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| Consider the market for a new DVD movie, where the price is initially $20 and 20 copies are sold per day at a superstore, as indicated in the figure. The superstore is considering lowering the price to $18. What is the price elasticity of demand between these two prices (use the Midpoint Formula)? | The price elasticity of demand is 1.73 |
| Midpoint formula is | absolute value > 1 - elastic absolute value < 1 - inelastic absolute value = 1 - unit elastic |
| How is the price elasticity of demand measured? The price elasticity of demand is measured as | the percentage change in the quantity demanded divided by the percentage change in price. |
| Perfectly inelastic demand | The case where the quantity demanded is completely unresponsive to price, and the price elasticity of demand equals zero. In this case, the demand curve is vertical. |
| Perfectly elastic demand | The case where the quantity demanded is infinitely responsive to price, and the price elasticity of demand equals infinity. In this case, the demand curve is horizontal. |
| Consider the polar case where the demand curve is perfectly elastic. Use the line drawing tool to draw a perfectly elastic demand curve. Label this line 'D'. | |
| Consider the two demand curves illustrated in the figure to the right. Which of the two is relatively more elastic? | D1 is more elastic. While elasticity is not the same as slope, it is true that if two demand curves intersect, the one with the smaller slope (in absolute value)—the flatter demand curve—is more elastic. Therefore, Upper D 1 is more elastic than Upper D 2 because it is flatter. |
| Elasticity | A measure of how much one economic variable responds to changes in another economic variable. |
| Compare the demand for sugar with demand for food. The demand for sugar is likely | more inelastic because sugar tends to represent a smaller fraction of a consumer's budget. |
| Compare the demand for pencils with demand for food. The demand for pencils is likely | more inelastic because pencils tend to represent a smaller fraction of a consumer's budget. The demand for a good will be more elastic the larger the share of the good in the average consumer's budget. People tend to buy pencils infrequently and in small quantities, compared to "big-ticket" items such as food. Therefore, the demand for pencils is likely more inelastic. |
| Determinants of the price elasticity of demand: | ≻Availability of close substitutes ≻Passage of time ≻Luxuries versus necessities ≻Narrowness of definition of the market ≻Share of the good in the consumer's budget |
| Suppose Wendy's hamburgers have many close substitutes available. If so, then an increase in the price of Wendy's hamburgers will likely | decrease the quantity of Wendy's hamburgers by a relatively large amount. If a product has more substitutes available, it will have more elastic demand. If a product has fewer substitutes available, it will have less elastic demand. Since Wendy's hamburgers have many close substitutes, their demand will be relatively elastic, and a price increase will decrease the quantity demanded by a relatively large amount. |
| MIT economist Jerry Hausman has estimated the price elasticity of demand for Post Raisin Bran cereal to be −2.5 and the price elasticity of demand for all types of breakfast cereals to be −0.9. The demand for Post Raisin Bran cereal is ___ and the demand for all types of breakfast cereals is ___. | elastic; inelastic |
| Why might the demand for Post Raisin Bran cereal be more elastic than the demand for all types of breakfast cereals? Post Raisin Bran cereal | is defined more narrowly. If a product has more substitutes available, it will have a more elastic demand. In a narrowly defined market, consumers have more substitutes available. The demand for Post Raisin Bran cereal is likely more elastic than the demand for all cereal because Post Raisin Bran cereal has more substitutes. Alternatively, Post Raisin Bran cereal is a market defined more narrowly. |
| Compare the demand for water with the demand for wine. The demand for wine is likely | relatively more elastic because wine is a luxury. |
| Consider the demand for cigarettes. Suppose the government increases the price of cigarettes by raising cigarette taxes. How will this affect the demand for cigarettes over time? If the price of cigarettes increases, then the quantity of cigarettes demanded will | increase, and this effect will likely become larger (in absolute value) over time. The more time that passes, the more elastic the demand for a product becomes. This is because it usually takes consumers some time to adjust their buying habits when prices change. Therefore, if the price of cigarettes decreases, then the quantity of cigarettes demanded will increase, and this effect will become larger (in absolute value) over time. |
| Consider the market for a new CD, where the price is initially $10.00 and 20 thousand copies are sold, as indicated in the figure to the right at point A. The music company is considering lowering the price to $9.00, at which price 24 thousand copies would be sold. What is total revenue at the initial price (at point A)? What would total revenue be at the lower price (at point B)? Given this change in total revenue, is demand between these prices elastic or inelastic? | Revenue is initially $200 thousand. ($10.00 multiplied by 20 thousand units) Revenue would be $216 thousand. ($9.00 multiplied by 24 thousand units) Demand (in this range of prices) is elastic. A decrease in price increases total revenue, so demand is elastic. |
| Total revenue | The total amount of funds received by a seller of a good or service, calculated by multiplying the price per unit by the number of units sold. |
| When demand is inelastic, price and total revenue move in the same direction: | An increase in price raises total revenue, and a decrease in price reduces total revenue. |
| When demand is elastic, price and total revenue move inversely: | An increase in price reduces total revenue, and a decrease in price raises total revenue. |
| Consider the demand curve illustrated in the figure. Is demand elastic or inelastic? At what price is total revenue maximized? | Demand is elastic at all prices above $10.00 and inelastic at all prices below $10.00. Along most demand curves, elasticity is not constant. For example, elasticity is not constant along a linear demand curve. At prices above the midpoint of a linear demand curve, demand is elastic, and at prices below the midpoint of a linear demand curve, demand is inelastic. Total revenue is maximized when price equals $10. Total revenue is maximized when the demand curve is unit elastic. That is, total revenue is maximized at the price at the midpoint of a linear demand curve. |
