Price Elasticities of Demand

1
Price Elasticities of Demand
2
Definition

• Price elasticity of demand is a measure of the
  responsiveness of the quantity demanded of a good
  to a change in its price when all other
  influences on buyers plans remain the same
• To determine price elasticity of demand compare
  the change in the quantity demanded with the
  percentage change in price

3
Percentage Price in Change

• Starbucks raised the price of a latte from 3 to
  5 a cup. What is the percentage change in price?

4
Percentage Change in Price

• Starbucks cuts the price of a latte from 5 to 3
  a cup. What now is the percentage change in
  price?

5
Percentage Change in Price

• Elasticity compares the percentage change in the
  quantity demanded with the percentage change in
  price
• Midpoint Method -- To calculate the percentage
  change that does not depend on the direction of
  the price change

6
Percentage Price in Change

• Midpoint Method Calculation
• Starbucks Latte price changing from 5 to 3. 5
  for a new price and 3 for the initial price.

7
Percentage Change in Price

• Average price is the same regardless of whether
  the price rises or falls

8
Percentage Change in Quantity Demanded

• Price of a Latte rises from 3 to 5 a cup, the
  quantity demanded decreases from 15 cups to 5
  cups an hour.
• Uses the midpoint formula again

9
Percentage Change in Quantity Demanded

• When the price of a good rises, the quantity
  demanded of it decreases
• A positive change in price bring a negative
  change in the quantity demanded
• When the price of a good falls, the quantity
  demanded of it increases
• Negative change in price brings a positive change
  in the quantity demanded

10
Elastic and Inelastic Demand

• Elastic Demand when the percentage change in
  the quantity demanded exceeds the percentage
  change in price
• Unit Elastic Demand percentage change in the
  quantity demanded equals the percentage change in
  price
• Inelastic Demand percentage change in the
  quantity demanded is less than the percentage
  change in price

11
Elastic Demand

• Perfectly Elastic Demand an almost zero
  percentage change in the price brings a very
  large percentage change in the quantity demanded
• Consumers are willing to buy any quantity of the
  good at a given price but none at a higher price

12
Perfectly Elastic Demand
13
Elastic Demand

• A percentage change in the quantity demanded
  exceeds the percentage change in price

14
Unit Elastic Demand

• The percentage change in the quantity demanded
  equals the percentage change in price

15
Inelastic Demand

• Percentage change in the quantity demanded is
  less than the percentage change in price

16
Perfectly Inelastic Demand

• Percentage change in the quantity demanded is
  zero for any percentage change in price

17
Influences on Price Elasticity of Demand

• Two influences
• Availability of substitutes
• Proportion of income spent

18
Influences on Price Elasticity of Demand

• Demand for good is elastic if a substitute is
  easy to find
• Soft drink containers
• Demand for good is inelastic if a substitute is
  hard to find
• Oil substitutes?

19
Influences on Price Elasticity of Demand

• Three factors that influence the ability to find
  a substitute for a good
• Whether good is a luxury or a necessity
• How narrowly it is defined
• Amount of time available to find a substitute for
  it

20
Price Elasticity of Demand

• The greater the proportion of income spend on a
  good, the greater is the impact of a rise in its
  price on the quantity of that good that people
  can afford to buy and the more elastic it is the
  demand for that good
• Toothpaste?

21
Computing Price Elasticity of Demand

• If the price elasticity of a demand is greater
  than 1, the demand is elastic
• If the price elasticity of demand equals 1,
  demand is unit elastic
• If the price elasticity of demand is less than 1,
  demand is inelastic

22
Computing Price Elasticity of Demand
23
Elasticity Along a Linear Demand Curve

• Slope measures responsiveness. But slope and
  elasticity are not the same thing!
• Along a linear (straight-line) demand curve, the
  slope is constant but the elasticity varies.
• Along a linear demand curve, demand is
• Unit elastic at the midpoint of the curve.
• Elastic above the midpoint of the curve.
• Inelastic below the midpoint of the curve.

24
Elasticity Along a Linear Demand Curve
25
Total Revenue and the Price Elasticity of Demand

• Total revenue is the amount spent on a good and
  received by its sellers and equals the price of
  the good multiplied by the quantity sold
• Starbucks Latte -- 3
• Demand is 15 cups an hour
• Total Revenue is 45 an hour
• Total Revenue Test is a method of estimating the
  price elasticity of demand by observing the
  change in total revenue that results from a price
  change

26
Total Revenue and the Price Elasticity of Demand

• If demand is elastic
• A given percentage rise in price brings a larger
  percentage decrease in the quantity demanded.
• And total revenue decreases.
• If demand is inelastic
• A given percentage rise in price brings a
  smaller percentage decrease in the quantity
  demanded.
• And total revenue increases.

27
Total Revenue Test

• Total revenue test
• If price and total revenue change in the opposite
  directions, demand is elastic.
• If a price change leaves total revenue unchanged,
  demand is unit elastic.
• If price and total revenue change in the same
  direction, demand is inelastic.

