Lecture_03_Elasticities_v1-5

Acknowledgement of Traditional Owners

• QUT acknowledges the traditional owners of the lands where it stands: the Turrbal and Yugara peoples.

• Respect is paid to their Elders, lores, customs, and creation spirits, recognizing the historical significance of these lands for teaching, research, and learning.

• Acknowledgment of the important role Aboriginal and Torres Strait Islander people play within the QUT community.

Review of Last Week’s Lecture

Question 1: Changes in Demand

• Question: A decrease in quantity demanded is indicated by:

  • Upward shift of the demand curve.

  • Upward movement to the left along the demand curve.

  • Downward shift of the demand curve.

  • Downward movement to the right along the demand curve.

• Answer: [Pending]

Question 2: Effects of a Baby Boom

• Question: What immediate effect will a baby boom have on the disposable diaper market?

  • Supply increases.

  • Supply decreases.

  • Demand increases.

  • Demand decreases.

• Answer: [Pending]

Question 3: Supply of Corn

• Question: Which option is most likely to increase the supply of corn?

  • Successful pay increase negotiation for corn harvest workers.

  • Surgeon General announcement linking corn bread to baldness in men.

  • Elimination of subsidies for corn farmers.

  • Farmers can also grow corn, and soybean prices drop significantly.

• Answer: [Pending]

Question 4: Market Price Dynamics

• Question: In the diagram, if price is currently at $75, what will likely happen?

  • Shortage; increase in price.

  • Shortage; decrease in price.

  • Surplus; increase in price.

  • Surplus; decrease in price.

• Answer: [Pending]

Lecture 3: Elasticities

• Focus on how responsive individuals are to changes in price.

Objectives of the Lecture

• Define and calculate the price elasticity of demand and its influencing factors.

• Define and calculate the price elasticity of supply and its influencing factors.

• Define and explain cross elasticity of demand and income elasticity of demand.

Outline of Lecture

• Price elasticity of demand.

• Determinants of price elasticity of demand.

• Elasticity along the demand curve.

• Total revenue test.

• Price elasticity of supply.

• Determinants of price elasticity of supply.

• Cross elasticity of demand.

• Income elasticity of demand.

Elasticities of Demand and Supply

• Example: Price changes for bananas from $3.00/kg to $5.00/kg, and from $3.00/kg to $15.00/kg.

Price Elasticity of Demand

• Definition: Price elasticity of demand measures how much the quantity demanded changes with price changes.

• Calculating Ped:

  • Compares percentage change in quantity demanded (%∆Qd) with percentage change in price (%∆P).

Visual Illustration of Price Elasticity

• Example: Price of latte rising from $4 to $5 decreases quantity demanded from 10 cups to 6 cups.

Calculation of Price Elasticity of Demand

• Formula: %∆Qd / %∆P x 100

• Use average values for accurate calculation:

  • New Price – Initial Price / (New Price + Initial Price) ÷ 2 x 100

  • New Quantity – Initial Quantity / (New Quantity + Initial Quantity) ÷ 2

• Example:

  • Price of latte increases from $4 to $5;

  • Quantity decreases from 10 cups to 6 cups:

    • %∆Qd = (New Quantity - Initial Quantity) / (New Quantity + Initial Quantity) ÷ 2) = ((6-10)/((6+10)/2)) = -50.

    • %∆P = ((New Price - Initial Price) / (New Price + Initial Price) ÷ 2) = ((5-4)/((5+4)/2)) = +22.22.

• Therefore, Ped = -50 / 22.22 = -2.25 (ignore negative sign).

Price Elasticity of Demand Examples

• Example 1: Price increase leads to reduced demand.

• Example 2: Price decrease and its effect on demand.

• Use initial values for denominator affects elasticity calculation.

Range of Price Elasticity of Demand

• Perfectly Elastic: Demand changes infinitely with a small price change (Ped = ∞)

• Elastic: Demand changes significantly with price change (Ped > 1)

• Unit Elastic: Demand changes proportionately (Ped = 1)

• Inelastic: Demand changes minimally with price change (0 < Ped < 1)

• Perfectly Inelastic: Demand does not change with price change (Ped = 0)

Determinants of Price Elasticity of Demand

• Closeness of substitutes; time since price change; proportion of income spent on the good.

Applying Price Elasticity of Demand

• Understanding elasticity helps firms adjust prices for maximum revenue.

Total Revenue Test

• Example of elasticity with coffee prices and total revenue.

• Elastic goods: price increase leads to decreased total revenue.

• Inelastic goods: price increase leads to increased total revenue.

Income Elasticity of Demand

• Measures changes in demand with income changes.

• Normal goods (Ied > 0) vs. inferior goods (Ied < 0).

Cross Elasticity of Demand

• Measures demand changes in response to price changes of substitutes or complements.

• Positive correlation for substitutes, negative for complements.

Determinants of Price Elasticity of Supply

• Resource substitution possibilities and time frame for supply decisions.

Review of Today’s Lecture

• Key focus areas: price elasticity of demand, cross elasticity of demand, income elasticity of demand, and price elasticity of supply.