Chapter 6 Elasticity, Study Guides, Projects, Research of Business Economics

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Elasticity

Revised by Solina Lindahl

WHAT YOU WILL LEARN IN THIS CHAPTER

• Why is elasticity used to measure the response to changes in prices or income?
• What are the different elasticity measures and what do they mean?
• What factors influence the size of these various elasticities?
• Why is it vitally important to determine the size of the relevant elasticity before setting prices or government fees?

PRICE ELASTICITY OF DEMAND PART 2

• A demand curve is elastic when an increase in price reduces the quantity demanded a lot (and vice versa).
• When the same increase in price reduces quantity demanded just a little, then the demand curve is inelastic.

PRICE ELASTICITY OF DEMAND

• The more responsive quantity demanded (QD) is to a change in price, the more elastic is the demand curve.

DEFINING AND MEASURING ELASTICITY

PART 1

• Price elasticity of demand = the percentage change in quantity demanded divided by the percentage change in price. %changeinprice %change inquanity demand Price elasticity of demand 

DEFINING AND MEASURING ELASTICITY

PART 2

• Example:
  • If the price of oil increases by 10% and the quantity demanded falls by 5%, then the price elasticity of demand for oil is: 0. 10% 5%   
• Note: since we know that price and quantity demanded will always move in opposite directions (law of demand) we usually drop the minus sign (for price elasticity of demand ONLY).

THE MIDPOINT METHOD

• Instead of dividing by the initial quantity or price, we’ll use the average quantity or price. 2 100 StartingValueof X FinalValueof X Averagevalueof X AverageValueof X Changein X %changeinX    

MATHEMATICS OF DEMAND ELASTICITY

• Example: At the initial price of $10, the quantity demanded is 100. When the price rises to $20, the quantity demanded is 90.

66.6% 66.6% 10.5% 100 10.5% 2 100 90 90 100 100 66.6% (10 20) 2 20 10               priceelasticityof demanded %changeinquantity demanded %changeinprice

ESTIMATING ELASTICITIES

• Economists (and many others) are interested in price elasticity of demand.
• Estimating elasticity is crucial to understanding and predicting market outcomes. TABLE 6 - 1 Some Estimated Price Elasticities of Demand Good Price elasticity of demand Inelastic demand Gasoline (short-run) 0. Gasoline (long-run) 0. College (in-state tuition) 0.60–0. Airline travel (business) 0. Soda 0. Elastic demand Housing 1. College (out-of-state tuition) 1. Airline travel (leisure) 1. Coke/Pepsi 3.

INTERPRETING THE PRICE ELASTICITY OF

DEMAND

• Classification of price elasticity of demand:
• A good can have a price elasticity as low as zero or as high as infinity.
• If the |Ed| < 1 , the demand curve is inelastic.
• If the |Ed| > 1 , the demand curve is elastic.
• If the |Ed| = 1 , the demand curve is unit elastic.

UNIT-ELASTIC DEMAND

INELASTIC DEMAND

ELASTICITY AND TOTAL REVENUE

• Total revenue: price times quantity demanded (sold). TR = P × Q
• Sellers need to know how elastic their good is so they can plan.

TOTAL REVENUE BY AREA