SUPPLY AND DEMAND (3.6.2)

Decide if you would purchase each of these items at the indicated price. If yes, raise your hand when told to do so. Keep track of the survey results as they are written on the board. When the “New Price” is revealed, decide if you would pay this new price and raise your hand when told to do so.

Go to the Survey

Copyright © 2013 N.S.

Elasticity Survey Original Price

Original Demand

New Price

New Demand

Elasticity Survey Coefficient of Elasticity

Original Price

$10 Large Pizza

Original Demand

New Price

$10

$15

$500

$750

$5,000

$2,500

Coefficient of Elasticity

New Demand

Large Pizza

$500 Smart Phone

Smart Phone

$5,000 Vacation to Europe

Vacation to Europe Repeat Survey at the New Price

Calculate the Coefficient of Elasticity

Elasticity Survey Original Price

$10

Original Demand

New Price

New Demand

“Elasticity of Demand” Targets Coefficient of Elasticity

Knowledge Understand the difference between elastic and inelastic demand.

$15

$750

Reasoning Determine whether items are elastic or inelastic using the determinants of elasticity.

$2,500

Skill Use formulas to calculate the price elasticity of demand, the cross-price elasticity of demand, and the income elasticity of demand.

Large Pizza

$500 Smart Phone

$5,000 Vacation to Europe

Calculate the “Coefficient of Elasticity” using this formula. (The denominator for all three is 50%.) % change in demand

(New Demand - Original Demand) / (Original Demand)

% change in price

0.5

1

The Price Elasticity of Demand

The Price Elasticity of Demand

The elasticity of demand measures how much the quantity demanded will change when other factors change.

The elasticity of demand measures how much the quantity demanded will change when other factors change. 1) Price elasticity of demand measures how sensitive consumers are to a change in price.

In the opening activity, we measured how sensitive you were to changes in price.

The Price Elasticity of Demand

The Price Elasticity of Demand

The elasticity of demand measures how much the quantity demanded will change when other factors change.

The elasticity of demand measures how much the quantity demanded will change when other factors change.

1) Price elasticity of demand measures how sensitive consumers are to a change in price.

1) Price elasticity of demand measures how sensitive consumers are to a change in price.

2) Elastic demand means consumers are sensitive to a change in price.

2) Elastic demand means consumers are sensitive to a change in price. 3) Inelastic demand means consumers are not sensitive to a change in price. Consumers are highly sensitive to a change in price for a meal at a sit-down restaurant. They will consume much less even if the price rises just a little.

Consumers are not sensitive to a change in price for gasoline. They will consume only a little less even if the price rises a lot.

The Price Elasticity of Demand

The Midpoint Method

The elasticity of demand measures how much the quantity demanded will change when other factors change.

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

1) Price elasticity of demand measures how sensitive consumers are to a change in price. 2) Elastic demand means consumers are sensitive to a change in price. 3) Inelastic demand means consumers are not sensitive to a change in price.

4) Elasticity equals the percent change in quantity demanded divided by the percent change in price.

Price elasticity of demand

% change in quantity % change in price We will use this formula to calculate the price elasticity of demand. The midpoint method tells us how to calculate each “% change” properly.

Price elasticity of demand

% change in quantity % change in price

2

The Midpoint Method

The Midpoint Method

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

1) Formula to find the numerator:

% change in quantity

1) Formula to find the numerator:

Change in quantity Average quantity

% change in quantity

Change in quantity Average quantity

2) Numerator formula rewritten:

Quantity Demanded (Q)

Situation 1

$3

12

Situation 2

$5

8

Q2 - Q1 (Q1 + Q2) / 2

% change in quantity

% change in quantity

Price elasticity of demand

Example Price (P)

Calculate % change in quantity

% change in quantity

Price elasticity of demand

% change in price

% change in price

The Midpoint Method

The Midpoint Method

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

1) Formula to find the numerator: % change in quantity

Change in quantity Average quantity

2) Numerator formula rewritten: % change in quantity

Q2 - Q1 (Q1 + Q2) / 2

Example

1) Formula to find the numerator:

