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# ECO Week 4 - Day 2 Lecture Notes Eco 2023

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This 12 page Class Notes was uploaded by Erika Huber on Friday September 16, 2016. The Class Notes belongs to Eco 2023 at University of Florida taught by Mark Rush in Fall 2016. Since its upload, it has received 20 views. For similar materials see Principles of Economics: Microeconomics in Economics at University of Florida.

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Date Created: 09/16/16

9/14/16 ECO 2023 Week 4 – Day 2 Lecture Notes Chapter 4 Elasticity Elasticity An example with a qualitatively the same answer…. But a BIG quantitative difference… The key word: RESPONSIVENESS Graph A Price Graph B Price S1 S1 S S D D Quantity Quantity - Price increases by a little. - Price increases by a lot. - Quantity demanded decreases by a lot. - Quantity demanded decreases by a little. STONG RESPONSE! WEAK RESPONSE! Definition of the price elasticity of demand Slope = Rise = P The slope…? Run Q Price Price $21 2100 cents 1900 cents $19 Demand Demand 9 11 Quantity 9 11 Quantity Slope = Rise = P Slope = Rise = P Run Qd Run Qd Slope = 21-19 = 2 = -1 Slope = 2100-1900 = 200 = -100 9-11 -2 9-11 -2 The slope changes when you change units. These two demand curves are exactly the same but because we used different units (dollars vs. cents), when we calculate the slope of each, we get two different answers. So we cannot use the slope formula. Something better: Price Elasticity of Demand ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????????????????? ???????????????????????????????? %???????? E = | ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????? | = |%???? | Elasticity and responsiveness How does the formula display “responsiveness”? - If a Big Mac’s price changes from $3 to $4, that’s a big percentage change. - If a BMW’s price changes from $30,000 to $30,001, that’s a small percentage change. Let’s look at more examples: - One example: E = 2.0 E = 2.0 Price: increases by 10% Quantity demanded: decreases by ? *Let’s use the Price Elasticity of Demand formula to solve this! E =|%???????? | = E ∗ %P = %Qd %???? Answer: The quantity 2 * 10% = 20% demanded decreased by 20% o Because the price decreased, we know that the quantity demanded is going to decrease. This is why there is an absolute value sign because we don’t need a negative or positive sign. In this case, we know that we are solving for the percentage the quantity demanded decreased by. - Another example: E=0.5 E = 0.5 Price: increases by 10% Quantity demanded: decreases by ? %???????? E =| %???? | = E ∗ %P = %Qd 0.5 * 10% = 5% Answer: The quantity demanded decreased by 5% - A last example: E=1.0 E = 1.0 Price: increases by 10% Quantity demanded: decreases by ? %???????? E =| %???? | = E ∗ %P = %Qd 1 * 10% = 10% Answer: The quantity demanded decreased by 10% Elasticity: more definitions Which brings us to some more definitions. Elastic: when the elasticity exceeds 1.0 (strong response) Unit elastic: when the elasticity equals 1.0 Inelastic: when the elasticity is less than 1.0 (weak response) Elasticity Midpoint Formula Back to the formula for some algebra: Midpoint Formula How is this formula used? *Not to scale Price $21 A To find % change of quantity demanded $20 C from point A to point B: 9−11 2 | 9 | =9= 22% To find % change of $19 B quantity demanded from point B to point A: 11−9 2 | 11 | 11 = 18% Demand 9 10 11 Quantity Elasticity differs between whether you go up or down the demand curve. So you have to use the Midpoint formula to find the percentage change of the quantity demanded. Midpoint formula: ???????? ???????? So for the example above, we use the midpoint (point C) for the price and quantity E = | ???? | demanded, and points A & B to find the change in price and quantity demanded. ???? 9−11 2 ( 10 ) (10) 2 20 40 E = | 21−19 | = |2 | =10 * 2 = 20= 2 ( 20 ) (20) You get the same answer! And if you do it the other way around… 11−9 2 ( 10 ) (10) 2 20 40 E = | 19−21 | = |2 | = * = = 2 ( 20 ) (20) 10 2 20 Elasticity Along a Linear Demand Curve Back to the formula for still… some more algebra… ???????? ???????? ???????? ???? ????????∗???? ????????∗???? ???????? ???? E = | ????| = |???????? ∗ ???? | = ????????∗???? | = ????∗???????? | = |???? ∗ ???????? | ???? And because: Slope = Rise = P Run Qd ???????? ???? 1 ???? | ∗ | = | ∗ | ???? ???????? ???????????????????? ???????? WHY???? To show you a result… ???? 9−5 4 Slope ????????