ch 6 econ 2302
time
product demand is more elastic over long time periods. consumers often need time to adjust to price changes. Ex) when the price of a product rises, consumers need to find and experiment with other products.
Consumers may not immediately reduce their purchases very much when the price of beef rises by 10%, but in time they may shift to chicken, pork, or fish. A related consideration is called:
product durability
relatively inelastic
products such as toothpaste, consumers pay much less attention to price changes. Does not change much in the amount purchased
Elastic
refers to a market for a product or service that is price sensitive; that is, relatively small changes in price will generate fairly large changes in the quantity demanded (have many substitutes)
For policy makers, it means that achieving the goal of a higher total farm income requires that farm output be:
restricted
Elastic demand
specific % change in price in the denominator resulting in a larger % change in quantity demanded in the numerator. In such cases, Ed will be GREATER THAN 1.
inelastic demand
specific % change in price produces a smaller % change in quantity demanded, demand is inelastic. In such cases, Ed will be LESS THAN 1.
application: the cross elasticity coefficient is important to business and government. example:
suppose that coca cola is considering to lower the price of its Sprite brand. Before making its decision, it wants to know about the price elasticity of demand for Sprite (will the price cut increase or decrease total revenue?) but it is also interested in knowing if the increased sales of Sprite will come at the expense of its Coke brand
the government pays attention to elasticity of demand when it selects foods and services to tax. If the government levies a $1 excise tax on a product and 10,000 units are sold, tax revenue will be:
$10,000 ($1 x 10,000 units sold = $10,000)
unit elastic demand
% change in price and the resulting % change in quantity demanded are the SAME. ex) suppose that a 2% drop in the price of chocolate causes a 2% increase in quantity demanded. this case is termed unit elasticity because Ed is EXACTLY 1, or UNITY.
excise taxes are levied on:
1) products with a low elasticity of demand 2) the quantity of products sold 3) the product of specific products
Formula for cross elasticity of demand:
EXY= % change in quantity demanded of product X / % change in the price of substitute product Y
Economists measure the degree to which demand is price elasticity or inelastic with the coefficient Ed, defined as:
Ed= % change in quantity demanded of product X / % change in price of product X Ex) 42.85% / 33.33% = 1.28%
Midpoint formula & calculation simply averages two prices and the two quantities:
Ed= change in quantity demanded / sum of quantities / 2 ________________________________ change in price / sum of prices / 2
The percentage changes in the equation are calculated by dividing the CHANGE in quantity demanded by ORIGINAL quantity demanded, and by dividing the CHANGE in price by the ORIGINAL price, so the formula is:
Ed= change in quantity demanded of X \ change in price of X ______________________________ original quantity demanded of X / original price of X
income elasticity of demand formula
El= % change in quantity demanded / % change in income
Calculation of price elasticity/inelasicity formula:
Es= % change in quantity supplied of product X / % change in price of product X
proportion of income
Other things equal, the higher the price of a good relative to consumers' incomes, the greater the price elasticity of demand. Ex) a 10% increase in the price of low-priced pencils or chewing gum amounts to a few more pennies spent from a consumers income, and quantity demanded will probably decline only slightly. Thus, price elasticity for low-price items tends to be low.
which product, when purchased NEW, would have the lowest price elasticity of demand?
Socks
determinant of price elasticity of demand
Substitutability, proportion of income, luxuries versus necessities, time
independent goods (0)
a zero or near zero cross elasticity suggests that the 2 products are UNRELATED or independent goods Ex) walnut and plums. we do not expect a change in price of walnuts to have any effect on the purchases of plums, and vice versa
Specifically, in the upper left segment of the demand curve, the % change in quantity is LARGE because the original reference quantity is SMALL. Similarly, the % change in price is SMALL in that segment because the original reference price is LARGE.
The relatively LARGE % change in quantity DIVIDED by the relatively SMALL % change in price yields a LARGE Ed (elastic demand)
in the case of unit elasticity, an INCREASE or a DECREASE in price leaves:
Total revenue unchanged
Which of the following would most exemplify perfectly inelastic demand?
a diabetics demand for insulin
Inelastic
a given change in price causes a relatively smaller change in the quantity demanded (have no substitutes)
in the tomato industry, our farmer has time to acquire additional land and buy more machinery and equipment. furthermore, other farmers may, over time, be attracted to tomato farming by the increased demand and higher price. such adjustments create:
a larger supply response
What item will exhibit relatively LARGE price elasticity of demand?
a luxury cruise
inferior goods -
a negative income elasticity coefficient designates an inferior good. cabbage, long distance bus tickets, and used clothing are likely inferior goods. consumers decrease their purchases of inferior goods and income rises
long run
a time period long enough for firms to adjust their plant sizes and for new firms to enter the industry (or existing firms to leave the industry)
Economists typically express elasticity coefficient as an absolute value in order to:
avoid ambiguity (inexactness)
Suppose the owner of a small farm brings to market one truckload of tomatoes that is the entire seasons output. The supply curve for the tomatoes is perfect inelastic (vertical); the farmer will sell the truckload whether the price is high or low. Why?
because the farmer can only offer one truckload of tomatoes
changing elasticity along a demand curve, downward sloping demand curve that price and quantity demanded are:
inversely related. This, price elasticity is a NEGATIVE number
the inelastic nature of farm products means that the increased output brought about by a good growing season results in:
decreased prices and decreased total revenue
in the price elasticity coefficient formula, the numerator being greater than the denominator indicates that:
demand is elastic
Suppose a 2% decline in the price of coffee in the denominator leads to only a 1% increase in quantity demanded in the numerator. that would imply that:
demand is inelastic
Suppose that a 2% decline in the price of cut flowers in the denominator results in a 4% increase in quantity demanded in the numerator. The demand for cut flowers is:
elastic
complement (-) sign:
if cross elasticity of demand is NEGATIVE, we know that X and Y "go together"; and increase in the price of one DECREASES the demand for the other. so the two are complementary goods. ex) a decrease in the price of digital cameras will INCREASE the number of memory sticks purchased. the larger the negative cross coefficient, the greater is the complementary between the 2 goods.
