more price elastic - University at Albany, SUNY

1 Things to know about price elasticity of demanda. Meaning: The amount (as a percentage of total) that quantity demandedchanges as price Factors that make demandmore price elastic - close substitutes available at comparable price . butter, margarine- the market is narrowly defined. Hondas as opposed to cars, Mcintoshapples as opposed to time frame is Definition: negative of percentage change in quantity demanded dividedby percentage change in price . This is (Q2 Q1)/[(Q1+Q2)/2](P2 P1)/[(P1+P2) the price elasticity of demand between two pointsP1andP2on the Properties- If the demand curve is a downward-sloping straight line, the elasticity be-comes higher as the average of the two pricesP1andP2rises. The elasticityabove the midpoint of the line segment in the positive quadrant is greater than1.]

2 The elasticity below the midpoint is less than The flatter the demand curve is between fixed pricesP1andP2, the moreelastic it is Uses- For a given size of supply shift (with fixed initial equilibrium point), thelower demand elasticity is, the greater the change in price will If the price elasticity of demand is greater than 1, a rise in price causes andecrease in revenue for the the price elasticity of demand is lower than 1, a rise in price causes anincrease in revenue for the the price elasticity of demand equals 1, a rise in price causes no changein revenue for the If elasticity is greater than 1 and the supply curve shifts to the left, pricewill rise. Thus revenue will elasticity is less than 1 and the supply curve shifts to the left, price willrise.

3 Thus revenue will Income elasticity of demanda. meaning: The amount (as a percentage of total) that demand changes asincome Definition: Percentage change in quantity demanded divided by percent-age change in income. This is(Q2 Q1)/[(Q1+Q2)/2](I2 I1)/[(I1+I2)/2],for two income pointsI1andI2. When calculating income elasticity of demand ,assume price does not Types of good distinguished by their income elasticity of demand :- If the income elasticity of demand is greater than zero, the good is a normalgood. It means that demand for the good rises as income rises. Most goods arenormal If the income elasticity of demand is less than zero, the good is an inferiorgood. It means that demand for the good falls as income rises. bus rides,poor quality substitutes for normal the income elasticity of demand for a good is greater than 1, the goodis called a luxury (A higher proportion of budget is spent on the good as theconsumer gets richer).

4 Concerts, the income elasticity of demand for a good is less than 1, the good is calleda necessity. (A lower portion of budget is spent on the good as the consumergets richer). Cross- price elasticity of demanda. meaning: the amount (as a percentage of total) that demand for good Achanges as price of good B Definition: Percentage change in quantity demanded of good A dividedby percentage change in price of good B. This is(QA2 QA1)/[(QA1+QA2)/2](PB2 PB1)/[(PB1+PB2)/2]whereQA1andQA2are quantities demanded of goodAandPB1andPB2arecorresponding prices of goodB. Assume when calculating cross- price elasticityof demand that price of goodAand income remain constant as price of Types of good distinguished by their cross- price elasticity of Good A is a substitute for good B if the demand for good A rises when theprice of good B rises.

5 Thus good A is a substitute for good B if the cross-priceelasticity of demand of A for B is greater than 0 ((QA2 QA1)/[(QA1+QA2)/2](PA2 PA1)/[(PB1+PB2)/2]>0). and dvds, soy milk and rice milk, pencil and A is a complement for good B if the demand for good A falls when theprice of good B rises. Thus good A is a complement for good B if the cross-priceelasticity of demand of good A for good B is less than zero(QA2 QA1)/[(QA1+QA2)/2](PA2 PA1)/[(PB1+PB2)/2]<0. potato chips and tv, paper and price elasticity of supplya. meaning: the amount (as a percentage of total) that supply changes whenprice Factor that makes supply of a goodmoreelastic-time frame considered is longc. Definition: Percentage change in quantity supplied divided by percentage3change in price .

6 This is(Q2 Q1)/[(Q1+Q2)/2](P2 P1)/[(P1+P2)/2,whereQ1andQ2are points on the supply curve andP1andP2are the corre-sponding Properties- a linear upward sloping supply curve that hasP <0 whenQ= 0 is inelas-tic a linear upward sloping supply curve that hasP >0 whenQ= 0 is a linear upward sloping supply curve that hasP= 0 whenQ= 0 is unitelastic Uses- For a given size of demand shift (with fixed initial equilibrium point), themore inelastic supply is, the more price will of Supply and demand Elasticity1. Taxation. Government sometimes tries to reduce the supply of a good orraise revenue by taxing the purchase of a tax of sizeton each unit sold of a good has the effect of shifting the supplycurve up (vertically) byt. This is because given a priceP, the seller only receivesP tfor each unit sold.]

7 Therefore they must get a unit priceP+tto be willingto sellQunits when before they were willing to sellQunits at a price quantity supplied at each price decreases after the tax is imposed, unlessthe supply curve is effects of the tax depend on the elasticities of the demand and the more inelastic demand is, the more price will rise due to the more inelastic demand is, the more revenue government will collect from4the more inelastic demand is, the smaller is the change in quantity bought dueto the Guide page order to reduce teen smoking, the government places a $2 per pack taxon cigarettes. After one month, while the price to the consumer has increaseda great deal, the quantity demanded of cigarettes has been reduced only Is the demand for cigarettes over the period of one month elastic or inelastic?

8 Mankiw, page 111, drugs have an inelastic demand and computers have an elasticdemand. Suppose that technological advance doubles the supply of both prod-ucts (that is, the quantity supplied at each price is twice what it was).a. What happens to the equilibrium price and quantity in each market?b. Which product experiences a larger (percentage) change in price ?c. Which product experiences a larger (percentage) change in quantity?d. What happens to total consumer spending on each product?5