Price (P)

Quantity Demanded (Q)

Situation 1

$3

12

Situation 2

$5

8

8 - 12 (12 + 8) / 2

-4 10

% change in quantity

Change in quantity Average quantity

2) Numerator formula rewritten: - 0.4

Q2 - Q1 (Q1 + Q2) / 2

% change in quantity

Example Price (P)

Quantity Demanded (Q)

Situation 1

$3

12

Situation 2

$5

8

8 - 12 (12 + 8) / 2

-4 10

- 0.4

3) Denominator has a similar formula: P2 - P1 (P1 + P2) / 2

% change in price % change in quantity

Price elasticity of demand

Calculate % change in price

% change in quantity

Price elasticity of demand

% change in price

% change in price

The Midpoint Method

The Midpoint Method

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

1) Formula to find the numerator: % change in quantity

Change in quantity Average quantity

2) Numerator formula rewritten: % change in quantity

Q2 - Q1 (Q1 + Q2) / 2

Example

1) Formula to find the numerator:

Price (P)

Quantity Demanded (Q)

Situation 1

$3

12

Situation 2

$5

8

8 - 12 (12 + 8) / 2

-4 10

P2 - P1 (P1 + P2) / 2

Change in quantity Average quantity

2) Numerator formula rewritten: - 0.4

3) Denominator has a similar formula: % change in price

% change in quantity

% change in quantity

Q2 - Q1 (Q1 + Q2) / 2

Example Price (P)

Quantity Demanded (Q)

Situation 1

$3

12

Situation 2

$5

8

8 - 12 (12 + 8) / 2

-4 10

- 0.4

$5 - $3 ($3 + $5) / 2

$2 $4

0.5

3) Denominator has a similar formula: $5 - $3 ($3 + $5) / 2

$2 $4

0.5

% change in price

P2 - P1 (P1 + P2) / 2

4) This is the complete formula: Price elasticity of demand

% change in quantity % change in price

PED

Q2 - Q1 (Q1 + Q2) / 2

÷

P2 - P1 (P1 + P2) / 2

Complete the Final Step

3

The Midpoint Method

Extra Practice

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

1) Formula to find the numerator:

% change in quantity

Change in quantity Average quantity

2) Numerator formula rewritten:

Example Quantity Demanded (Q)

Situation 1

$3

12

Situation 2

$5

8

P2 - P1 (P1 + P2) / 2

-4 10

- 0.4

% change in quantity

$5 - $3 ($3 + $5) / 2

$2 $4

0.5

% change in price

Q2 - Q1 (Q1 + Q2) / 2

÷

P2 - P1 (P1 + P2) / 2

Example Price (P)

Quantity Demanded (Q)

Situation 1

$9

9

Situation 2

$11

7

7-9 (9+7) / 2

-2 8

- 0.25

$11 - $9 ($9 + $11) / 2

$2 $10

0.2

Q2 - Q1 (Q1 + Q2) / 2

3) Denominator has a similar formula:

4) This is the complete formula: PED

Change in quantity Average quantity

2) Numerator formula rewritten:

3) Denominator has a similar formula: % change in price

% change in quantity

8 - 12 (12 + 8) / 2

Q2 - Q1 (Q1 + Q2) / 2

% change in quantity

1) Formula to find the numerator:

Price (P)

P2 - P1 (P1 + P2) / 2

4) This is the complete formula: PED

- 0.4 ÷ 0.5

- 0.8

PED

Q2 - Q1 (Q1 + Q2) / 2

÷

P2 - P1 (P1 + P2) / 2

PED

- 0.25 ÷ 0.2

1.25

Extra Practice

Coefficient of Elasticity

When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item.

1) Formula to find the numerator: % change in quantity

Change in quantity Average quantity

2) Numerator formula rewritten: % change in quantity

Example Price (P)

Quantity Demanded (Q)

Situation 1

$8

12

Situation 2

$15

8

Q2 - Q1 (Q1 + Q2) / 2

3) Denominator has a similar formula: % change in price

P2 - P1 (P1 + P2) / 2

4) This is the complete formula: PED

Q2 - Q1 (Q1 + Q2) / 2

÷

All price elasticities of demand are negative by definition (or zero). Economists usually drop the negative signs, however, for simplicity.

