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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 doesnt 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

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