chapter-5.ppt
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chapter-5.ppt
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ElasticityanditsApplication,Economics,PRINCIPLESOF,N.GregoryMankiw,PremiumPowerPointSlidesbyRonCronovich,5,Inthischapter,lookfortheanswerstothesequestions:
Whatiselasticity?
Whatkindsofissuescanelasticityhelpusunderstand?
Whatisthepriceelasticityofdemand?
Howisitrelatedtothedemandcurve?
Howisitrelatedtorevenue&expenditure?
Whatisthepriceelasticityofsupply?
Howisitrelatedtothesupplycurve?
Whataretheincomeandcross-priceelasticitiesofdemand?
1,Youdesignwebsitesforlocalbusinesses.Youcharge$200perwebsite,andcurrentlysell12websitespermonth.Yourcostsarerising(includingtheopportunitycostofyourtime),soyouconsiderraisingthepriceto$250.Thelawofdemandsaysthatyouwontsellasmanywebsitesifyouraiseyourprice.Howmanyfewerwebsites?
Howmuchwillyourrevenuefall,ormightitincrease?
Ascenario,0,2,ELASTICITYANDITSAPPLICATION,3,Elasticity,Basicidea:
Elasticitymeasureshowmuchonevariablerespondstochangesinanothervariable.Onetypeofelasticitymeasureshowmuchdemandforyourwebsiteswillfallifyouraiseyourprice.Definition:
ElasticityisanumericalmeasureoftheresponsivenessofQdorQstooneofitsdeterminants.,0,ELASTICITYANDITSAPPLICATION,4,PriceElasticityofDemand,PriceelasticityofdemandmeasureshowmuchQdrespondstoachangeinP.,Looselyspeaking,itmeasurestheprice-sensitivityofbuyersdemand.,0,ELASTICITYANDITSAPPLICATION,5,PriceElasticityofDemand,Priceelasticityofdemandequals,0,Prisesby10%,Qfallsby15%,Example:
ELASTICITYANDITSAPPLICATION,6,PriceElasticityofDemand,AlongaDcurve,PandQmoveinoppositedirections,whichwouldmakepriceelasticitynegative.Wewilldroptheminussignandreportallpriceelasticitiesaspositivenumbers.,0,ELASTICITYANDITSAPPLICATION,7,CalculatingPercentageChanges,0,Demandforyourwebsites,Standardmethodofcomputingthepercentage(%)change:
GoingfromAtoB,the%changeinPequals,($250$200)/$200=25%,ELASTICITYANDITSAPPLICATION,8,CalculatingPercentageChanges,0,Demandforyourwebsites,Problem:
Thestandardmethodgivesdifferentanswersdependingonwhereyoustart.,FromAtoB,Prises25%,Qfalls33%,elasticity=33/25=1.33FromBtoA,Pfalls20%,Qrises50%,elasticity=50/20=2.50,ELASTICITYANDITSAPPLICATION,9,CalculatingPercentageChanges,So,weinsteadusethemidpointmethod:
0,Themidpointisthenumberhalfwaybetweenthestart&endvalues,theaverageofthosevalues.Itdoesntmatterwhichvalueyouuseasthe“start”andwhichasthe“end”yougetthesameanswereitherway!
ELASTICITYANDITSAPPLICATION,10,CalculatingPercentageChanges,Usingthemidpointmethod,the%changeinPequals,0,The%changeinQequals,Thepriceelasticityofdemandequals,ACTIVELEARNING1Calculateanelasticity,11,Usethefollowinginformationtocalculatethepriceelasticityofdemandforhotelrooms:
ifP=$70,Qd=5000ifP=$90,Qd=3000,ACTIVELEARNING1Answers,12,Usemidpointmethodtocalculate%changeinQd(50003000)/4000=50%changeinP($90$70)/$80=25%Thepriceelasticityofdemandequals,ELASTICITYANDITSAPPLICATION,13,Whatdeterminespriceelasticity?
Tolearnthedeterminantsofpriceelasticity,welookataseriesofexamples.Eachcomparestwocommongoods.Ineachexample:
Supposethepricesofbothgoodsriseby20%.ThegoodforwhichQdfallsthemost(inpercent)hasthehighestpriceelasticityofdemand.Whichgoodisit?
Why?
Whatlessondoestheexampleteachusaboutthedeterminantsofthepriceelasticityofdemand?
0,ELASTICITYANDITSAPPLICATION,14,EXAMPLE1:
Breakfastcerealvs.Sunscreen,Thepricesofbothofthesegoodsriseby20%.ForwhichgooddoesQddropthemost?
Why?
Breakfastcerealhasclosesubstitutes(e.g.,pancakes,Eggowaffles,leftoverpizza),sobuyerscaneasilyswitchifthepricerises.Sunscreenhasnoclosesubstitutes,soconsumerswouldprobablynotbuymuchlessifitspricerises.Lesson:
Priceelasticityishigherwhenclosesubstitutesareavailable.,0,ELASTICITYANDITSAPPLICATION,15,EXAMPLE2:
“BlueJeans”vs.“Clothing”,Thepricesofbothgoodsriseby20%.ForwhichgooddoesQddropthemost?
Why?
