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2009South-Western,apartofCengageLearning,allrightsreservedCHAPTERElasticityanditsApplicationEconomicsPRINCIPLESOFPRINCIPLESOFN.GregoryMankiwPremiumPowerPointSlidesbyRonCronovich5Inthischapter,lookfortheanswerstothesequestions:
Whatiselasticity?
Whatkindsofissuescanelasticityhelpusunderstand?
Whatisthepriceelasticityofdemand?
Howisitrelatedtothedemandcurve?
Howisitrelatedtorevenue&expenditure?
Whatisthepriceelasticityofsupply?
Howisitrelatedtothesupplycurve?
Whataretheincomeandcross-priceelasticitiesofdemand?
11ELASTICITYANDITSAPPLICATIONYoudesignwebsitesforlocalbusinesses.Youcharge$200perwebsite,andcurrentlysell12websitespermonth.Yourcostsarerising(includingtheopportunitycostofyourtime),soyouconsiderraisingthepriceto$250.Thelawofdemandsaysthatyouwontsellasmanywebsitesifyouraiseyourprice.Howmanyfewerwebsites?
Howmuchwillyourrevenuefall,ormightitincrease?
Ascenario22ELASTICITYANDITSAPPLICATIONElasticityBasicidea:
Elasticitymeasureshowmuchonevariablerespondstochangesinanothervariable.Onetypeofelasticitymeasureshowmuchdemandforyourwebsiteswillfallifyouraiseyourprice.Definition:
ElasticityisanumericalmeasureoftheresponsivenessofQdorQstooneofitsdeterminants.3ELASTICITYANDITSAPPLICATIONPriceElasticityofDemandPriceelasticityofdemandmeasureshowmuchQdrespondstoachangeinP.Priceelasticityofdemand=PercentagechangeinQdPercentagechangeinPLooselyspeaking,itmeasurestheprice-sensitivityofbuyersdemand.4ELASTICITYANDITSAPPLICATIONPriceElasticityofDemandPriceelasticityofdemandequalsPQDQ2P2P1Q1Prisesby10%Qfallsby15%15%10%=1.5Priceelasticityofdemand=PercentagechangeinQdPercentagechangeinPExample:
5ELASTICITYANDITSAPPLICATIONPriceElasticityofDemandAlongaDcurve,PandQmoveinoppositedirections,whichwouldmakepriceelasticitynegative.Wewilldroptheminussignandreportallpriceelasticitiesaspositivenumbers.PQDQ2P2P1Q1Priceelasticityofdemand=PercentagechangeinQdPercentagechangeinP6ELASTICITYANDITSAPPLICATIONCalculatingPercentageChangesPQD$2508B$20012ADemandforyourwebsitesStandardmethodofcomputingthepercentage(%)change:
endvaluestartvaluestartvaluex100%GoingfromAtoB,the%changeinPequals($250$200)/$200=25%7ELASTICITYANDITSAPPLICATIONCalculatingPercentageChangesPQD$2508B$20012ADemandforyourwebsitesProblem:
Thestandardmethodgivesdifferentanswersdependingonwhereyoustart.FromAtoB,Prises25%,Qfalls33%,elasticity=33/25=1.33FromBtoA,Pfalls20%,Qrises50%,elasticity=50/20=2.508ELASTICITYANDITSAPPLICATIONCalculatingPercentageChangesSo,weinsteadusethemidpointmethod:
endvaluestartvaluemidpointx100%Themidpointisthenumberhalfwaybetweenthestart&endvalues,theaverageofthosevalues.Itdoesntmatterwhichvalueyouuseasthe“start”andwhichasthe“end”yougetthesameanswereitherway!
9ELASTICITYANDITSAPPLICATIONCalculatingPercentageChangesUsingthemidpointmethod,the%changeinPequals$250$200$225x100%=22.2%The%changeinQequals12810x100%=40.0%Thepriceelasticityofdemandequals40/22.2=1.810ELASTICITYANDITSAPPLICATIONACTIVELEARNINGACTIVELEARNING11Calculateanelasticity11Usethefollowinginformationtocalculatethepriceelasticityofdemandforhotelrooms:
ifP=$70,Qd=5000ifP=$90,Qd=300011ELASTICITYANDITSAPPLICATIONACTIVELEARNINGACTIVELEARNING11Answers12Usemidpointmethodtocalculate%changeinQd(50003000)/4000=50%changeinP($90$70)/$80=25%Thepriceelasticityofdemandequals50%25%=2.012ELASTICITYANDITSAPPLICATIONWhatdeterminespriceelasticity?
Tolearnthedeterminantsofpriceelasticity,welookataseriesofexamples.Eachcomparestwocommongoods.Ineachexample:
Supposethepricesofbothgoodsriseby20%.ThegoodforwhichQdfallsthemost(inpercent)hasthehighestpriceelasticityofdemand.Whichgoodisit?
Why?
Whatlessondoestheexampleteachusaboutthedeterminantsofthepriceelasticityofdemand?
13ELASTICITYANDITSAPPLICATIONEXAMPLE1:
Breakfastcerealvs.SunscreenThepricesofbothofthesegoodsriseby20%.ForwhichgooddoesQddropthemost?
Why?
Breakfastcerealhasclosesubstitutes(e.g.,pancakes,Eggowaffles,leftoverpizza),sobuyerscaneasilyswitchifthepricerises.Sunscreenhasnoclosesubstitutes,soconsumerswouldprobablynotbuymuchlessifitspricerises.Lesson:
Priceelasticityishigherwhenclosesubstitutesareavailable.14ELASTICITYANDITSAPPLICATIONEXAMPLE2:
“BlueJeans”vs.“Clothing”Thepricesofbothgoodsriseby20%.ForwhichgooddoesQddropthemost?
Why?
Foranarrowlydefinedgoodsuchasbluejeans,therearemanysubstitutes(khakis,shorts,Speedos).Therearefewersubstitutesavailableforbroadlydefinedgoods.(Therearenttoomanysubstitutesf