Microeconomics Chapter 6: Elasticity (PDF)

microeconomics McConnell Brue Flynn Chapter 6 Elasticity © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. ...

microeconomics McConnell Brue Flynn Chapter 6 Elasticity © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Demand The Total-Revenue Test Determinants of Price Elasticity of Demand Price Elasticity of Supply Cross Elasticity and Income Elasticity of Demand 6-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Demand Measures buyers’ responsiveness to price changes. Elastic demand: Sensitive to price changes. Large change in quantity demanded. Inelastic demand: Insensitive to price changes. LO6.1 Small change in quantity demanded. 6-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity Coefficient Percentage change in quantity demanded of product X Ed = Percentage change in price of product X LO6.1 6-4 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Midpoint Formula Use the midpoint formula. Ensures consistent results. Change in quantity Change in price Ed = ÷ Sum of quantities/2 Sum of prices/2 LO6.1 6-5 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Demand Formula Use percentages: Unit free measure Compare elasticities across products Eliminate the minus sign: Easier to compare elasticities LO6.1 6-6 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Interpretation of Elasticity of Demand Ed > 1 demand is elastic. Ed < 1 demand is inelastic. Ed = 1 demand is unit elastic. Extreme cases: Ed = 0 demand is perfectly inelastic. Ed = ∞ demand is perfectly elastic. LO6.1 6-7 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Extreme Cases: Perfectly Inelastic Demand P D1 Perfectly inelastic demand (Ed = 0) Q 0 Perfectly inelastic demand LO6.1 6-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Extreme Cases: Perfectly Elastic Demand P D2 Perfectly elastic demand (Ed = ∞) Q 0 Perfectly elastic demand LO6.1 6-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Total Revenue Test Overview Total Revenue = Price × Quantity Total Revenue Test Elastic demand: P and TR move in opposite directions. Inelastic demand: P and TR move in the same direction. Unit elastic demand: TR does not change when P changes. LO6.2 6-10 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Total Revenue Test with Elastic Demand Lower price and elastic demand. Blue gain exceeds yellow loss. P $3 a 2 b 1 D1 Q 0 10 20 30 40 Elastic LO6.2 6-11 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Total Revenue Test with Inelastic Demand Lower price and inelastic demand. Yellow loss exceeds blue gain. P c $4 3 2 1 d D2 Q 0 10 20 LO6.2 Inelastic 6-12 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Total Revenue Test with Unit-Elastic Demand Lower price and unit-elastic demand. Blue gain equals yellow loss. P e $3 2 f 1 D3 Q 0 10 20 30 Unit-elastic LO6.2 6-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Total Revenue Test Example Elastic $20 $8 Ed > 1 a 18 7 (Thousands of dollars) b Unit-elastic 16 6 Ed = 1 14 Total revenue c 5 Price 12 d Inelastic 4 10 e Ed < 1 3 8 f 6 2 g 4 1 h D 2 TR 0 1 2 3 4 5 6 7 8 0 1 2 3 4 5 6 7 8 9 Quantity demanded (thousands) Quantity demanded (thousands) LO6.2 (a) Demand curve (b) Total-revenue curve 6-14 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Demand: A Summary Impact on Total Revenue of a: Absolute Value of Elasticity Coefficient Demand Is: Description Price Increase Price Decrease Greater than 1 Elastic or relatively Quantity demanded Total revenue Total revenue (Ed > 1) elastic changes by a larger decreases increases percentage than does price Equal to 1 Unit- or unitary elastic Quantity demanded Total revenue is Total revenue (Ed = 1) changes by the same unchanged is unchanged percentage as does price Less than 1 Inelastic or relatively Quantity demanded Total revenue Total revenue (Ed < 1) inelastic changes by a smaller increases decreases percentage than does price LO6.2 6-15 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Substitutability and Proportion of Income Substitutability: More substitutes, demand is more elastic. Proportion of income: Higher proportion of income, demand is more elastic. LO6.3 6-16 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Luxury and Time Luxuries versus necessities: Luxury goods, demand is more elastic. Time: More time available, demand is more elastic. LO6.3 6-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Selected Price Elasticities of Demand Coefficient of Price Coefficient of Price Product or Service Elasticity of Demand (Ed) Product or Service Elasticity of Demand (Ed) Newspapers.10 Milk.63 Electricity (household).13 Household appliances.63 Bread.15 Liquor.70 Major League Baseball tickets.23 Movies.87 Cigarettes.25 Beer.90 