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# INTRODUCTION TO MICROECONOMICS ECON 201

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This 6 page Class Notes was uploaded by Verner Kilback on Monday October 19, 2015. The Class Notes belongs to ECON 201 at Oregon State University taught by Staff in Fall. Since its upload, it has received 39 views. For similar materials see /class/224544/econ-201-oregon-state-university in Economcs at Oregon State University.

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Date Created: 10/19/15

Econ 201 Lecture 8 Price Elasticity of Demand measure of the responsiveness of quantity demanded to changes in price Highly responsive quotelasticquot Highly unresponsive quotinelasticquot Price elasticity of demand The percentage change in the quantity demanded that results from a one percent change in price Example 81 If a 1 percent rise in the price of shelter caused a 2 percent reduction in the quantity of shelter demanded the price elasticity of demand for shelter would be 2 The price elasticity of demand will always be negative or zero because price changes always move in the opposite direction from changes in quantity demanded For convenience we usually drop the negative sign and speak of price elasticities in absolute value terms The demand for a good is said to be elastic with respect to price if its price elasticity is more than 1 The demand for a good is inelastic with respect to price if its price elasticity is less than 1 Demand is unit elastic with respect to price if its price elasticity is equal to 1 Unit elastic Inelastigi ic 0 1 2 3 A more general formula for price elasticity Let P the current price of a good Q the quantity demanded at that price AP a small change in the current price and AQ the resulting change in the quantity demanded Elasticity percentage change in quantity percentage change in price AQQAP 3 A Geometric Interpretation of Price Elasticity P P P AP I Elasticity AQQAPP AQAP P Q APAQ the slope of the demand curve so A AP s ope Elasticity PQlslope Example 82 Find the price elasticity of demand at point A on the demand curve below slope 105 2 so 1slope 12 PQ at point A 43 So elasticity PQ 1slope 23 a 3 b 2 c 05 d 025 e 13 In the diagram below the absolute value of the price elasticity of demand at point D is equal to 100 75 50 25 50 100 150 200 Q Elasticity PQ1slope 25150200100 13 For straightline demand curves Price Slope is the same at every point so 1slope is also the same at every point The ratio PQ declines as we move downward along the demand curve So elasticity which equals PQ1slope declines as we move downward along a straightline demand curve Two polar cases P Perfectly elastic P Perfectly inelastic demand elasticity 00 demand elasticity 0 D D Q 39 Q The UnitFree Property of Elasticity Q Why measure priceresponsiveness with elasticity which is relatively complex rather than with the slope which is relatively simple A Because elasticity is unitfree whereas slope is not P 55 gallon Slopezooz P ounce 003125 S ope000015625 00234375 elasticity3 elasticity3 50 Q Q gallonsday 50 gallonsday Some Representative Elasticity Estimates Good or Service Price Elasticity green peas 2 8 electricity 12 beer 12 movies 09 air travel foreign 08 shoes 07 theater opera 02 Elasticity and Total Expenditure quotWill more be spent on the product if we sell more units at a lower price or fewer units at a higher pricequot Example 83 Suppose you are the administrator in charge of setting tolls for the Golden Gate Bridge At the current toll of 1trip 100000 trips per hour are taken across the bridge 1f the price elasticity of demand for trips is 20 what will happen to the number of trips taken per hour if you raise the toll by 10 percent A 10 percent increase in price will produce a 20 percent reduction in quantity Thus the number of trips will fall to 80000hr39 Total expenditure at the higher toll will be 80000 tripshI110trip 88000hr39 Note that this is smaller than the total expenditure of 100000hr39 that occurred under the 1 toll Example 84 Now suppose that the price elasticity had been not 20 but 05 How would the number of trips and total expenditure then be affected by a 10 percent increase in the toll This time the number of trips will fall by 5 percent to 95000hr39 which means that total expenditure will rise to 95000 tripshr110trip 104500hr39 If your goal as an administrator is to increase the total revenue collected from the bridge toll you will need to know something about the price elasticity of demand for trips before deciding whether to raise the toll or to lower it 4 A price reduction will increase total revenue if and only if the price elasticity of demand is greater than 1 An increase in price will increase total revenue if and only if the price elasticity of demand is less than 1 Elasticity gt 1 A price reduction increases total expenditure a price increase reduces it Elasticity 1 Total expenditure is at a maximum Elasticity lt l A price reduction reduces total expenditure a price increase increases it Q If demand is A price increase will A price reduction will reduce total increase total expenditure expenditure elastic a gt 1 E il x x increase total reduce total expenditure expenditure in el asti c s lt 1 x Example 85 What happens to total expenditure on shelter when the price is reduced from 12sq yd to 10sq yd Price sq yd Reduction in expenditure from sale at a lower price Increase in expenditure from additional sales antit s dswk 0246810121416Qu 1y When price goes down total expenditure will rise fall if the gain from sale of additional units is larger smaller than the loss from the sale of existing units at the lower price 5 A director of a big bus company said quotFor each 1 percent fare hike we lose 02 percent of our ridersquot We can conclude that a a fare increase will increase total revenue b demand for bus service will go up as fares increase c demand is price elastic d a 10 percent fare hike will produce a 20 percent reduction in riders e the price elasticity is 5 We are told that when APP 1 AQQ 02 Elasticity AQQ APP 02 inelastic So answer a is correct Determinants of Price Elasticity of Demand OSubstitution Possibilities Vaccine against rabies no good substitutes highly inelastic Salt no good substitutes highly inelastic Morton39s salt perfect substitutes highly elastic Morton39s salt at Wegm an s still more elastic 0Budget Share Items that occupy a large share of a consumer39s budget tend to have higher price elasticity of demand Example price elasticity of demand for cigarettes higher for teenagers than for adults 0Time Because substitution takes time demand is more elastic in the long run than in the short run THE PRICE ELASTICITY OF SUPPLY The percentage change in quantity supplied that occurs in response to a one percent change in price price elasticity of supply AQQAPP PQxAQAP Since AQAP is the reciprocal of the slope of the supply curve we have Elasticity of supply PQxlslope which is the same as the equation for price elasticity of demand Price and quantity are always positive as is the slope of the typical supply curve which implies that price elasticity of supply will be a positive number at every point Example 86 Find the price elasticity of supply at point A on the supply curve shown P 39 rlce B S 3 AP AQ 100 150 Quantity The slope of this supply curve is 150 so the reciprocal of this slope is 50 Using the formula this means that the price elasticity of supply at A is 2 100x50 l The corresponding expression at B 3 150x50 yields exactly the same value Indeed because the ratio PQ is the same at every point along the supply curve shown price elasticity of supply will be exactly one at every point along this curve The special property that explains why price elasticity equals one at every point along the supply curve in Example 66 is the fact that the supply curve was a straight line through the origin r movements along any such line both price and quantity always change in exactly the same proportion Elasticity is not constant however along straightline supply curves like the one below which does not pass through the origin Although the slope of this supply curve is equal to 1100 at every point the ratio PQ declines as we move to the right along the curve Elasticity at A is equal to 2100x100 2 and declines to 3200x100 32 at B Price B S 3 AP AQ 100 200 Quantity Determinants of Supply Elasticity Flexibility of inputs Mobility of inputs Ability to produce substitute inputs Time

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