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54 Cards in this Set
- Front
- Back
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a measure of how responsive consumers are to change in price
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price elasticity of demand
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Compare the elasticity demand for Cigarettes vs. Coke.
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More elasticity demand for Coke
Coke has more substitutes than cigarettes |
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Computation of price elasticity of demand
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E = %△Q^D / %△P
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Compute the price elasticity of demand in the following examples:
a) A drugstore notices that when the price of an antibiotic went up by 20%, the quantity sold of the antibiotic decreased by only 2% |
E = -2 / 20 = -0.1
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Compute the price elasticity of demand in the following examples:
b) A restaurant manager notices that the restaurant sold 20% more meals in November (than in October) when there was a 10% discount promotion. |
E = 20 / -10 = -2
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When the price of gasoline increases from $2 to $4, John reduces his consumption from 14 to 10 gallons per month. Compute his demand elasticity. Interpret this elasticity.
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E = ((10-14)/12) / (4-2)/3)) = (-4/12) / (2/3) = (-1/3) / (2/3) = -0.5
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A 1% increase in price induces, no change in quantity demanded
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perfectly inelastic demand
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A 1% increase in price induces, a less than 1% decrease in quantity demanded
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inelastic demand
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A 1% increase in price induces, a more than 1% decrease in quantity demanded
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elastic demand
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A 1% increase in price induces, an infinite decrease in quantity demanded
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perfectly elastic demand
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How price elastic would you expect the demand for the following goods to be?
a) essential medicine |
Perfectly inelastic demand
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How price elastic would you expect the demand for the following goods to be?
b) cigarette |
Inelastic demand
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How price elastic would you expect the demand for the following goods to be?
c) Pepsi |
Elastic demand
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How price elastic would you expect the demand for the following goods to be?
d) Farmer Smith's corn |
Perfectly elastic demand (horizontal curve)
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For linear demand curves, the _______ the price, the more _______ the demand
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greater; elastic
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Is the price elasticity of demand equal to the slope of the demand curve? Why are they different?
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No.
Slope = ∆P / ∆Q^D E = (1 / Slope) x (Average P / Average Q) |
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What explains the price elasticity of demand for the following goods?
a) E = -2.5 for Pepsi |
Because of substitute goods
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What explains the price elasticity of demand for the following goods?
b) E = -0.1 for hospital services |
Not many substitutes
Very essential |
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What explains the price elasticity of demand for the following goods?
c) E = -0.1 for eggs |
Its so cheap, no one cares
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What explains the price elasticity of demand for the following goods?
d) E = -0.2 for gasoline in the short-run, but E = -1.5 for gasoline in the long-run (after some years) |
Time to adjust
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Determinants of price elasticity of demand:
Greater substitutability --> |
More elastic demand
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Determinants of price elasticity of demand:
Greater necessity --> |
Less elastic demand
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Determinants of price elasticity of demand:
Greater budget burden --> |
More elastic demand
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Determinants of price elasticity of demand:
Greater time horizon --> |
More elastic demand
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Do you expect the following goods/services to have an elastic demand? Explain.
a) Restaurant meals |
Yes. You can eat at home (substitute)
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Do you expect the following goods/services to have an elastic demand? Explain.
b) Milk |
No. Not many good substitutes and is very cheap
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Do you expect the following goods/services to have an elastic demand? Explain.
d) Foreign travel |
Yes. Good substitutes, expensive, and not necessary
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Which good/service do you expect to have a more price-elastic demand:
b) Coke or cola drinks in general? |
Coke because there is more substitutes
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In the previous problem, when prices increase, why does the revenue of cigarette sales increase, but the revenue of Coke sales decreases?
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A price change has two effects:
1. Higher price --> Higher revenue per unit 2. Higher price --> Less amount sold --> Less revenue |
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Mnemonics:
If demand is inelastic |
Revenue ^ = Price ^ x Quantity V
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Mnemonics:
If demand is elastic |
Revenue V = Price ^ x Quantity V
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Over time, farming technology developed drastically, allowing farmers to produce much more at lower costs. However, farmers ended up losing revenues. Why?
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Price of Food = V
Revenue V = Price V x Quantity ^ Elastic Demand |
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Suppose you manage a coffee shop and you currently charge $1.50 per cup of coffee. The rent of the coffee shop will increase next year by $2,000 and you need to do something to increase revenues to cover the increased rent. Suppose other costs are more or less constant regardless of whether you sell more or fewer coffees. Should you increase or decrease the price of coffee per cup?
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Price of Coffee = $1.50
P = V Revenue ^ = Price V x Quantity (Alot) ^ |
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a measure of how responsive suppliers are to changes in price
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price elasticity of supply
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In which case below would suppliers be more responsive to an increase in price?
Supply of land in an island or Supply of pizzas in the U.S. |
Supply of pizzas in the U.S.
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Computation of price elasticity of supply
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E = %∆Q^S / %∆P
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When the world demand for oil increased between 2004 and 2007, the price of oil increased from $60 to $100. The quantity supplied of oil increased from 75 to 85 millions of barrels per day. Compute the price elasticity of supply of oil during this period based on the numbers above.
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E = ((85-75)/80) / (100-60)/80)) = (1/8 / 1/2) = 2/8 = 1/4
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A 1% increase in price induces, no change in quantity supplied
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perfectly inelastic supply
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A 1% increase in price induces, a less than 1% increase in quantity supplied
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inelastic supply
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A 1% increase in price induces, a more than 1% increase in quantity supplied
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elastic supply
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A 1% increase in price induces, an infinite increase in quantity supplied
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perfectly elastic supply
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Explain why:
a) the supply of land in an island is perfectly inelastic |
No matter the price, the amount of land is the same
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Explain why:
b) the supply of oil (petroleum) is inelastic (at least in the short run) |
It is not easy to find oil and extract oil
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Explain why:
c) the supply of construction material in a town is very elastic |
Not very difficult to find construction material in a town
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Explain why:
d) the U.S. supply of copper is less elastic than the world supply of copper |
The U.S. can import from other countries, but you can't import from other worlds
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Explain why:
e) the world supply of cars is inelastic in the short run, but elastic in the long run (after many years) |
When price of cars goes up, in the short-run there is little change, whereas in the long run, the supply can respond
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greater availability of inventories --> ____ elastic supply
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more
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greater unused capacity --> ____ elastic supply
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more
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greater availability of resources --> ____ elastic supply
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more
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greater time horizon for expansion of PPF --> ____ elastic supply
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more
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Very elastic supply for low production levels when there is large capacity available, but very inelastic supply as production reaches capacity
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typical supply curve
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When there was an increase in demand for houses between 2001 and 2005, the price of houses increased drastically in some areas in the U.S. Use a demand-supply graph and the concept of price elasticity of supply to explain this drastic change in price.
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You can't import houses and it takes time to build a house
Supply is inelastic |
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While housing prices increased drastically in some regions during the 2001-2005 period (by more than 100%), prices decreased later (2006-2008) in those same regions (although staying higher than in 2001). Show that even if demand had not increased, prices should in fact have gone down in the long term.
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Demand increases, price goes down, production goes up
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In 1979, the OPEC reduced the world supply of oil, increasing the price of oil from $10 to $60 at that time, but by 1995 the price was down to $15. Why? Use a demand-supply graph and the concept of price elasticity of demand to explain these price changes.
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Oil has many uses
Demand is inelastic in short-run and elastic in long run |