| Consider firms that introduce new products, such as DVDs in 2001. When firms introduce new products, how do they typically determine the price elasticity of demand for those products? Firms with new products often | estimate price elasticity of demand by experimenting with different prices. |
| Market experiments | Firms try different prices and observe the change in quantity demanded that results. That is, when firms are unsure of the price elasticity of the demand curves they face (such as when firms introduce new products), they often experiment with different prices to help determine the price elasticity of demand. |
| What information must economists have to estimate the price elasticity of demand? To estimate the price elasticity of demand, economists need to know | the demand curve for a product. |
| Suppose the price of pepper increases by 25 percent and, as a result, the quantity of salt demanded (holding the price of salt constant) decreases by 4 percent. In this example, pepper and salt are Instead, suppose pepper and salt were substitutes. If so, then the cross-price elasticity of demand between pepper and salt would be | The cross-price elasticity of demand between pepper and salt is -.16. compliments. positive. |
| An increase in the price of a substitute will lead to an increase in quantity demanded, so the cross-price elasticity of demand will be | positive. |
| Suppose income increases by 20 percent and, as a result, the quantity of a particular brand of automobile demanded (holding the price for this particular automobile constant) increases by 15 percent. This particular brand of automobile is a(n) ___ good. In another example, suppose market research shows that a particular brand of truck is a normal good and a necessity. If so, then the income elasticity of demand for this truck is | The income elasticity of demand for this brand of car is .75. normal less than 1 but greater than 0. |
| Economist X. M. Gao and two colleagues have estimated that the cross-price elasticity of demand between beer and wine is 0.31. If so, then beer and wine are ___. Gao and colleagues have estimated that the cross-price elasticity of demand between beer and spirits is 0.15. If the price of spirits increases by 10 percent, then the quantity of beer demanded will ___ by __ percent. In addition, Gao and colleagues have estimated the income elasticity of demand for beer to be −0.09. If so, then beer is | substitutes. increase by 1.5 percent. (0.15 x 10) an inferior good. |
| Substitute: | An increase in the price of a substitute will lead to an increase in quantity demanded, so the cross-price elasticity of demand will positive. |
| Complement: | An increase in the price of a complement will lead to a decrease in the quantity demanded, so the cross-price elasticity of demand will be negative. |
| cross-price elasticity of demand | is positive or negative depending on whether the two products are substitutes or complements. |
| An increase in the price of a complement will lead to a decrease in the quantity demanded, so the cross-price elasticity of demand will be | negative. |
| A good is a ___ if the quantity demanded is very responsive to changes in income, so that a 10 percent increase in income results in more than a 10 percent increase in quantity demanded. | Luxury |
| A good is a ___ if the quantity demanded is not very responsive to changes in income, so that a 10 percent increase in income results in less than a 10 percent increase in quantity demanded. | Necessity |
| Refer to the diagrams above. Identify the two goods which are substitutes. | Good X and Good Z. |
| Identify the two goods which are complements. | Good Y and Good Z |
| Between 1950 and 2006, the price of wheat fell dramatically from $15.81 per bushel to $3.40 per bushel. Suppose between 1950 and 2006, the supply of wheat increased substantially due to increases in productivity, shifting the wheat supply curve to the right. With this supply shift, the amount by which the price of wheat falls will be larger the more ___the demand for wheat. In addition, assume that between 1950 and 2006 the income of the average American increased substantially and that wheat is a normal good. With this increase in income, | inelastic If the supply of wheat increases, then this will decrease the market price of wheat. If the price elasticity of demand for wheat is inelastic, then this decrease in price will be larger than if the price elasticity of demand for wheat were more elastic. the amount by which the price of wheat rises will be smaller the lower the income elasticity of wheat. If wheat is a normal good, then an increase in income will increase the demand for wheat, raising the market price of wheat. If the income elasticity of wheat is low, then this increase in demand will be smaller, and the price of wheat will increase by a smaller amount than if the income elasticity of demand for wheat were high. |
| What is the impact of an increase in worker productivity when demand is relatively more elastic? | An increase in sales revenue received by the firm. |
| Suppose a frost destroys the tomato crop in California but farmers see an increase in their revenues. Which of the following best explains this? | The demand for tomatoes is price inelastic. |
| Which of the following is a primary determinant of the price elasticity of supply? The price elasticity of supply is affected by In particular, the supply curve for a particular product will be increasingly more elastic over a ___ period of time. | the passage of time. longer |
| Over the past 30 years, the price of oil has been relatively unstable, fluctuating between $11.00 and well over $100 per barrel. Which of the following potentially contributes to oil-price instability? Oil prices are relatively unstable because | the supply of oil is inelastic. |
| Suppose a professional basketball game is to be played at a downtown urban arena, which increases demand for parking on the night of the game. If the urban area has limited ability to create additional parking during periods of peak demand, then | the supply of parking will be more inelastic and the price of parking will increase by a relatively large amount the night of the game. |
| Bringing oil to the market is a relatively long and costly process. The whole process from exploration to pumping significant amounts of oil can take years. What does this indicate about the price elasticity of the supply of oil? | The elasticity coefficient is likely to be low and supply is highly price inelastic. |
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