P2 - P1 (P1 + P2) / 2

Coefficient of Elasticity

Coefficient of Elasticity

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item.

1) Coefficient Is Zero

1) Coefficient Is Zero

Perfectly inelastic demand: Consumers pay no attention to price.

Perfectly inelastic demand: Consumers pay no attention to price.

2) Coefficient Is Between 0 and 1 Inelastic demand: Consumers are not sensitive to price.

D

When demand is perfectly inelastic, its graph is a vertical line. Any change in price has no effect on quantity.

D

D

Inelastic demand is relatively steep. Notice how even a large change in price has had only a minimal effect on quantity.

4

Coefficient of Elasticity

Coefficient of Elasticity

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item.

1) Coefficient Is Zero

1) Coefficient Is Zero

Perfectly inelastic demand: Consumers pay no attention to price.

Perfectly inelastic demand: Consumers pay no attention to price.

2) Coefficient Is Between 0 and 1

2) Coefficient Is Between 0 and 1

Inelastic demand: Consumers are not sensitive to price.

Inelastic demand: Consumers are not sensitive to price.

3) Coefficient Is 1

3) Coefficient Is 1

Unit elastic demand: Demand is not elastic or inelastic.

D

Unit elastic demand: Demand is not elastic or inelastic. D

D

D

4) Coefficient Is Greater Than 1 Elastic demand: Consumers are sensitive to price.

Unit elastic demand shows an equal change in price and quantity. Using the midpoint method, price has changed by 40% and quantity has changed by 40%.

Coefficient of Elasticity

Elastic demand is relatively flat. Notice how only a small change in price has had a large effect on quantity.

Total Revenue Test

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item.

Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works.

1) Coefficient Is Zero Perfectly inelastic demand: Consumers pay no attention to price.

2) Coefficient Is Between 0 and 1 Inelastic demand: Consumers are not sensitive to price.

D

3) Coefficient Is 1

D

Unit elastic demand: Demand is not elastic or inelastic.

4) Coefficient Is Greater Than 1 Elastic demand: Consumers are sensitive to price.

5) Coefficient Is Infinite Perfectly elastic demand: Price changes infinitely affect quantity.

Perfectly elastic demand is a horizontal line. Any rise in price will eliminate all demand. The coefficient is infinite since you must divide by zero in the formula.

Total Revenue Test Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works.

1) Calculations

Total Revenue Test Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works.

1) Calculations

A) Total Revenue = Price x Quantity

A) Total Revenue = Price x Quantity B) Calculate total revenue for the original price and quantity.

The top graph is a regular demand curve. The bottom graph shows total revenue for each of the corresponding quantities from the top graph.

For example, suppose the firm in this market has a price of $1 and a quantity of 9. The total revenue in this situation is $9.

5

Total Revenue Test

Total Revenue Test

Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works.

Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. Inelastic

1) Calculations

1) Calculations

A) Total Revenue = Price x Quantity

A) Total Revenue = Price x Quantity

B) Calculate total revenue for the original price and quantity.

B) Calculate total revenue for the original price and quantity.

C) Calculate total revenue for the new price and quantity.

C) Calculate total revenue for the new price and quantity.

2) Results A) INELASTIC: total revenue moved in the same direction as price. Now, suppose the price increases to $2 and the quantity drops to 8. Total revenue is now $16. This firm has increased its revenue by increasing price.

Notice that this firm will increase its revenue as long as it keeps increasing its price up to $5. Price and revenue are moving in the same direction.

Total Revenue Test Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works.

Total Revenue Test Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works.

Elastic

Inelastic

1) Calculations

Unit Elastic Inelastic

1) Calculations

A) Total Revenue = Price x Quantity

A) Total Revenue = Price x Quantity

B) Calculate total revenue for the original price and quantity.

