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09_Elasticities - Lecture 9 Lecture 9 Elasticities...

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Unformatted text preview: Lecture 9 Lecture 9 Elasticities Elasticities are measures of responsiveness – – – – The response of one variable to changes in another Can be positive or negative If “close” to zero, relative unresponsive If “far” from zero, relatively responsive Calculated as the ratio of two percentage changes: – This is said to be “the elasticity of Y with respect to X” E = (%∆Y)/(%∆X) Consider this hypothetical Consider this hypothetical relationship The elasticity of grades with respect to Study Time/week time spent studying – Likely positive – Ε = (%∆G)/(%∆S) > 0 – If E > 1, we say “elastic” If (relatively responsive) (relatively – If E < 1, we say “inelastic” If (relatively unresponsive) (relatively 0 Grade Another hypothetical example Another hypothetical example The elasticity of grades with respect to alcohol consumption Alcohol Consumption/week – Likely negative – E = (%∆G)/(%∆W) < 0 – If |E| >1, we say “elastic” (relatively responsive) (relatively – If |E| < 1, we say “inelastic” If (relatively unresponsive) (relatively 0 Grades Real elasticity computation regarding alcohol: a 10% price Real increase leads to a 5.8% decline in traffic fatalities. increase The (own) Price Elasticity of Demand The (own) Price Elasticity of Demand Measures the responsiveness of quantity demanded to changes in the price of the good itself – Defined thus: ε = [(%∆in quantity demanded)/(%∆ in price)] Or ε = [(%∆Qd)/(%∆P)] Or Note that ε must be negative (Law of Demand) Note must Sometimes convenient to refer to the absolute Sometimes value |ε| so we can ignore the negative sign value so Examples of demand elasticities Examples of demand elasticities Suppose a 10% rise in the price of a good causes a 20% reduction in the quantity demanded in a measured time period ε = ­20%/+10% = ­2 Suppose a 15% decline in the price of a good causes a 10% increase quantity demanded in a measured time period ε = +10%/­15% = ­0.67 Categories of demand elasticities Categories of demand elasticities “Elastic” demand Elastic demand – |ε| > 1 – Qd relatively responsive to price Qd relatively – Price change leads to spending Price change in opposite direction change Price Demand – Thus, Higher price → lower spending Lower price → higher spending Q/time When is a good likely to have When is a good likely to have sensitive elasticity? If a product is not unique so it has many close substitutes and consumers know about the alternatives. When buyers’ expenditures are a large part of their income so they shop more carefully. The product is an input in production that is price sensitive, so the producer will keep close watch on input prices. Demand elasticity . . . Demand elasticity “Inelastic” demand Inelastic demand – |ε| < 1 Price – Qd relatively unresponsive to price Qd relatively – Price change leads to spending Price change in same direction change – Thus, Higher price → higher spending Lower price → lower spending Demand Q/time When is elasticity likely to be When is elasticity likely to be less sensitive? When comparisons to substitutes is difficult. Door­to­door sales. Complex products that are hard to compare. When consumers pay only a fraction of the cost —when insurance covers most of the bill. When the cost of switching would be high—when the consumer has developed expertise in using a product. When a product is used with another product that the consumer is committed to—such as ink cartridges. Some uses of demand elasticities Some uses of demand elasticities More Accurate Pricing – Use of UPC bar codes to aid in pricing products (e.g., Wal­Mart and other retailers data) Trying to Maximize Profits – A higher price is no guarantee of higher revenue (will study below) Plan ahead – If you think you know about future trends — plan more precisely (hotels and conventions) Real World Elasticities Real World Elasticities (all negative numbers) Product or Service Lamb Bread Coffee Tires Auto Repairs Theatre & Opera 0.2 Movies Foreign Travel by U.S. Residents 0.1 Public Transportation Electricity Jewelry & Watches Alcohol and Tobacco Recreation Estimated Elasticity Short Run Long Run 2.65 0.15 0.16 0.8 1.4 0.9 0.6 0.1 0.4 0.3 1.1 ­­ ­­ ­­ 1.2 2.4 3.7 1.2 1.8 0.6 0.9 3.5 0.3 1.8 Example Example The Macon Telegraph sponsored a road race for charity. Entry fee was $12 per runner. 1,600 runners participated. Fees were $19,200. To raise more money, fee raised to $20 the next year. Same weather. 900 runners participated. Fees $18,000. Price elasticity (arc) of demand? 1.12 Example Example ESPN football videogame: 2003 price: $40 2004 price: $20 (50% decrease) 2003 Qd: 400,000 2004 Qd: 2.7 million (575% increase) E = 575%/50% = 11.5 Note: major competitor, Madden football, did not change price; its sales rose less than 10% from 2003 to 2004 Example Example Kelkoo.com, owned by Yahoo!, is 3rd largest retail website in UK; 10 million users per month. Data for sales of PDAs in 100 days in 2003: 18 models sold by 19 retailers. If click on one model, may get prices offered by 12 retailers. Price elasticities of demand for various models offered by different retailers ranged from ­1.75 to ­14.7. Average was ­4.6. Lowest price retailer saw demand rise 60.4%. Cross­price elasticities Cross­price elasticities Cross­price elasticity of demand – Measure of responsiveness of demand to changes in prices of substitutes and complements: (%∆ Dx) / (%∆ Py) – If positive, goods are substitutes, by definition – If negative, goods are complements, by definition Estimates of Cross Elasticities Estimates of Cross Elasticities These are estimates of cross elasticities of various goods (goods that are substitutes) in the U.S.: 0.20 (weak substitutes) 0.20 0.44 0.81 (strong substitutes) Electricity and natural gas Beef and Pork Natural gas and fuel oil Margarine and butter Income Elasticity Income Elasticity Income elasticity of demand (%∆ Dx) / (%∆ l) – Measure of responsiveness of demand to changes in income: – If positive, good is normal, by definition (>1, superior) – If negative, good is inferior, by definition Estimates of Income Elasticities Estimates of Income Elasticities Estimates of income elasticities from different studies in the U.S.: Flour ­0.36 (inferior good) Margarine ­0.20 (inferior good) Milk and cream 0.07 (little change) Beef 0.51 to 1.05 Apples 1.32 Dental Services 1.41 (highly responsive to Restaurant meals 1.48 income increases) Personal air travel 1.8 Endless Elasticities Endless Elasticities Many measures of elasticity can be performed simultaneously. The demand for cans of Coke varies across state. Even when price is the same, sales are higher in Southern states (Georgia has highest consumption) compared to Northern (ND lowest). What factors could you consider? Elasticity Elasticity A study of gasoline sales found that price elasticity for regular gasoline was ­.6 and for premium gasoline was ­.3. What does that mean? ...
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