1490 words - 6 pages

Chapter 7: Elasticity

1

What you will learn in this chapter

1. Define and measure elasticity of demand and elasticity of supply. 2. Determine the relationship between demand elasticity and total revenue. 3. Understand the factors that determine elasticity of demand and elasticity of supply.

Punchline

â¢ Imagine that some event drives up the price of gasoline (think about two examples) â¢ How would consumers respond to the higher price? â¢ By how much would consumption of gasoline fall?

Answer to the gasoline question

â¢ Many studies have examined consumersâ response to gasoline prices. â¢ Consumption responds more in the long run than it does in the short run. â¢ A 10% ...view middle of the document...

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:

ï 5% 10% ï½ ï0.5

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).

Example 2

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

90 ï 100 % change in quantity demanded ï½ Ã100 ï½ ï10.5% 100 ï« 90 2

20 ï 10 % change in price ï½ Ã100 ï½ 66.6% 10 ï« 20 2

ï 10.5% Priceelasticityof demandï½ ï½ ï0.15 66.6%

Your turn

If the price of a sushi roll drops from $8 to $4 and sales rise from 20 to 40 units, what is the (absolute value) of the price elasticity of demand?

a) 0.5 b) 0.66 c) 1 d) 2

To Next Active Learning

Elastic or Inelastic?

If the price elasticity of demand is equal to 0, demand is perfectly inelastic If the price elasticity of demand is between 1 and infinity, demand is elastic

0

1

If the price elasticity of demand is between 0 and 1, demand is inelastic If the price elasticity of demand is equal to 1, demand is unit-elastic

Infinity

If the price elasticity of demand is equal to infinity, demand is perfectly elastic

Estimating Elasticities

Economists (and many others) are interested in price elasticity of demand. Estimating elasticity is crucial to understanding and predicting market outcomes.

Total Revenue by Area

Price of An espresso

$0.90

Total revenue = price Ã quantity = $990

D

0

1,100

Quantity of espressos (per day)

Elasticity and total revenue

â¢ As we move along the demand curve, price and quantity are pulling against each other with respect to their impact on total revenue.

â¢ The price effect is the impact of a change in price on total revenue. â¢ The quantity effect is the impact of a change in quantity on total revenue.

Effect of a Price Increase on Total Revenue

Price of An espresso Price effect of price increase: higher price for each unit sold. Quantity effect of price increase: fewer units sold.

$1.10 C 0.90

B

A

D

0

900

1,100

Quantity of espressos (per day)

Elasticity and total revenue

â¢ Total revenue will increase following an increase in either the price or the quantity demanded. â¢ Total revenue will decrease following a decrease in either the price or the quantity demanded.

â¢ The final impact on total revenue depends on the whether the demand is inelastic or elastic.

Your turn

Price

$60 $40

Quantity

6 12

If price falls from $60 to $40, total revenue changes by _______, so demand is _______. a) $240; inelastic b) $480; elastic

c) $360; inelastic

d) $120; elastic

Your turn

The elasticity of demand for eggs has been estimated to be 0.1. If egg producers raise their prices by 10 percent, what will happen to their total revenue? a) It will increase. b) It will decrease. c) It wonât change.

Your turn

If a fashionable...

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