Price Elasticity Coefficient Formula

• Ed = % change in quantity demanded of product X

% change in price of product XCalculating % change% Change in quantity = nqd – iqd

initial quantity demanded

Example: % Change in quantity100,000 nqd - 110,000 iqd = - 10,000

-10,000 = .10 or 10%

100,000

1

Price Elasticity Coefficient Formula

• Ed = % change in quantity demanded of product X

% change in price of product X

• Change in price = New Price – Initial Price Initial price

New Price = $4Initial Price = $3

$4 np - $3 ip = $1 = .33 or 33%

$3 ip $3

Price Elasticity Coefficient Formula

• Ed = % change in quantity demanded of product X

% change in price of product X

10% = .30 or 30%33%

Chapter 6: Extensions of Supply,

Demand, and Supply Analysis

Elasticity

• It is all about how things respond to changes in prices– Responsive or not responsive

5

Supply and Demand Review

1. Define the Law of Demand2. Define the Law of Supply3. What is the difference between a change in

demand and a change in quantity demanded?

4. What happens if price is above equilibrium?5. What happens if price is below equilibrium?6. Define Consumer’s and Producer’s Surplus7. Identify the rule for double shifts in S&D 8. Explain the results of an excise tax

HOW MUCH MORE OR LESS?DOES IT MATTER?

THE LAW OF DEMAND SAYS...

Consumers will buy more when prices go down and less when prices go up

7

ElasticityElasticity shows how sensitive quantity is

to a change in price.

Summary of the Chapter

• Paul Salmon Video - Elasticity

9

Goals Of This Chapter

• By the end of this chapter you should be able to do the – Elasticity Slide

10

4 Types of Elasticity

1. Elasticity of Demand2. Elasticity of Supply3. Cross-Price Elasticity (Subs or Comp)4. Income Elasticity (Norm or Inferior)

Total Revenue

• Total revenue = total amount the seller receives from the sale of a product or service – In a particular time period

• Formula TR = P * Q

• TR = total revenue• P = Price• Q = quantity

12

Total Revenue• Formula

TR = P X Q• TR = total revenue• P = Price• Q = quantity

• Example–Price is $3.50 per gallon–Quantity = 10 gallons–$3.5 * 10 = $35 Total Revenue

13

What Happens If---

• What happens to total revenue if– Prices go up?– Prices go down?

• We know about the Supply and Demand Curve– Does not tell us what happens

if---• Brings us to elasticity

14

Elasticity

• Measure of the responsiveness of the quantity demanded to a good or service– To change in price– When all other factors remain the

same

1. Elasticity of DemandElasticity of Demand- • Measurement of consumers

responsiveness to a change in price.

• What will happen if price increase? How much will it affect Quantity Demanded

Who cares?• Used by firms to help

determine prices and sales• Used by the government to

decide how to tax

Elasticity of Demand• In the previous section, supply

and demand curves were drawn as straight lines.

• This is a simplification, – we assume rate of change of

demand or supply is the same for all prices in the market.

• At some prices, a small change in price may– cause a large change in the

quantity demanded.

Name---

• In the short run, name • Products whose price change

will not change demand much

• Products whose price change will change demand significantly

18

This shown in the diagram as the movement from Pe to Pe1; a small change in price which causes an even larger percentage decrease in quantity demanded (from Qe to Qe1.

At other prices, a large increase in price may see a much smaller decrease in demand. This shown in the diagram as the movement from Pe2 to Pe3; a large change in price which causes a smaller percentage decrease in quantity demanded (from Qe2 to Qe3.

Inelastic Demand

Inelastic Demand

• If price increases, quantity demanded will fall a little

• If price decreases, quantity demanded increases a little.

In other words, people will continue to buy it.

20%

5%

INelastic = Quantity is INsensitive to a change in price.

Examples:• Gasoline• Milk• Diapers

A INELASTIC demand curve is steep! (looks like an “I”)

• Chewing Gum• Medical Care• Toilet paper

Inelastic Demand

• If percentage change in price produces a smaller percentage change in quantity demanded

22

Inelastic Demand

20%

5%

General Characteristics of INelastic Goods:

•Few Substitutes•Necessities•Small portion of income•Required now, rather than later

•Elasticity coefficient less than 1

Example: Calculate

24

Elastic Demand

Elastic Demand

• If price increases, quantity demanded will fall a lot

• If price decreases, quantity demanded increases a lot.

