D curve: relatively steep
P P1 P2 D P falls by 10% Q
Consumers’ price sensitivity: relatively low
Elasticity: <1
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Q1 Q2
Q rises less than 10%
ELASTICITY AND ITS APPLICATION
Demand for your websites
P
$250 $200 B A D 8
CHAPTER 5
end value – start value x 100% start value
Going from A to B, the % change in P equals ($250–$200)/$200 = 25%
So, we instead use the midpoint method:
end value – start value x 100% midpoint
Using the midpoint method, the price elasticity of
demand equals
40/22.2 = 1.8
CHAPTER 5
ELASTICITY AND ITS APPLICATION
3
Price Elasticity of Demand
Price elasticity of demand Percentage change in Qd
=
Percentage change in P
P P rises P2 by 10% P1 D Q2 Q1 Q
D 8
CHAPTER 5
Demand for your websites
P
$250 $200 B A
12
From B to A, P falls 20%, Q rises 50%, Q elasticity = 50/20 = 2.50
6
ELASTICITY AND ITS APPLICATION
Calculating Percentage Changes
A scenario…
You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you’re thinking of raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase?
12
“Perfectly inelastic demand” (one extreme case)
% change in Q Price elasticity = = of demand % change in P 0% 10%
D
=0
D curve: vertical
P P1 P2 P falls by 10%
Why?
CHAPTER 5
ELASTICIT:
Rice Krispies vs. Sunscreen
EXAMPLE 2:
“Blue Jeans” vs. “Clothing”
EXAMPLE 3:
Insulin vs. Caribbean Cruises
Q
12
ELASTICITY AND ITS APPLICATION
5
Calculating Percentage Changes
Problem: The standard method gives different answers depending on where you start. From A to B, P rises 25%, Q falls 33%, elasticity = 33/25 = 1.33
CHAPTER 5
ELASTICITY AND ITS APPLICATION
11
The Variety of Demand Curves
The price elasticity of demand is closely related to the slope of the demand curve.
8
What determines price elasticity?
To learn the determinants of price elasticity, we look at a series of examples. Each compares two common goods. In each example:
16
“Perfectly elastic demand” (the other extreme)
any % % change in Q Price elasticity = infinity = = of demand 0% % change in P
D curve: horizontal
P P2 = P1
Example:
Price elasticity of demand equals
15% = 1.5 10%
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Q falls by 15%
4
ELASTICITY AND ITS APPLICATION
Calculating Percentage Changes
Standard method of computing the percentage (%) change:
Consumers’ price sensitivity: 0
Elasticity: 0
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Q1 Q changes by 0%
Q
ELASTICITY AND ITS APPLICATION
13
“Inelastic demand”
< 10% % change in Q Price elasticity <1 = = of demand 10% % change in P
D curve: relatively flat
P P1 P2 P falls by 10% D Q
Consumers’ price sensitivity: relatively high
Elasticity: >1
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Q1
Q2
Q rises more than 10%
ELASTICITY AND ITS APPLICATION
CHAPTER 5
ELASTICITY AND ITS APPLICATION
7
1: Calculate an elasticity
ACTIVE LEARNING
Use the following information to calculate the price elasticity of demand for hotel rooms: if P = $70, Qd = 5000 if P = $90, Qd = 3000
CHAPTER 5 ELASTICITY AND ITS APPLICATION
1
Elasticity
Basic idea: Elasticity measures how much
one variable responds to changes in another variable. • One type of elasticity measures how much demand for your websites will fall if you raise your price.
14
“Unit elastic demand”
% change in Q Price elasticity = = of demand % change in P 10% 10%
=1
D curve: intermediate slope
P P1 P2 P falls by 10% D
Consumers’ price sensitivity: intermediate
5
Elasticity and its Application
PRINCIPLES OF
MICROECONOMICS
FOURTH EDITION
N. G R E G O R Y M A N K I W
PowerPoint® Slides by Ron Cronovich
© 2007 Thomson South-Western, all rights reserved
The price elasticity of demand depends on:
the extent to which close substitutes are available
whether the good is a necessity or a luxury how broadly or narrowly the good is defined the time horizon: elasticity is higher in the long run than the short run.