5 Demand Elasticity A high cross elasticity of

Contents ● Elasticity: The Measure of Responsiveness ● Price Elasticity of Demand: Its Effect

Contents (continued) ● The Time Period of the Demand Curve and Economic Decision Making

Elasticity: The Measure of Responsiveness ● Elasticity = measure of the responsiveness of one

5 -1(a) The Hypothetical Demand Curves for Film FIGURE DS Price per Package $20

5 -1(b) The Hypothetical Demand Curves for Film FIGURE Df Price per Package $20

Elasticity: The Measure of Responsiveness ● Elastic demand = price elasticity of demand >

Elasticity: The Measure of Responsiveness ● Equation for Price Elasticity of Demand ♦ %

Elasticity: The Measure of Responsiveness ● Percentages calculated in terms of the averages of

5 -2 a Sensitivity of Slope to Units of Measurement Price per Pizza FIGURE

5 -2 b Sensitivity of Slope to Units of Measurement Price per Pizza FIGURE

Price Elasticity of Demand the Shapes of Demand Curves ● The Relationship between Elasticity

5 -1 Estimates of Price Elasticities TABLE Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

5 -3 Demand Curves with Different Elasticities FIGURE $0. 75 D 0 90 Quantity

5 -3(d) Unit Elastic Demand Curve FIGURE Unitelastic demand curve Price D $30 20

Price Elasticity of Demand ● price revenues if the demand curve is elastic ●

FIGURE Curve 5 -4 An Elastic Demand $6 Price 5 D R S W

What Determines Demand Elasticity? ● Nature of the good ● Availability of close substitutes

Elasticity as a General Concept ● Elasticity can be used to measure the responsiveness

Elasticity as a General Concept ● Cross Elasticity of Demand ♦ Cross elasticity of

Changes in Demand: Movements Along vs Shifts ● price movement along the demand curve

Changes in Demand: Movements Along vs Shifts ● Demand Shifters ♦ Consumer incomes rise

5 -5 Shifts in a Demand FIGURE Curve D 1 D 0 R S

The Demand Curve and Economic Decision Making ● The demand curve shows the quantity

Expected Demand at Various Six-Month Prices Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Real-World Application: Polaroid versus Kodak ● In 1989, Polaroid vs Kodak—copyright infringement ● Key

Real-World Application: Polaroid versus Kodak ● Cross elasticity of demand ♦ After 1980, decline

Real-World Application: Polaroid versus Kodak ● Third issue: How much could Polaroid’s total revenue

Appendix: How Can We Find a Legitimate Demand Curve from the Statistics?

Finding a Legitimate Demand Curve ● In the real world we usually only observe

Finding a Legitimate Demand Curve ● Prices and quantities observed at different times in

5 -2 Historical Data on Price and Quantity TABLE Copyright© 2003 South-Western/Thomson Learning. All

Finding a Legitimate Demand Curve ● Simply connecting the points may not give a

5 -6 Plot of Historical Data on Price and Quantity FIGURE $8. 20 Average

5 -7 Plot of Historical Data and True Demand Curves FIGURE $8. 20 T

5 -3 Annual Rainfall in St. Louis, 1993 -2001 TABLE Copyright© 2003 South-Western/Thomson Learning.

5 -8 Legitimate Demand Curve Est. from Statistical Data FIGURE S 00 D Price

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5 Demand Elasticity A high cross elasticity of demand [between two goods indicates that they] compete in the same market. [This can prevent a supplier of one of the products] from possessing monopoly power over price. U. S. SUPREME COURT, DUPONT CELLOPHANE DECISION, 1956

Contents ● Elasticity: The Measure of Responsiveness ● Price Elasticity of Demand: Its Effect on Total Revenue and Total Expenditure ● What Determines Demand Elasticity? ● Elasticity as a General Concept ● Changes in Demand: Movements Along the Demand Curve vs Shifts in the Demand Curve Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Contents (continued) ● The Time Period of the Demand Curve and Economic Decision Making ● Real-World Application: Polaroid versus Kodak ● Appendix: How to Find a Legitimate Demand Curve from the Statistics Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Elasticity: The Measure of Responsiveness ● Elasticity = measure of the responsiveness of one variable to changes in another variable % quantity ● Price elasticity of demand = % price Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Elasticity: The Measure of Responsiveness ● Elastic demand = price elasticity of demand > 1 ● Inelastic demand = price elasticity of demand < 1 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Elasticity: The Measure of Responsiveness ● Equation for Price Elasticity of Demand ♦ % Quantity % Price ♦ [(Q 1 - Q 0) / (average of Q 1 and Q 0)] [(P 1 - P 0) / (average of P 1 and P 0)] Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Elasticity: The Measure of Responsiveness ● Percentages calculated in terms of the averages of the prices and quantities ● Minus sign dropped Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