In other words, the amount people buy is sensitive to price.

Elastic = Quantity is sensitive to a change in price.

An ELASTIC demand curve is flat!Examples:• Soda• Boats• Beef

• Real Estate• Pizza• Gold

Elastic DemandGeneral Characteristics of

Elastic Goods:• Many Substitutes• Luxuries• Large portion of income

• Plenty of time to decide• Elasticity coefficient greater than 1

Price Elasticity Coefficient Formula

• Ed = % change in quantity demanded of product X

% change in price of product XCalculating % change% Change in quantity = nqd – iqd

initial quantity demanded

Example: % Change in quantity100,000 nqd - 110,000 iqd = - 10,000

-10,000 = .10 or 10%

100,000

28

Price Elasticity Coefficient Formula

• Ed = % change in quantity demanded of product X

% change in price of product X

• Change in price = New Price – Initial Price Initial price

New Price = $4Initial Price = $3

$4 np - $3 ip = $1 = .33 or 33%

$3 ip $3

Price Elasticity Coefficient Formula

• Ed = % change in quantity demanded of product X

% change in price of product X

10% = .30 or 30%33%

Graph

• Graph the previous example• Is it elastic or inelastic? WHY?

– Inelastic because change in % change in quantity demanded is less than % change in price• Or a 33% change in price created a

10% drop in quantity demanded• Calculated price elastic is < 1

therefore price is inelastic

You Solve

• Decide the price elasticity of demand for a slice of pizza at $2.00 by examining a price decrease from $2.00 to $1.50 per slice. In this case, the demand pizza would increase from 7 million slices to 10 million slices. You can use these figures to calculate the price elasticity of demand

• Ed = % change in quantity demanded of product X

% change in price of product X

• Ed = (10M – 7M) ÷ 7M (DN-O÷O)

($1.50 - $2.00) ÷ $2.00 (PN-O÷O)

• Ed = .43 = -1.72 - 0.25

Drop the negative: Ed is > 1 therefore the demand for pizza slices is elastic

Negative Numbers• If price increases by 10% and

consumers respond by decreasing purchases by 20%

• the equation computes the elasticity coefficient as -2.

• The result is negative because an increase in price (a positive number)

• leads to a decrease in purchases (a negative number).

• Because the law of demand says it will always be negative, many economists ignore the negative sign

Elastic or Inelastic?Beef- 1.27Gasoline- .20Real Estate- 1.6Medical Care- .31 Electricity- .13Gold- 2.6

Elastic INelastic Elastic INelastic INelastic Elastic

What about the demand for insulin for

diabetics?

Perfectly INELASTIC(Coefficient = 0)

What if % change in quantity demanded equals

% change in price?

Unit Elastic (Coefficient =1)

2. Price Elasticity of SupplyElasticity of Supply- • Elasticity of supply shows how sensitive producers

are to a change in price.

Elasticity of supply is based on time limitations.Producers need time to produce more.

INelastic = Insensitive to a change in price (Steep curve)• Most goods have INelastic supply in the short-run Elastic = Sensitive to a change in price (Flat curve)• Most goods have elastic supply in the long-runPerfectly Inelastic = Q doesn’t change (Vertical line)• Set quantity supplied

• Elasticity of supply is influenced by a number of factors. These include :

• the length of the production period. In the late 1990's, demand for Australia wines overseas has reached all time records. Vines take three years to grow to a point where they yield adequate amounts of fruit. Increases in demand for Australian wine has seen prices rise (from Po to P1), and returns to existing grape growers are excellent. Those who wish to buy grapes face a market where supply can only increase marginally (from Qo to Q1), in the short term.

• However, many new stands of vines are being planted, and in a few years, returns to growers may stabilise, as supply increases. Prices will fall from P1 to P2 as the supply of grapes increases from Q1 to Q2.