Substitutes (+) sign:
if cross elasticity of demand is POSITIVE, meaning that the sales of X move in the SAME direction as change in the price of Y, then X and Y are SUBSTITUTE GOODS ex) evian water (X) and dasani water (y). an increase in the price of evian causes consumers to buy MORE of dasani, resulting in a positive cross elasticity. the larger the positive-cross elasticity coefficient, the greater the substitutability between the 2 products.
determinants of demand elasticity
if demand is elastic, a price increase REDUCES total revenue. The revenue gained from a higher price per unit will be MORE THAN offset by the revenue LOST from the LOWER quantity sold. If demand is elastic, a DECREASE in the price INCREASES total revenue.
price elasticity of supply
if quantity supplied by producers is relatively responsive to price changes, supply is ELASTIC If it relatively sensitive to price changes, supply is INELASTIC
supply is perfectly inelastic during the:
immediate market period
Normal goods +
income elasticity coefficient Ei is positive, meaning that more of those goods are demanded as incomes rise. such goods are called normal or superior goods. ex) income elasticity of demand for automobiles is about +3.0, while income elasticity for most farm products is only about +0.2
A small % change in quantity demanded divided by a larger % change in price indicates:
inelastic demand
The downward sloping demand curve shows that price and quantity demanded are:
inversely related. Thus, the price elasticity coefficient on demand Ed will always be a NEGATIVE number ex) if price declines, quantity demanded will increase. This means that the numerator in our formula will be positive and the denominator negative, yielding a negative Ed.
excise taxes
is a tax levied on the production of a specific product or in the quantity of the product purchased
immediate market period
is the length of time over which producers are unable to respond to a change in price with a change in quantity supplied
if a product demand is relatively elastic, what will be the effect on total revenue if the price is increased?
it decreases
in the short run, our farmers plant has time to acquire additional land and buy more machinery and equipment. furthermore, other farmers may, over time, be attracted to tomato farming by the increased demand and higher price. such adjustments create a:
larger supply response
If a product demand is elastic, consumers will be more sensitive to price changes if:
many substitutes, big percent of income, luxury item, or more time to adjust
income elasticity of demand
measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good
price elasticity of demand
measures the responsiveness of consumers to a change in the price of a product (the % of change in quantities demanded DIVIDED by the % change in price)
cross elasticity of demand
measures the sensitivity of consumer purchases of one product (call it X) to a change in the price of some other product (call it Y). We calculate the coefficient of cross elasticity of demand EXY as the % change in consumption of X to the % change in the price of Y.
When we say demand is "inelastic" we do not mean that consumers are completely unresponsive to a price change. in that extreme situation, where a price change results in NO change in quantity demanded, we say that demand is:
perfectly inelastic
an addicts demand for heroin is an example of demand that is
perfectly inelastic
For all downward sloping straight-line and most other demand curves, demand is more:
price elastic toward the upper left than the lower right
Luxuries vs. Necessities
price elasticity of demand is higher for luxury goods than it is for necessities. Electricity is a necessity, it is difficult to get along without it. A price increase will not significantly reduce the amount of lighting and power used in a household.
If a 4% decrease in the price of coffee leads to a 2% increase in the quantity demanded, the price elasticity demand for coffee is relatively:
price inelastic
the degree of price elasticity of supply depends on how quickly and easily producers can shift resources between alternative uses. the more easily and rapid producers can shift resources between alternative uses,
the greater the price elasticity of supply
Substitutability
the more substitutes that are available; the greater the price elasticity of demand
Cross elasticity of demand measures:
the responsiveness of consumer purchases of one product due to a change in the price of some other product
factors such as increased population, higher income, and greater enthusiasm for collecting antiques have increased the demand for antiques over time. because the supply of antiques is limited and inelastic,
those increases in demand have greatly boosted the prices of antiques
determinant of supply elasticity is
time
short run
time period too short to change plant capacity but long enough to use the fixed sized plant more intensively or less intensively
Consumer Reponsiveness (sensitivity)
to a price change is measured by a products Price Elasticity of Demand. (ex. restauraunt meals, consumers are highly responsive to price changes, which would be relatively elastic, or simply elastic)
total revenue
total amount the seller receives from the sale of a product in a particular time period; it is calculated by multiplying the product price (P by the quantity sold (Q) TR= P x Q Ex) TR= $5 price X 10 quantity = $50 total revenue
total revenue test
total revenue and price elasticity of demand are RELATED.. If total revenue changes in the OPPOSITE direction from price, demand is ELASTIC. If total revenue changes in the SAME direction as price, demand is INELASTIC. If total revenue does NOT CHANGE when price changes, demand is UNIT ELASTIC.
If the loss in revenue from a lower price is exactly offset by the gain in revenue from the increase in sales, the. the price elasticity of demand is:
unit elastic
calculation of price elasticity or inelasticity of supply
uses the coefficient Es, defined almost like Ed, however we use % change in quantity supplied
perfect inelastic demand
where a price change results in NO CHANGE in the quantity demanded
perfectly elastic demand
where a small price reduction causes buyers to increase their purchases from ZERO to all they can obtain, the elasticity coefficient is INFINITY