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Unformatted text preview: Lecture 5 • What happens if gasoline prices increase by 10%? • Consumption of gasoline falls, but by how much? • This can be explained by elasticity . What is it? • How is it related to the demand curve? • How is it related to revenue and expenditure? Elasticity • Ex. Suppose you design websites for local businesses. • Sell 12 websites per month; charge $200 per website • Suppose your cost rises and you raise the price to $250. • How much less would you sell? Would your revenue increase or decrease? Elasticity • Elasticity measures how much one variable responds to changes in another variable • Numerical measure of the responsiveness of Qs or Qd to one of its determinants • Pr ice elasticity of demand : measures how much the quantity demanded responds to a change in price • Pr ice elasticity of demand = pc. Price elasticity of demand = P Q D Q 2 P 2 P 1 Q 1 P rises by 10% Q falls by 15% 15% 10% = 1.5 Price elasticity of demand = Percentage change in Q d Percentage change in P Example: Calculating Percentage Changes (Standard Method) P Q D $250 8 B $200 12 A Demand for your websites From A to B, P rises 25%, Q falls 33%, elasticity = 33/25 = 1.33 From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50 Calculating percentage changes • We use the midpoint method : • End valuestart value x 100 • Midpoint • Midpoint is the midpoint or the average between the two values • I t doesn’t matter which value you choose as the start or the end: you get the same answer! Calculating the Price Elasticity of Demand • Ex. Use the following infor mation to calculate the pr ice elasticity of demand for hotel r ooms: • I f P= $70, Qd=5000 • I f P= $90, Qd=3000 Determinants of the price elasticity of demand • Availability of close substitutes • Necessities vs Luxuries • Definition of a market • Time horizon Price Elasticity of Demand Br eakfast Cer eal vs Sunscr een • The price of both goods rise by 20%. For which good does the quantity dd. fall the most? Why? • Breakfast cereal has many close substitutes like pancakes, Eggo Waffles, leftover pizza • Sunscreen has no close substitutes Price Elasticity of Demand • I nsulin vs Car ibbean Cr uises • I f the price of both goods rise by 20%, for which good does quantity demanded fall the most? Why?...
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 Fall '09
 OZTURK
 Supply And Demand, PR ICE, Elast icit

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