Elasticity Over Time - Supply

38

Elasticity Over Time - Supply

39

Elasticity Over Time - Supply

40

2.Price Elasticity of Supply Over Time

Price Elasticity of Supply Over Time

• How would you graph the supply elasticity of Gas over time?

• Lets see

42

3. Cross-Price Elasticity of Demand• Cross-Price elasticity shows how sensitive a

product is to a change in price of another good

• It shows if two goods are substitutes or complements% change in price of product “a”

% change in quantity of product “b”

• (test) If coefficient is negative (shows inverse relationship) then the goods are complements

• If coefficient is positive (shows direct relationship) then the goods are substitutes

P increases 20% Q decreases 15%

Think

• Pizza and Burgers are elastic and substitutes of each other

• If the price of pizza declines• 1. What happens to the sale of

pizza?• 2. What happens to the sale of

burgers?• 2. Soda is a compliment to pizza.

What happens to the sale of soda?

• Lets Graph

• Income elasticity shows how sensitive a product is to a change in INCOME

• It shows if goods are normal or inferior

% change in income% change in quantity

• (test) If coefficient is negative (shows inverse relationship) then the good is inferior

• If coefficient is positive (shows direct relationship) then the good is normal

Ex: If income falls 10% and quantity falls 20%…

Income increases 20%, and quantity decreases 15% then the good is a…

4. Income-Elasticity of Demand

INFERIOR GOOD

Total Revenue TestUses elasticity to show how changes in price will

affect total revenue (TR). (TR = Price x Quantity)

Elastic Demand- • Price increase causes TR to decrease• Price decrease causes TR to increase

Inelastic Demand- • Price increase causes TR to increase• Price decrease causes TR to decrease

Unit Elastic-• Price changes and TR remains unchanged

Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases?

Is the range between A and B, elastic, inelastic, or unit elastic?

A

B

10 x 100 =$1000 Total Revenue

5 x 225 =$1125 Total Revenue

Price decreased and TR increased, so…

Demand is ELASTIC

125%

50%

You Should Now Get This

• Elastic and Inelastic Demand Baby– Winner 2013 Econ video contest

48

Total Revenue Test

Total Revenue Test

}inelastic

} unit elastic

}elastic

Elasticity Practice

53

• Graph the following chart• Calculate the Ed using the top set

of numbers and prices rising

Answers -Graph• This is what your graph should look

like

Answers - Ed

• Ed = % change in quantity demanded of product X

% change in price of product X

% Change in quantity = nqd – iqd initial quantity

demanded % Change in price = New Price – Initial

Price Initial price

Ed = (90 – 100) ÷ 100 ($2 - $1.00) ÷ $1.00

• Ed = -.10 = -.1 1

Drop the negative: Ed is < 1 therefore the demand for is INelastic

• Calculate the TR and determine if Total Revenue increased or decreased with a price increase

• What is gain or loss on price move?

Answers

• $3 * 70 = $210

• $2 * 90 = $180

• Total Revenue increased $30

What Happens If ---

• Graph the following chart• Calculate the Ed using the bottom

two numbers and prices rising

Answers - Ed

• Ed = % change in quantity demanded of product X

% change in price of product X

% Change in quantity = nqd – iqd initial quantity

demanded % Change in price = New Price – Initial

Price Initial price

Ed = (40 – 70) ÷ 70 ($4 - $3.00) ÷ $3.00

• Ed = -.4285 or 42.85% = 1.28

.3333 or 33.33%

Drop the negative: Ed is > 1 therefore the demand for is elastic

Ed & TR Test “quiz”

Practice Problem

• See handout

Consumer and Producer Surplus

• Consumer Surplus– Difference between maximum

price willing to pay and the actual price producers charge

– Think of it as a “willing to pay” curve

63

Marginal Benefit & Surplusses

• Marginal Benefit– What you gain when you get one

more unit– Measured by what you are willing

to give up– Everyday life we say “getting

value for our money”– There is a difference between

value and price

Value vs. Price

• Value is what we get• Price is what we pay

• Everyday idea of value is marginal benefit

OR• The measure of the maximum

price what consumers are willing to pay for another unit of a good or service

Pizza Sales Per Slice

P

D

2

1.5

$1

.5

20 30 40 10

Consumer Surplus

Amount Paid

Market Price

Consumer surplus from 10th slice of pizza

Willing to pay

Voluntary ExchangeIn the free-market, buyers and sellers

voluntarily come together to seek mutual benefits.