B) Calculate total revenue for the original price and quantity.

C) Calculate total revenue for the new price and quantity.

C) Calculate total revenue for the new price and quantity.

2) Results

2) Results

A) INELASTIC: total revenue moved in the same direction as price. B) ELASTIC: total revenue moved in the opposite direction as price.

Elastic

A) INELASTIC: total revenue moved in the same direction as price. Notice that as price increases beyond $5, total revenue gets smaller. Price and revenue are moving in opposite directions.

B) ELASTIC: total revenue moved in the opposite direction as price. C) UNIT ELASTIC: total revenue did not change.

When total revenue reaches its maximum, the demand is unit elastic. Notice that moving from $4 to $6, for example, does not change total revenue.

Determinants of Elasticity

Determinants of Elasticity

Several factors help determine whether an item is relatively elastic or inelastic.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available.

Pizza restaurants have many competitors and, thus, many substitutes. If one chain raises their prices, consumers can easily find a substitute.

6

Determinants of Elasticity

Determinants of Elasticity

Several factors help determine whether an item is relatively elastic or inelastic.

Several factors help determine whether an item is relatively elastic or inelastic.

1) Items Are Elastic If…

1) Items Are Elastic If…

A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income.

A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury.

For most people, airline travel is extremely costly. Although flying has few substitutes, many people will simply choose not to travel if prices are too high.

Food in general is a very inelastic item. When discussing the market for restaurant food, however, the good is considered a luxury and is thus elastic.

Determinants of Elasticity

Determinants of Elasticity

Several factors help determine whether an item is relatively elastic or inelastic.

Several factors help determine whether an item is relatively elastic or inelastic.

1) Items Are Elastic If…

1) Items Are Elastic If…

A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury.

A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury.

D) Consumers have a lot of time to adjust to a change in price.

D) Consumers have a lot of time to adjust to a change in price.

2) Items Are Inelastic If… A) Substitutes are hard to find or may not exist. Gasoline is inelastic in the short run but is elastic in the long run. This is because consumers will find alternative fuels and adjust their habits if given time.

Electricity is a necessary good for most people. If the price of electricity increases, we may complain about it, but we will certainly pay it.

Determinants of Elasticity

Determinants of Elasticity

Several factors help determine whether an item is relatively elastic or inelastic.

Several factors help determine whether an item is relatively elastic or inelastic.

1) Items Are Elastic If…

1) Items Are Elastic If…

A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price.

A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price.

2) Items Are Inelastic If… A) Substitutes are hard to find or may not exist. B) The item is a small portion of a person’s income.

2) Items Are Inelastic If…

A cup of coffee generally costs very little. Thus, even large percentage increases in price may go largely unnoticed by the consumer.

A) Substitutes are hard to find or may not exist. B) The item is a small portion of a person’s income. C) The item is a necessity.

Consumers often have little choice about whether or not to take a prescription medication. They will pay almost any price if it means feeling healthy.

7

Determinants of Elasticity

Cross-Price Elasticity of Demand

Several factors help determine whether an item is relatively elastic or inelastic.

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price.

2) Items Are Inelastic If… A) Substitutes are hard to find or may not exist. B) The item is a small portion of a person’s income. C) The item is a necessity.

Consumers may be able to find alternative fuels and adjust their habits in the long run, but they are not sensitive to increases in gas prices in the short run.

D) Consumers have little time to adjust to a change in price.

Cross-Price Elasticity of Demand

Cross-Price Elasticity of Demand

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

1) We use a slightly different formula:

1) We use a slightly different formula:

Cross elasticity of demand

% change in quantity of A % change in price of B

Example Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

Cross elasticity of demand

% change in quantity of A % change in price of B

Example Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

2) Still use the midpoint method for calculating each percent change.

Calculate % change in quantity of A

Cross-Price Elasticity of Demand

Cross-Price Elasticity of Demand

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

1) We use a slightly different formula: Cross elasticity of demand

% change in quantity of A % change in price of B

2) Still use the midpoint method for calculating each percent change.

