McConnell_21e_IPPT_Ch06

Chapter 6: Elasticity

6-2 Price Elasticity of Demand

• Definition: Measures buyers’ responsiveness to price changes.

• Types of Demand:

  • Elastic Demand: Sensitive to price changes; large change in quantity demanded.

  • Inelastic Demand: Insensitive to price changes; small change in quantity demanded.

6-3 Price Elasticity of Demand Formula

• Formula:

  • [ Ed = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}} ]

6-4 Price Elasticity of Demand Formula Continued

• Midpoint Formula:

  • Ensures consistent results:

  • [ Ed = \frac{\text{Change in Quantity}}{\text{Sum of Quantities}/2} \div \frac{\text{Change in Price}}{\text{Sum of Prices}/2} ]

6-5 Price Elasticity of Demand Formula Concluded

• Additional Notes:

  • Use percentages for a unit-free measure.

  • Eliminating the minus sign helps compare elasticities across products effectively.

6-6 Interpretation of Elasticity of Demand

• Values Interpretation:

  • Ed > 1: Demand is elastic.

  • Ed = 1: Demand is unit elastic.

  • Ed < 1: Demand is inelastic.

  • Extreme Cases:

    • Ed = 0: Perfectly inelastic demand.

    • Ed = ∞: Perfectly elastic demand.

6-7 Extreme Cases of Demand

• Perfectly Inelastic Demand:

  • Characterized by an vertical line on a graph indicating demand does not change with price.

6-8 Perfectly Elastic Demand

• Perfectly Elastic Demand:

  • Represented by a horizontal line indicating a small change in price leads to an infinite change in quantity demanded.

6-9 Total Revenue Test

• Total Revenue Formula: [ TR = Price \times Quantity ]

• Total Revenue Test:

  • Inelastic demand: Price and Total Revenue move in the same direction.

  • Elastic demand: Price and Total Revenue move in opposite directions.

6-10 Total Revenue Test with Elastic Demand

• Example:

  • Lowering price leads to a gain (blue area) that exceeds loss (yellow area).

6-11 Total Revenue Test with Inelastic Demand

• Example:

  • Lowering price leads to a loss (yellow area) that exceeds gain (blue area).

6-12 Total Revenue Test with Unit-Elastic Demand

• Example:

  • Lowering price results in equal gain (blue area) and loss (yellow area).

6-13 Summary of Price Elasticity of Demand

• Summary Table:

  • Demand Categories:

    • Ed > 1: Elastic; Price increase decreases Total Revenue, Price decrease increases Total Revenue.

    • Ed = 1: Unit elastic; Total Revenue is unchanged with price changes.

    • Ed < 1: Inelastic; Price increase increases Total Revenue, Price decrease decreases Total Revenue.

6-16 Determinants of Price Elasticity of Demand

• Factors:

  • Substitutability: More substitutes mean more elastic demand.

  • Proportion of Income: Higher proportion means more elastic demand.

6-17 Determinants Continued

• Luxury vs. Necessities: Luxury goods have more elastic demand.

• Time: More time available increases elasticity of demand.

6-18 Selected Price Elasticities of Demand

• Examples:

  • Newspapers: 0.10, Milk: 0.63, Cigarettes: 0.25, Gasoline: 0.60, Restaurant meals: 2.27.

6-19 Applications of Price Elasticity of Demand

• Implications:

  • Large crop yields can lead to lower revenue if demand is inelastic.

  • Excise taxes may yield more revenue when demand is inelastic.

  • Decriminalization of illegal drugs could similarly influence demand and revenue.

6-20 Price Elasticity of Supply

• Definition: Measures sellers’ responsiveness to price changes; elastic supply indicates producers are responsive, while inelastic indicates less responsiveness.

6-21 Price Elasticity of Supply Formula

• Formula:

  • [ Es = \frac{\text{Percentage Change in Quantity Supplied}}{\text{Percentage Change in Price}} ]

6-22 Interpretation of Supply Elasticity

• Elastic Supply: [ Es > 1 ]

• Unit Elastic Supply: [ Es = 1 ]

• Inelastic Supply: [ Es < 1 ]

• Perfectly Inelastic Supply: [ Es = 0 ]

6-23 Time and Elasticity of Supply

• Time Periods:

  • Immediate market period: Perfectly inelastic supply.

  • Short run: More elastic than immediate period.

  • Long run: Even more elastic than short run.

6-27 Applications of Elasticity of Supply

• Examples:

  • Antiques: Inelastic supply.

  • Reproductions: More elastic supply.

  • Volatile gold prices: Inelastic supply.

6-28 Cross Elasticity of Demand

• Formula:

  • [ Exy = \frac{\text{Percentage Change in Quantity Demanded of X}}{\text{Percentage Change in Price of Y}} ]

6-29 Applications of Cross Elasticity

• Responsiveness:

  • Positive elasticity indicates substitute goods.

  • Negative elasticity indicates complementary goods.

  • Zero elasticity indicates independent goods.

6-31 Income Elasticity of Demand

• Formula:

  • [ Ei = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Income}} ]

6-32 Income Elasticity of Demand Continued

• Normal Goods: Positive elasticity.

• Inferior Goods: Negative elasticity.

6-34 Cross and Income Elasticities

• Definitions:

  • Positive cross elasticity indicates substitutes.

  • Negative cross elasticity indicates complements.

  • Positive income elasticity indicates normal goods.

  • Negative income elasticity indicates inferior goods.

6-35 Elasticity and Pricing Power

• Strategies:

  • Implementing different pricing strategy based on demand elasticity to maximize revenue.