L5 - Economics 101:Principles of Microeconomics Professor...

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Economics 101:Principles of  Microeconomics Professor Jo Hertel Lecture 5: Elasticities The price elasticity of demand The uses of elasticities Price elasticity of demand and revenue Price elasticity of supply Income elasticity of demand Cross-price elasticity of demand
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  2 R R Reminder: elasticities and taxes price quantity 40 80 120 160 200 240 4 8 12 16 20 S price quantity 40 80 120 160 200 240 4 8 12 16 20 S $4 tax $4 tax D D D’ D’ E 2 E 1 p s = p c p s supply and demand elastic: large behavior change, small tax revenue E 1 E 2 supply and demand inelastic: small behavior change, large tax revenue
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  3 The price elasticity of demand (1) ‘Law of Demand’: the quantity demanded decreases as the price increases. The question is, how much does quantity react to the price change? The price elasticity of demand measures the relative change in quantity demanded, proportional to the relative change in price. Price elasticity of demand = % change in quantity demanded % change in price Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition
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  4 Why the bother with percentages? price quantity (in 1000 of gallons ) 2 3 4 3.5 Madison market for milk total change in q total change in p = 500 1 = 500 price quantity (in mio of gallons ) 2 3 4 3.5 US market for milk total change in q total change in p = 0.5 mio 1 = 0.5 mio Price elasticity of demand = % change in quantity demanded % change in price Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition
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  5 Conventions with describing  the  price elasticity of demand (definition  slide!) Demand is elastic if the price elasticity of demand is greater than 1: e p >1 Demand is inelastic if the price elasticity of demand is less than 1: e p <1 Demand is unit elastic if the price elasticity of demand is exactly 1: e p =1 % change in quantity > % change in price! % change in quantity < % change in price! % change in quantity = % change in price! e p = % change in quantity % change in price
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  6 Two Examples p q D 1.00 1.20 1,000 900 A 20% increase in price… … generates a 10% decrease in the quantity demanded, so e p =0.5 q p D 1.00 1.20 1,000 600 A 20% increase in price… … generates a 40% decrease in the quantity demanded, so e p =2.0 Price elasticity of demand = % change in quantity demanded % change in price Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition inelastic demand elastic demand
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