Telephone service.26 Shoes.91 Sugar.30 Motor vehicles 1.14 Medical care.31 Beef 1.27 Eggs.32 China, glassware, tableware 1.54 Legal services.37 Residential land 1.60 Automobile repair.40 Restaurant meals 2.27 Clothing.49 Lamb and mutton 2.65 Gasoline.58 Fresh peas 2.83 LO6.3 6-18 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Applications of Price Elasticity of Demand Large crop yields: Inelastic demand, lower total revenue Excise taxes: Inelastic demand, more total revenue Decriminalization of illegal drugs: Inelastic demand, more total revenue LO6.3 6-19 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Supply Overview Measures sellers’ responsiveness to price changes. Elastic supply, producers are responsive to price changes. Inelastic supply, producers are not as responsive to price changes. LO6.4 6-20 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Supply Formula Percentage change in quantity supplied of product X Es = Percentage change in price of product X LO6.4 6-21 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Supply Es > 1 supply is elastic. Es = 1 supply is unit elastic. Es < 1 supply is inelastic. Additionally, Es = 0 supply is perfectly inelastic. LO6.4 6-22 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Price Elasticity of Supply and Time Time is primary determinant of elasticity of supply. Time periods considered: Immediate market period Short run Long run LO6.4 6-23 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Immediate Market Period Perfectly inelastic supply P Sm Pm Po D2 D1 Q 0 Qo (a) Immediate market period 6-24 ©LO6.4 McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Short Run Short-run supply is more elastic than in the immediate market period. P Ss Ps Po D2 D1 Q 0 Qo Qs (b) LO6.4 6-25 Short run © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Long Run Long-run supply is even more elastic than in the short P run. SL PI Po D2 D1 Q 0 Qo Ql (c) LO6.4 Long run 6-26 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Applications of Elasticity of Supply Antiques: Inelastic supply Reproductions: More elastic supply Volatile gold prices: Inelastic supply LO6.4 6-27 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Formula for Cross Elasticity of Demand percentage change in quantity demanded of product X Exy = percentage change in price of product Y LO6.5 6-28 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Cross Elasticity of Demand Measures responsiveness of purchases of one good to change in the price of another good. Substitute goods if elasticity is positive. Complementary goods if elasticity is negative. Independent goods if elasticity is zero or near-zero. LO6.5 6-29 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Applications of Cross Elasticity of Demand Should a company change a price? Should the government allow a merger? LO6.5 6-30 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Global Perspective 6.1 LO6.5 6-31 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. Source: Economic Research Service, United States Department of Agriculture  Formula for Income Elasticity of Demand percentage change in quantity demanded Ei = percentage change in income LO6.5 6-32 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Income Elasticity of Demand Measures responsiveness of buyers to changes in their income. Normal goods if elasticity is positive. Inferior goods if elasticity is negative. 6-33 ©LO6.5 McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Income Elasticity Insights High income elasticities: Most affected by a recession. Low or negative income elasticity: Not affected that much by a recession. LO6.5 6-34 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Cross and Income Elasticities Value of Coefficient Description Type of Good(s) Cross elasticity: Quantity demanded of W changes Substitutes Positive (Ewz > 0) in same direction as change in price of Z Negative (Exy < 0) Quantity demanded of X changes in Complements opposite direction from change in price of Y Income elasticity: Quantity demanded of the product Normal or superior Positive (Ei > 0) changes in same direction as change in income Negative (Ei < 0) Quantity demanded of the product Inferior changes in opposite direction from change in income LO6.5 6-35 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Global Perspective 6.2 LO6.5 6-36 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. Source: U.S. Energy Information Administration  Last Word: Elasticity and Pricing Power: Why Different Consumers Pay Different Prices Charge different prices to different buyers based on price elasticities. Business air travelers. Children discounts. College tuition. LO6.5 6-37 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.