28
Total Revenue Test

• At 3 a cup, the quantity demanded is 15 cups an
  hour.
• Total revenue is 45 an hour.
• When the price rises to 5 a cup, the quantity
  demanded decreases to 5 cups an hour.
• Total revenue decreases to 25 an hour.
• Demand is elastic.

29
Total Revenue Test

• At 50 a book, the quantity demanded is 5 million
  books.
• Total revenue is 250 million.
• When the price rises to 75 a book, the quantity
  demanded decreases to 4 million books.
• Total revenue increases to 300 million.
• Demand is inelastic.

30
Addiction and Elasticity

• Nonusers demand for addictive substances is
  elastic.
• So a moderately higher price leads to a
  substantially smaller number of people trying a
  drug.
• Existing users demand for addictive substances
  is inelastic.
• So even a substantial price rise brings only a
  modest decrease in the quantity demanded.

31
Price Elasticities of Demand Notes
32
Definition

• Price elasticity of demand is
• To determine price elasticity of demand compare
  the change in the quantity demanded with the
  percentage change in price

33
Percentage Price in Change

• Starbucks raised the price of a latte from 3 to
  5 a cup. What is the percentage change in price?

34
Percentage Change in Price

• Starbucks cuts the price of a latte from 5 to 3
  a cup. What now is the percentage change in
  price?

35
Percentage Change in Price

• Elasticity compares the percentage change in the
  quantity demanded with the percentage change in
  price
• Midpoint Method --

36
Percentage Price in Change

• Midpoint Method Calculation
• Starbucks Latte price changing from 5 to 3. 5
  for a new price and 3 for the initial price.

37
Percentage Change in Price
38
Percentage Change in Quantity Demanded

• Price of a Latte rises from 3 to 5 a cup, the
  quantity demanded decreases from 15 cups to 5
  cups an hour.
• Uses the midpoint formula again

39
Percentage Change in Quantity Demanded

• When the price of a good rises, the quantity
  demanded of it decreases
• When the price of a good falls, the quantity
  demanded of it increases

40
Elastic and Inelastic Demand

• Elastic Demand
• Unit Elastic Demand
• Inelastic Demand

41
Elastic Demand

• Perfectly Elastic Demand
• Consumers are willing to buy any quantity of the
  good at a given price but none at a higher price

42
Perfectly Elastic Demand
43
Elastic Demand
44
Unit Elastic Demand
45
Inelastic Demand
46
Perfectly Inelastic Demand
47
Influences on Price Elasticity of Demand

• Two influences
• Availability of ________________
• Proportion of ___________spent

48
Influences on Price Elasticity of Demand

• Demand for good is elastic if a substitute is
  easy to find
• Demand for good is inelastic if a substitute is
  hard to find

49
Influences on Price Elasticity of Demand

• Three factors that influence the ability to find
  a substitute for a good

50
Price Elasticity of Demand

• The greater the proportion of income spend on a
  good, the greater is the impact of a rise in its
  price on the quantity of that good that people
  can afford to buy and the more elastic it is the
  demand for that good

51
Computing Price Elasticity of Demand

• If the price elasticity of a demand is greater
  than 1, the demand is ____________
• If the price elasticity of demand equals 1,
  demand is ____________
• If the price elasticity of demand is less than 1,
  demand is ____________

52
Computing Price Elasticity of Demand
53
Elasticity Along a Linear Demand Curve

• Slope measures responsiveness. But slope and
  elasticity are not the same thing!
• Along a linear (straight-line) demand curve, the
  slope is constant but the elasticity varies.
• Along a linear demand curve, demand is
• ____________ at the midpoint of the curve.
• ____________ above the midpoint of the curve.
• ____________ below the midpoint of the curve.

54
Elasticity Along a Linear Demand Curve
55
Total Revenue and the Price Elasticity of Demand

• Total revenue is the amount spent on a good and
  received by its sellers and equals the price of
  the good multiplied by the quantity sold
• Starbucks Latte -- 3
• Demand is 15 cups an hour
• Total Revenue is 45 an hour
• Total Revenue Test is a method of estimating the
  price elasticity of demand by observing the
  change in total revenue that results from a price
  change

56
Total Revenue and the Price Elasticity of Demand

• If demand is elastic
• If demand is inelastic

57
Total Revenue Test

• Total revenue test
• If price and total revenue change in the opposite
  directions, demand is ________
• If a price change leaves total revenue unchanged,
  demand is ____________.
• If price and total revenue change in the same
  direction, demand is ____________.

58
Total Revenue Test

• At 3 a cup, the quantity demanded is 15 cups an
  hour.
• Total revenue is ____________
• When the price rises to 5 a cup, the quantity
  demanded decreases to 5 cups an hour.
• Total revenue decreases to ____________.
• Demand is ____________.

59
Total Revenue Test

• At 50 a book, the quantity demanded is 5 million
  books.
• Total revenue is ____________
• When the price rises to 75 a book, the quantity
  demanded decreases to 4 million books.
• Total revenue increases to ____________.
• Demand is ____________.

60
Addiction and Elasticity

• Nonusers demand for addictive substances is
  ____________.
• Existing users demand for addictive substances
  is ____________.