an increase in total revenue.
Revenue is maximum when Ed=1.
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 14
Predicting Changes in TRPredicting Changes in TRPredicting Changes in TRPredicting Changes in TR
Elasticity and Total Revenue (TR)
Type of demand Value of Ed
Change in quantity versus change in price
Effect of an increase in price on total revenue
Effect of a decrease in price on total revenue
Elastic Greater than 1.0
Larger percentage change in quantity
Total revenue decreases
Total revenue increases
Inelastic Less than 1.0 Smaller percentage change in quantity
Total revenue increases
Total revenue decreases
Unitary elastic
Equal to 1.0 Same percentage change in quantity and price
Total revenue does not change
Total revenue does not change
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 15
Price Elasticity of SupplyPrice Elasticity of SupplyPrice Elasticity of SupplyPrice Elasticity of Supply
Price elasticity of supplyPrice elasticity of supply is a measure of the responsiveness in quantity supplied to changes in price.
Elasticity of Supply
% Change in quantity supplied% Change in Price
== Es
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 16
Computing Price Elasticity of SupplyComputing Price Elasticity of SupplyComputing Price Elasticity of SupplyComputing Price Elasticity of Supply
% Q s
1 2 0 1 0 0
1 0 0
2 0
1 0 02 0 %
%$ 2. $ 2 .
$ 2 .
$ 0.
$ 2 .P
2 0 0 0
0 0
2 0
0 01 0 %
EQ
Pss
%
%.
2 0 %
1 0 %2 0
Elasticity of Supply
% Change in quantity supplied% Change in Price
== Es
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 17
Supply Elasticity and TimeSupply Elasticity and TimeSupply Elasticity and TimeSupply Elasticity and Time
Supply becomes more elastic over time.
The increase in quantity supplied as a response to an increase in price is greater when supply is more elastic.
Higher market prices give business firms an incentive to expand production and output. As time goes by, the ability of firms to expand productive capacity is greater, and supply becomes more elastic.
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 18
Predicting Price Changes Using Predicting Price Changes Using ElasticitiesElasticitiesPredicting Price Changes Using Predicting Price Changes Using ElasticitiesElasticities The price-change formula can be used to
predict the change in price resulting from a change in demand.
For changes in price resulting from a change in supply:
percentage change in price = percentage change in demand
E Es d
percentage change in price = percentage change in supply
E Es d
© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 19
Predicting Price Changes Using Predicting Price Changes Using Elasticities: an ExampleElasticities: an ExamplePredicting Price Changes Using Predicting Price Changes Using Elasticities: an ExampleElasticities: an Example
Assume that Ed=1.5 and Es=2.0, a rightward shift in demand by 35%, will increase price by the following percentage:
% P = 3 5 %
2 0 1 5
1 0 %. .
% P = % demand
E Es d