Week 3 Elasticity

# Week 3 Elasticity - Elasticity(TF Chapter 4 Last week The...

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Elasticity (TF Chapter 4)

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2 Last week… The supply and demand model: Factors that influence demand and supply Market equilibrium Changes in supply and demand and their effect on equilibrium P D S Q
3 Today’s Agenda Price elasticity of demand Explain whether a price change increases or decreases revenue Determinants of the price elasticity of demand Income elasticity of demand Cross-price elasticity of demand Price elasticity of supply

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4 MATHS Know how to: Use fractions Differentiate Interpret “percentage changes”
5 Elasticity Elasticity is a measure of how sensitive an economic variable is to another economic variable There are as many elasticities as pairs of economic variables Let’s start by considering the price elasticity of demand…

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6 Elasticity of Demand Price elasticity of demand A measure of the responsiveness of the quantity demanded of a good to a change in its price (ceteris paribus). The percentage change in quantity demanded in response to a one percentage change in the market price.
7 Elasticity of Demand Suppose you are the manager of a bus service There are empty seats in the buses (excess capacity). The manager decides the price of a bus ride. This price is not determined by the market (it happens sometimes). You wish to increase total revenue. Total Revenue = Price x Quantity

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8 Elasticity of Demand Should you raise the price? If you raise the price, the number of bus trips demanded will fall. The impact on total revenue depends on the elasticity of demand. Let’s consider increasing the price of a bus ride from \$1.00 to \$1.20 with two demand curves with different slopes…
9 Quantity (millions of trips per year) Price (dollars per trip) 1.00 1.20 D a 9.5 10 Revenue loss Revenue gain Steeper Demand and Total Revenue

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10 Quantity (millions of trips per year) Price (dollars per trip) 1.00 1.20 D b 8 10 Revenue loss Revenue gain Flatter Demand and Total Revenue
11 Slope vs. Elasticity In these two examples, we compared the slopes of the demand curves and found different effects on revenue. What is wrong with focusing on the slope? Slope depends on the units of measurement! Elasticity is independent of the units of measurement – it can be used to compare any goods and services.

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12 Importance of the Price Elasticity of Demand Remember comparative statics? We can evaluate the effect on price and
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Week 3 Elasticity - Elasticity(TF Chapter 4 Last week The...

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