5 -2 a Sensitivity of Slope to Units of Measurement Price per Pizza FIGURE $18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 D A B D 280 500 360 1, 000 1, 500 2, 000 2, 500 3, 000 Pizzas per Week (a) Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

5 -2 b Sensitivity of Slope to Units of Measurement Price per Pizza FIGURE $18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 D A B D 500 1, 000 1, 500 2, 000 2, 500 3, 000 2, 240 2, 880 Slices of Pizza per Week (b) Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Price Elasticity of Demand the Shapes of Demand Curves ● The Relationship between Elasticity and Slope ♦ Slope depends upon specific units while elasticity does not. ♦ If a demand curve has a constant slope (straight -line), the elasticity is not constant. ♦ If a demand curve has a constant elasticity (unit elastic), the slope is not constant. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

5 -3 Demand Curves with Different Elasticities FIGURE $0. 75 D 0 90 Quantity Demanded (a) D “Perfectly elastic” demand curve Straightline demand A curve D D Price “Perfectly inelastic” demand curve Price D $6 4 3 C 1 0 0 Quantity Demanded (b) 2 B C' 4 5 A' B' D 7 Quantity Demanded (c) Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Price Elasticity of Demand ● price revenues if the demand curve is elastic ● price revenues if the demand curve is inelastic ● price 0 revenues if the demand curve is unit elastic Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

What Determines Demand Elasticity? ● Nature of the good ● Availability of close substitutes ● Fraction of income absorbed ● Passage of time Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Elasticity as a General Concept ● Elasticity can be used to measure the responsiveness of anything to anything else. ● Income Elasticity ♦ Income elasticity of demand = % quantity demanded % income ● Price Elasticity of Supply ♦ Price elasticity of supply = % quantity of supply % price Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Elasticity as a General Concept ● Cross Elasticity of Demand ♦ Cross elasticity of demand (for product X to a change in the price of product Y) = % quantity demanded of X % price of Y ♦ If two goods are substitutes (complements), their cross elasticity of demand is positive (negative). Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Changes in Demand: Movements Along vs Shifts ● price movement along the demand curve ● any other factor that affects spending decisions shift between demand curves Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Changes in Demand: Movements Along vs Shifts ● Demand Shifters ♦ Consumer incomes rise ♦ Tastes change in favor of the good ♦ The price of substitute goods ♦ The price of complementary goods Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

5 -5 Shifts in a Demand FIGURE Curve D 1 D 0 R S T 28 D 0 Price $35 D 2 U D 1 D 0 40 D 2 D 0 60 Quantity of Sweaters in Thousands (a) Quantity of Sweaters (b) Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

The Demand Curve and Economic Decision Making ● The demand curve shows the quantity of demand buyers would hypothetically purchase at different prices during the same time period. ● It does not show the quantity actually bought at different prices at different times. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Real-World Application: Polaroid versus Kodak ● In 1989, Polaroid vs Kodak—copyright infringement ● Key issue: how much profit Polaroid lost? ● Price elasticity of demand ♦ growth in instant camera sales due to ■Kodak competition (lower price) OR ■Kodak’s reputation (Polaroid might have benefited from Kodak increasing potential number of customers) Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Real-World Application: Polaroid versus Kodak ● Cross elasticity of demand ♦ After 1980, decline in sales due to ■decreasing cost of 35 -mm photography ● then Kodak not to blame ■Kodak’s infringement ● Kodak damages due increase Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Real-World Application: Polaroid versus Kodak ● Third issue: How much could Polaroid’s total revenue increased if Kodak not infringe? ♦ Polaroid claimed lots! $9 billion or more ♦ Kodak claimed neighborhood of $450 million (very close to judge’s verdict) Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Appendix: How Can We Find a Legitimate Demand Curve from the Statistics?

Finding a Legitimate Demand Curve ● In the real world we usually only observe historical price-quantity combinations, so it is often difficult to distinguish between movement along a demand curve and shifts between demand curves. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Finding a Legitimate Demand Curve ● Prices and quantities observed at different times in the real world may result from shifting demand curves and not movement along a demand curve. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

5 -6 Plot of Historical Data on Price and Quantity FIGURE $8. 20 Average Price 8. 00 T April May R 7. 80 Feb. S March 7. 60 7. 40 Jan. 7. 20 7. 00 0 T 90 91 92 93 94 95 96 97 98 Quantity Demanded in Thousands Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

5 -7 Plot of Historical Data and True Demand Curves FIGURE $8. 20 T F Feb. Average Price 8. 00 R W S 7. 80 March M 7. 60 M F 7. 40 J 7. 20 Jan. J 7. 00 T 0 90 91 92 93 94 95 96 97 98 Quantity Demanded in Thousands Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

5 -8 Legitimate Demand Curve Est. from Statistical Data FIGURE S 00 D Price 2000 S 93 S 1994 S 96 1999 2001 1998 S 1993 1996 1997 S 95 1995 S S D Quantity of Umbrellas Sold Copyright© 2003 South-Western/Thomson Learning. All rights reserved.