Example

1) We use a slightly different formula:

Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

Calculate the value of the numerator 4 18 - 14 0.25 16 (14 + 18) / 2 Calculate % change in price of B

Cross elasticity of demand

% change in quantity of A % change in price of B

2) Still use the midpoint method for calculating each percent change.

Example Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

Calculate the value of the numerator 4 18 - 14 0.25 16 (14 + 18) / 2 Calculate the value of the denominator $2 $21 - $19 0.1 $20 ($19 + $21) / 2

Complete the Final Step

8

Cross-Price Elasticity of Demand

Cross-Price Elasticity of Demand

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

1) We use a slightly different formula: Cross elasticity of demand

% change in quantity of A % change in price of B

2) Still use the midpoint method for calculating each percent change.

Example

1) We use a slightly different formula:

Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

Cross elasticity of demand

% change in quantity of A % change in price of B

2) Still use the midpoint method for calculating each percent change.

Calculate the value of the numerator 4 18 - 14 0.25 16 (14 + 18) / 2 Calculate the value of the denominator $2 $21 - $19 0.1 $20 ($19 + $21) / 2

3) Goods with positive cross-price elasticities are substitutes.

Divide numerator by denominator CED

0.25 ÷ 0.1

Example Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

Calculate the value of the numerator 4 18 - 14 0.25 16 (14 + 18) / 2 Calculate the value of the denominator $2 $21 - $19 0.1 $20 ($19 + $21) / 2 Divide numerator by denominator

2.5

CED

Cross-Price Elasticity of Demand

0.25 ÷ 0.1

2.5

Cross-Price Elasticity of Demand

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

1) We use a slightly different formula:

1) We use a slightly different formula:

Cross elasticity of demand

% change in quantity of A % change in price of B

2) Still use the midpoint method for calculating each percent change. 3) Goods with positive cross-price elasticities are substitutes. 4) Goods with negative cross-price elasticities are complements.

Example Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

Calculate the value of the numerator 4 18 - 14 0.25 16 (14 + 18) / 2 Calculate the value of the denominator $2 $21 - $19 0.1 $20 ($19 + $21) / 2 Divide numerator by denominator CED

0.25 ÷ 0.1

2.5

Cross elasticity of demand

% change in quantity of A % change in price of B

2) Still use the midpoint method for calculating each percent change. 3) Goods with positive cross-price elasticities are substitutes.

Example Item A

P

Q

Item B

P

Q

Situation 1

$12

14

Situation 1

$19

34

Situation 2

$10

18

Situation 2

$21

30

Calculate the value of the numerator 4 18 - 14 0.25 16 (14 + 18) / 2

4) Goods with negative cross-price elasticities are complements.

Calculate the value of the denominator $2 $21 - $19 0.1 $20 ($19 + $21) / 2

5) Cross-price elasticities near zero mean the goods are unrelated.

CED

Divide numerator by denominator 0.25 ÷ 0.1

2.5

Income Elasticity of Demand

Income Elasticity of Demand

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Income elasticity of demand

Example P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity % change in income

Income

9

Income Elasticity of Demand

Income Elasticity of Demand

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

1) We use a slightly different formula: Income elasticity of demand

Example

% change in income

2) Still use the midpoint method for calculating each percent change.

1) We use a slightly different formula:

P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity

Income

Income elasticity of demand

Example P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity % change in income

2) Still use the midpoint method for calculating each percent change.

Calculate % change in quantity

Income

Calculate the value of the numerator 10 55 - 45 0.2 50 (45 + 55) / 2 Calculate % change in income

Income Elasticity of Demand

Income Elasticity of Demand

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

1) We use a slightly different formula: Income elasticity of demand

Example

% change in income

2) Still use the midpoint method for calculating each percent change.

1) We use a slightly different formula:

P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity

Income

Calculate the value of the numerator 10 55 - 45 0.2 50 (45 + 55) / 2

Income elasticity of demand

Example P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity % change in income

2) Still use the midpoint method for calculating each percent change.

