Principles of Economics 2 nd edition by Fred

Principles of Economics 2 nd edition by Fred M Gottheil Power. Point Slides prepared by Ken Long © 1999 South-Western College Publishing 1

Chapter 4 Elasticity © 1999 South-Western College Publishing 9/11/20 21 2

This chapter discusses principles associated with Determinants of Normal & Inferior Price Substitute Elasticity and of Cross Supply. Elasticity and Taxesto Demand Sensitivity Complementary Demand Goods Price Changes © 1999 South-Western College Publishing 3

How would you respond to a cut in the price of a Coke? That all depends on the price sensitivity of demand for Coke © 1999 South-Western College Publishing 4

A D B D Which demand curve is for spark plugs and which for Coca-Cola? © 1999 South-Western College Publishing 5

When consumers are very sensitive to a price change what does the demand curve look like? Relatively flat © 1999 South-Western College Publishing 6

When consumers are less sensitive to a price change what does the demand curve look like? Relatively steep © 1999 South-Western College Publishing 7

What factors influence Demand Sensitivity? • Low price goods • Income levels • Substitute goods • Basic goods • Linked goods • Time to adjust © 1999 South-Western College Publishing 8

What do low priced goods have to do with sensitivity? The lower the price of a good the less sensitive consumers are to a price change © 1999 South-Western College Publishing 9

How do income levels effect demand? Poor people are more sensitive to price changes than rich people © 1999 South-Western College Publishing 10

What do substitutes have to do with sensitivity? The more substitutes a good has, the more sensitive consumers are to a price change © 1999 South-Western College Publishing 11

What do basic goods have to do with sensitivity? The greater the need of a good to the consumer, the less sensitive the consumer is to a price change © 1999 South-Western College Publishing 12

What do linked goods have to do with sensitivity? When two goods have a complementary relationship, demand sensitivities are linked to one another © 1999 South-Western College Publishing 13

What are some examples of Complementary Goods? • computers and software • cars and gasoline • tapes and tape players © 1999 South-Western College Publishing 14

What does time have to do with sensitivity? The more time to adjust, the more sensitive consumers are to a price change © 1999 South-Western College Publishing 15

What is Elasticity? A term economists use to measure sensitivity © 1999 South-Western College Publishing 16

How do we measure the Price Elasticity of Demand? The percentage change in quantity demanded divided by the percentage change in price © 1999 South-Western College Publishing 17

If there is an increase from 3 units to 5, what is the percentage increase? 2/3 = 66% © 1999 South-Western College Publishing 18

If there is a decrease from 5 units to 3, what is the percentage decrease? 2/5 = 40% © 1999 South-Western College Publishing 19

P A 2 B 3 D Q © 1999 South-Western College Publishing 20 2

Problem - When we move along a demand curve between two points, we get different answers to elasticity depending if we are moving up or down the demand curve © 1999 South-Western College Publishing 21

If we go from 3 to 5, the percentage change is 2/3 , but if we go from 5 to 3, the percentage change is 2/5 , so the elasticities are different © 1999 South-Western College Publishing 22

The answer to this problem is to work with averages. . . © 1999 South-Western College Publishing 23

Price elasticity equals the change in quantity demanded sum of quantities/2 divided by change in price sum of prices/2 © 1999 South-Western College Publishing 24 24

Quantity Bananas 200 Oranges 240 400 280 Price $20 $18 $40 $70 © 1999 South-Western College Publishing 25 2 5

What is the Price Elasticity of Demand for bananas? 2 40 = 220 19 40 X 19 760 = 2 220 440 © 1999 South-Western College Publishing 26

What is the Price Elasticity of Demand for oranges? 120 30 = 340 55 120 X 55 6, 600 = 30 340 10, 200 © 1999 South-Western College Publishing 27

If a college raises tuition, what happens to revenue? If demand is elastic revenue goes down If demand is inelastic revenue goes up © 1999 South-Western College Publishing 28

If price increases and the revenue increases, the demand curve within the price range is price inelastic, < 1 © 1999 South-Western College Publishing 29

If price increases and the revenue decreases, the demand curve within the price range is price elastic, > 1 © 1999 South-Western College Publishing 30

If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1 © 1999 South-Western College Publishing 31

What strategies do Coca. Cola and Pepsi use to make the demand for their products less elastic? http: //www. cocacola. com http: //www. pepsi. com © 1999 South-Western College Publishing 32

What is Cross Elasticity of Demand? The percentage change in the quantity demanded of one commodity resulting from a 1 percent change in price of another commodity © 1999 South-Western College Publishing 33

If negative - complements (steak & steak sauce) If positive - substitutes (butter & margarine) © 1999 South-Western College Publishing 34

What is Income Elasticity of Demand? The ratio of the percentage change in quantity demanded to the percentage change in income © 1999 South-Western College Publishing 35

When is a demand curve income elastic? When a 1% change in income generates a greater than 1% change quantity demanded © 1999 South-Western College Publishing 36

When ia demand curve income inelastic? When a 1% change in income generates a less than 1% change quantity demanded © 1999 South-Western College Publishing 37

What is an Inferior Good? A good that people buy less of as their incomes increase © 1999 South-Western College Publishing 38

What is a Normal Good? A good that people buy more of as their incomes increase © 1999 South-Western College Publishing 39

What is Price Elasticity of Supply? The ratio of the percentage change in quantity supplied to the percentage change in price © 1999 South-Western College Publishing 40

Does time effect Supply Elasticities? Yes! The more time, the more elastic the supply curve © 1999 South-Western College Publishing 41

Which type of good would be best to tax to raise the most revenue? Goods with inelastic demand curves © 1999 South-Western College Publishing 42

What does the Tobacco Resource Center do to increase the elasticity of demand for cigarettes? http: //www. tobacco. neu. edu/ © 1999 South-Western College Publishing 43

• What factors influence Demand Sensitivity? • What is Elasticity? • How do we measure the Price Elasticity of Demand? • What is Cross Elasticity of Demand? • What is Income Elasticity of Demand? 44

END © 1999 South-Western College Publishing 45