Lecture8--PRICEELASTICITYOFDEMAND

Lecture8--PRICEELASTICITYOFDEMAND - Course Examination 1...

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Unformatted text preview: Course Examination 1 sDate: Monday, September 29 s Place: Here (Nelson Auditorium) s Time: 11:20 a.m. - 12:15 p.m. s Coverage: Chapters 1- 6 s Format: 25 multiple-choice questions s Remember to bring a number 2 pencil to the Exam-- Make-ups allowed within one week only with medical or other valid excuse. Price Elasticity of Demand A measure of the sensitivity of changes in quantity demanded to changes in price of a good or service Calculating Price Elasticity of Demand: Percentage change in quantity demanded Ed= Percentage change in price = Q/Q P/P Price = P Q Q P P Q 0 Quantity Demanded Categorizing Elasticity of Demand Demand is inelastic if the value of price elasticity of demand (ignoring the sign) is between zero and 1. s Demand is unit elastic if the value of price elasticity of demand (ignoring the sign) is 1. s Demand is elastic if the value of price elasticity of demand (ignoring the sign) exceeds 1. s Although slope is constant along a linear demand curve, price elasticity of demand varies from zero to - infinity along the curve = Q/Q P/P Price = P Q Q P Elasticity = - infinity P Q 0 Elasticity = zero Quantity Demanded Elasticity And Slope Both slope and elasticity are measures of responsiveness. Slope is expressed in units such as \$ per bushel. Elasticity is a pure number s Elasticity is related to slope in the following way: Elasticity = (P/Q)(1/slope) s Because the slope of demand curves is negative, price elasticity of demand is a negative number s Some Examples: s 1. Suppose a 20% increase in the price of gasoline causes a 10% decline in the quantity demanded. The price elasticity of demand is -10%/20% = -0.5 Some Examples: s s 2. Suppose the price elasticity of demand for men's suits is -3. How much of a price cut will result in a 30% increase in quantity demanded? The answer is -10% because: 30%/-10% = -3 A Real World Example: In 1991 Apple computer lowered the prices of its Macintosh machines by an average of 50% s The resulting increase in quantity demanded amounted to 85% s The price elasticity of demand for Macs at that time was therefore 85%/-50% = -1.7 s A perfectly inelastic demand Price Demand Quantity Demanded A perfectly elastic demand Price Demand Quantity Demanded Total Revenue s s s Total Revenue = Total Expenditure TR = PQ Total Revenue taken in by sellers can be P represented by the area whose height is market price and whose length is quantity sold. Price Supply Demand Q Quantity What happens to total revenue when market price goes up? s s The increase in price contributes to higher total revenue However when the P' price goes up quantity P demanded will fall. A decrease in quantity sold will contribute to decreased revenue Price P Q TR? New Supply Supply Demand Q' Q Quantity Price Elasticity of Demand and Total Revenue s s s If you know the price elasticity of demand of a product you can forecast the effects of price changes on total revenue: If demand is elastic the percentage change in quantity demanded will exceed the percentage change in price that caused it (ignoring direction of change) If demand is elastic the positive effect of a price increase on revenue will be offset by the negative effect of the fall in quantity demanded. Total revenue will therefore fall. Price Elasticity of Demand and Total Revenue If demand is inelastic a price increase will cause total revenue to rise s If demand is unit elastic any change in price will have no effect on total revenue s To test your understanding of the relationship between changes in price, elasticity, and total revenue, work out the effects of a price decrease on revenue in cases of elastic, inelastic, and unit elastic demand s The equation of this demand curve is PQ = k s s Question: What is the price elasticity of demand at any point on this demand curve? Answer: Price elasticity is always -1 because no matter what happens to price, quantity adjusts to make total expenditure (or revenue) constant P Demand Q ...
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This note was uploaded on 10/13/2008 for the course EC 205 taught by Professor Hymen during the Fall '08 term at N.C. State.

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