Calculate the value of the denominator $200 $900 - $700 0.25 $800 ($700 + $900) / 2

Income

Calculate the value of the numerator 10 55 - 45 0.2 50 (45 + 55) / 2 Calculate the value of the denominator $200 $900 - $700 0.25 $800 ($700 + $900) / 2 Divide numerator by denominator IED

Complete the Final Step

0.2 ÷ 0.25

0.8

Income Elasticity of Demand

Income Elasticity of Demand

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

1) We use a slightly different formula: Income elasticity of demand

Example

% change in income

2) Still use the midpoint method for calculating each percent change. 3) Normal goods income elasticities.

have

positive

1) We use a slightly different formula:

P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity

Income

Calculate the value of the numerator 10 55 - 45 0.2 50 (45 + 55) / 2 Calculate the value of the denominator $200 $900 - $700 0.25 $800 ($700 + $900) / 2 Divide numerator by denominator

IED

0.2 ÷ 0.25

0.8

Income elasticity of demand

Example P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity % change in income

2) Still use the midpoint method for calculating each percent change. 3) Normal goods income elasticities.

have

positive

4) If below 1, it is income-inelastic: demand rises slower than income.

Income

Calculate the value of the numerator 10 55 - 45 0.2 50 (45 + 55) / 2 Calculate the value of the denominator $200 $900 - $700 0.25 $800 ($700 + $900) / 2 Divide numerator by denominator

IED

0.2 ÷ 0.25

0.8

10

Income Elasticity of Demand

Income Elasticity of Demand

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

1) We use a slightly different formula: Income elasticity of demand

Example

% change in income

2) Still use the midpoint method for calculating each percent change. 3) Normal goods income elasticities.

have

positive

4) If below 1, it is income-inelastic: demand rises slower than income. 5) If above 1, it is income-elastic: demand rises faster than income.

1) We use a slightly different formula:

P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity

Income

Calculate the value of the numerator 10 55 - 45 0.2 50 (45 + 55) / 2 Calculate the value of the denominator $200 $900 - $700 0.25 $800 ($700 + $900) / 2 Divide numerator by denominator IED

0.2 ÷ 0.25

0.8

Determining Elasticity DETERMINANTS OF ELASTICITY The table lists the characteristics of an item that is elastic (first column) and the characteristics of an item that is inelastic (second column). In the problems that follow, first identify whether the item is elastic or inelastic. Then, write down the letter(s) from the table that lists the proper explanation. THE PRICE ELASTICITY OF DEMAND Use the formula for the price elasticity of demand to solve these problems. Remember, coefficients below 1 are inelastic; coefficients equal to 1 are unit elastic; and coefficients greater than 1 are elastic. TOTAL REVENUE TEST Use the Total Revenue Test to solve these problems. Remember, if total revenue moves in the same direction as price, it is inelastic; if total revenue stays the same, it is unit elastic; and if total revenue moves in the opposite direction as price, it is elastic.

Income elasticity of demand

Example P

Q

Situation 1

$25

45

Situation 1

$700

Situation 2

$21

55

Situation 2

$900

% change in quantity % change in income

2) Still use the midpoint method for calculating each percent change. 3) Normal goods income elasticities.

have

positive

4) If below 1, it is income-inelastic: demand rises slower than income. 5) If above 1, it is income-elastic: demand rises faster than income. 6) Inferior goods income elasticities.

have

negative

Income

Calculate the value of the numerator 10 55 - 45 0.2 50 (45 + 55) / 2 Calculate the value of the denominator $200 $900 - $700 0.25 $800 ($700 + $900) / 2 Divide numerator by denominator IED

0.2 ÷ 0.25

0.8

“Elasticity of Demand” Targets Knowledge Understand the difference between elastic and inelastic demand. Reasoning Determine whether items are elastic or inelastic using the determinants of elasticity. Skill Use formulas to calculate the price elasticity of demand, the cross-price elasticity of demand, and the income elasticity of demand.

Resources Images courtesy of www.sxc.hu

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