= 1−5= −4 = -1 Price 10 | 1 ∗ ???? |= |1 ∗ | = 9 = elastic ???????????????????? ???????? −1 1 9 8 7 | 1 ∗ ???? |= |1 ∗ | = 1 = unit elastic ???????????????????? ???????? −1 5 6 5 4 | 1 ∗ ???? |= | 1 ∗ | = 0.11 = inelastic ???????????????????? ???????? −1 9 3 2 1 Demand 0 Quantity 1 5 9 Conclusion: When moving downward along a downward sloping, linear demand curve, the elasticity of demand falls in size. - Why? - It’s just the way it is! There are demand curves where the elasticity doesn’t change. They would be hyperbole. Elasticity: Intuition Back to some intuition and more definitions Inelastic Elastic (Unresponsiveness – (Responsiveness – Weak Response) String Response) E < 1 E > 1 Perfectly Inelastic Perfectly Elastic E = 0 E = Elasticity: The Total Revenue Test Total Revenue Test: Total revenue = P * Qd EX: pizza P=$5 Q=2,000 TR= $5 * 2,000= $10,000 If they raise price by $1… P=$6 Q=1,000 TR= $6 * 1,000= $6,000 OR P=$6 Q=1,800 TR=$6 * 1,800= $10,800 Elasticity determines what happens to a firm’s total revenue. Total revenue test: - If your demand is elastic, when you raise your price, quantity demanded falls a lot, and total revenue decreases. - If your demand is elastic, when you lower the price, quantity demanded rises by a lot, and total revenue increases. - If demand is inelastic, when you raise the price, quantity demanded decreases but only by a little bit, so total revenue increases. - If demand is inelastic, when you lower the price, quantity demanded increase but only by a little, so total revenue decreases. - If demand is unit elastic and price increases, quantity demand decreases by the same amount, so total revenue stays the same. - If demand is unit elastic and price decreases, quantity demanded increases by the same amount, so total revenue stays the same. That’s a lot of words, so here’s a flow chart to make it a bit easier: P Qd = TR E > 1 P Qd = TR P Qd = TR E = 1 P Qd = TR P Qd = TR E < 1 P Qd = TR Economics of Elasticity What factors influence the size of the elasticity? 1. Number of substitutes: the larger the number of substitutes, the larger the elasticity of demand. Luxury versus necessity Luxury: lots of substitutes (EX: Caribbean cruise); more responsive elasticity Necessity: few substitutes (larger demand) (EX: toothpaste); less responsive elasticity Time passed since the price changed As time passes, you have more time to find more substitutes More substitutes are available and you can make more changes as time passes Elasticity increases as more time passes Lots of Substitutes: more time; larger elasticity Few Substitutes: less time: smaller elasticity Narrow “definition” of the good versus broad “definition” of the good Lots of Substitutes: narrow definition o EX: Pepsi max – Substitutes: Coke Zero, Diet Pepsi, Diet Coke, Diet Mountain Dew, water, juice, coffee o Same substitutes as wider definition plus more! Few Substitutes: wider definition o EX: soda Substitutes: water, juice, coffee 2. The fraction of the budget spent on the good: the larger the fraction of the budget spent on the good, the larger the elasticity of demand EX: demand for housing vs demand for salt o Housing: $500/month Price doubles= $1,000 You notice this difference and change you housing options, move to a smaller place or lower quality place high response, large elasticity o Salt: 10 cents/month Price doubles= 20 cents You don’t really care, buy same amount of salt low response, little elasticity Price elasticity E = |???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????????????????? ???????????????????????????????? |= |%???????? | ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????? %???? Income elasticity of Demand The percentage change in the quantity demanded caused by a percentage change in income ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????????????????? ???????????????????????????????? %???????? E INC= ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????????? = |%???????????? | Why no absolute value sign? Because sign determines if it’s a normal or inferior good. If E INC = a positive Income Demand = Normal Good number, it’s a normal (+) (+) good. If E INC = a negative number, it’s an inferior Income Demand = Inferior Good (+) (-) good. Cross Elasticity of Demand The percentage change in the quantity demanded caused by a percentage change in the price of another good. How does the quantity demanded of one good respond to change in price of another good? ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????????????????? ???????????????????????????????? %???????????? E CROSS = ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????? ???????? ????????????????ℎ???????? ???????????????? = | %???????? | Why no absolute value sign? Because sign tells us something. Sign determines if products are substitutes or compliments. Price (j) Quantity demanded (i) = Substitutes If ECROSS = a positive (+) (+) number, the products are substitutes. Price (j) Quantity demanded (i) = Compliments If ECROSS = a negative (+) (-) number, the products are compliments. Price Elasticity of Supply The percentage change in the quantity supplied caused by a percentage change in price. ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????????????????? ???????????????????????????????? %???????? E S= ???????????????????????????????????????? ????ℎ???????????????? ???????? ???????????????????? = |%???? | Why no absolute value sign? - Because of the Law of Supply

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