67

Voluntary ExchangeIn the free-market, buyers and sellers voluntarily

come together to seek mutual benefits.

68

Voluntary ExchangeIn the free-market, buyers and sellers voluntarily

come together to seek mutual benefits.

69

Voluntary ExchangeIn the free-market, buyers and sellers voluntarily

come together to seek mutual benefits.

70

Example of Voluntary Exchange

Ex: You want to buy a truck so you go to the local dealership. You are willing to spend up to $20,000 for a new 4x4. The seller is willing to sell this truck for no less than $15,000. After some negotiation you buy the truck for $18,000.

Analysis:

Buyer’ Maximum-

Sellers Minimum-

Price-

Consumer’s Surplus-

Producer’s Surplus-

$20,000

$15,000

$18,000

$2,000

$3,00071

Consumer Surplus is the difference between what you are willing to pay and what you actually pay.

CS = Buyer’s Maximum – Price

Producer’s Surplus is the difference between the price the seller received and how much they were willing to sell it for.

PS = Price – Seller’s Minimum

Voluntary Exchange Terms

72

S

P

Q

D

Consumer and Producer’s Surplus

$10

8

6$5

4

2

1

10 2 4 6 8

CS

PS

75

Calculate the :1. Consumer Surplus2. Producer Surplus3. Total Surplus

Calculating Consumer Surplus

In DollarsMax

Willing to pay

Actual price (E)

Calculate CS

$9 $5 9 – 5 = $4

$8 $5 8 – 5 = $3

$7 $5 7 – 5 = $2

$6 $5 6 – 5 = $1

$5 $5 5 – 5 = $0

76

Sum = CS = $10

Calculating Producer Surplus

In DollarsMin Price charged

Actual price (E)

Calculate PS

$2 $5 5 – 2 = $3

$3 $5 5 - 3 = $2

$4 $5 5 - 4 = $1

$5 $5 5 – 5 = $0

77

Sum = PS = $6

Surpluses

• Could be calculated in Quantity

78

Summary

Consumption Inefficiency

ProductionInefficiency

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $10, what is the value of Dons’ consumer surplus?

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $10, what is the value of Dons’ consumer surplus?

A. Willing to pay is $15. Market price is $10. Willing to pay ($15) – Actual Price ($10) = $5

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $11, what is the TOTAL value of consumer surplus?

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $11, what is the TOTAL value of consumer surplus?

A. 20 – 11 = 9, 15 – 11 = 4, 12 – 11 = 1

9 + 4 + 1 = $14 consumer surplus

• For a given linier demand curve, the value of consumer surplus does what as market price increases?

• For a given linier demand curve, the value of consumer surplus does what as market price increases?

• Decreases as market price increases

(1)Price

(2)QA

(3) 

(4)QB

(5) 

(6)QC

(7) 

$10 100 $_____ 100 $_____ 100 $_____

9 111 _____ 130 _____ 110 _____

8 125 _____ 170 _____ 120 _____

7 143 _____ 220 _____ 130 _____

6 167 _____ 280 _____ 140 _____

5 200 _____ 350 _____ 150 _____

86

15. A marketing firm has done a study of market demand for DVDs of three different movies. Calculate the total revenue for each movie in columns 3, 5, and 7.

Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue?

(1)Price

(2)QA

(3) 

(4)QB

(5) 

(6)QC

(7) 

$10 100 $1000 100 $1000 100 $1000

9 111 999 130 1170 110 990

8 125 1000 170 1360 120 960

7 143 1001 220 1540 130 910

6 167 1002 280 1680 140 840

5 200 1000 350 1750 150 750

87

Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue?

Applying the total revenue test, we see that total revenues remain approximately constant for movie A, meaning that demand is unit-elastic. Total revenues for movie B are increasing as price decreases, meaning that demand for movie B is elastic. Total revenues for movie C are decreasing as price decreases, meaning the demand for movie C is inelastic. [text: E pp. 77-80; MA pp. 77-80; MI pp. 77-80]