Foranarrowlydefinedgoodsuchasbluejeans,therearemanysubstitutes(khakis,shorts,Speedos).Therearefewersubstitutesavailableforbroadlydefinedgoods.(Therearenttoomanysubstitutesforclothing,otherthanlivinginanudistcolony.)Lesson:
Priceelasticityishigherfornarrowlydefinedgoodsthanbroadlydefinedones.,0,ELASTICITYANDITSAPPLICATION,16,EXAMPLE3:
Insulinvs.CaribbeanCruises,Thepricesofbothofthesegoodsriseby20%.ForwhichgooddoesQddropthemost?
Why?
Tomillionsofdiabetics,insulinisanecessity.Ariseinitspricewouldcauselittleornodecreaseindemand.Acruiseisaluxury.Ifthepricerises,somepeoplewillforegoit.Lesson:
Priceelasticityishigherforluxuriesthanfornecessities.,0,ELASTICITYANDITSAPPLICATION,17,EXAMPLE4:
GasolineintheShortRunvs.GasolineintheLongRun,Thepriceofgasolinerises20%.DoesQddropmoreintheshortrunorthelongrun?
Why?
Theresnotmuchpeoplecandointheshortrun,otherthanridethebusorcarpool.Inthelongrun,peoplecanbuysmallercarsorliveclosertowheretheywork.Lesson:
Priceelasticityishigherinthelongrunthantheshortrun.,0,ELASTICITYANDITSAPPLICATION,18,TheDeterminantsofPriceElasticity:
ASummary,Thepriceelasticityofdemanddependson:
theextenttowhichclosesubstitutesareavailablewhetherthegoodisanecessityoraluxuryhowbroadlyornarrowlythegoodisdefinedthetimehorizonelasticityishigherinthelongrunthantheshortrun,0,ELASTICITYANDITSAPPLICATION,19,TheVarietyofDemandCurves,Thepriceelasticityofdemandiscloselyrelatedtotheslopeofthedemandcurve.Ruleofthumb:
Theflatterthecurve,thebiggertheelasticity.Thesteeperthecurve,thesmallertheelasticity.FivedifferentclassificationsofDcurves.,0,ELASTICITYANDITSAPPLICATION,20,“Perfectlyinelasticdemand”(oneextremecase),Pfallsby10%,Qchangesby0%,0,0%,10%,=0,Consumerspricesensitivity:
Dcurve:
Elasticity:
vertical,none,0,ELASTICITYANDITSAPPLICATION,21,“Inelasticdemand”,Qriseslessthan10%,0,10%,10%,1,Pfallsby10%,Consumerspricesensitivity:
Dcurve:
Elasticity:
relativelysteep,relativelylow,1,ELASTICITYANDITSAPPLICATION,22,“Unitelasticdemand”,Qrisesby10%,0,10%,10%,=1,Pfallsby10%,Consumerspricesensitivity:
Elasticity:
intermediate,1,Dcurve:
intermediateslope,ELASTICITYANDITSAPPLICATION,23,“Elasticdemand”,Qrisesmorethan10%,0,10%,10%,1,Pfallsby10%,Consumerspricesensitivity:
Dcurve:
Elasticity:
relativelyflat,relativelyhigh,1,ELASTICITYANDITSAPPLICATION,24,“Perfectlyelasticdemand”(theotherextreme),P1,Pchangesby0%,Qchangesbyany%,0,any%,0%,=infinity,P2=,Consumerspricesensitivity:
Dcurve:
Elasticity:
infinity,horizontal,extreme,ELASTICITYANDITSAPPLICATION,25,ElasticityofaLinearDemandCurve,0,Theslopeofalineardemandcurveisconstant,butitselasticityisnot.,ELASTICITYANDITSAPPLICATION,26,PriceElasticityandTotalRevenue,Continuingourscenario,ifyouraiseyourpricefrom$200to$250,wouldyourrevenueriseorfall?
Revenue=PxQApriceincreasehastwoeffectsonrevenue:
HigherPmeansmorerevenueoneachunityousell.Butyousellfewerunits(lowerQ),duetoLawofDemand.Whichofthesetwoeffectsisbigger?
Itdependsonthepriceelasticityofdemand.,0,ELASTICITYANDITSAPPLICATION,27,PriceElasticityandTotalRevenue,Ifdemandiselastic,thenpriceelast.ofdemand1%changeinQ%changeinPThefallinrevenuefromlowerQisgreaterthantheincreaseinrevenuefromhigherP,sorevenuefalls.,Revenue=PxQ,0,ELASTICITYANDITSAPPLICATION,28,PriceElasticityandTotalRevenue,Elasticdemand(elasticity=1.8),WhenDiselastic,apriceincreasecausesrevenuetofall.,0,lostrevenueduetolowerQ,increasedrevenueduetohigherP,Demandforyourwebsites,ELASTICITYANDITSAPPLICATION,29,PriceElasticityandTotalRevenue,Ifdemandisinelastic,thenpriceelast.ofdemand1%changeinQ%changeinPThefallinrevenuefromlowerQissmallerthantheincreaseinrevenuefromhigherP,sorevenuerises.Inourexample,supposethatQonlyfallsto10(insteadof8)whenyouraiseyourpriceto$250.,Revenue=PxQ,0,ELASTICITYANDITSAPPLICATION,30,PriceElasticityandTotalRevenue,Now,demandisinelastic:
elasticity=0.82,WhenDisinelastic,apriceincreasecausesrevenuetorise.,0,lostrevenueduetolowerQ,increasedrevenueduetohigherP,Demandforyourwebsites,ELASTICITYANDITSAPPLICATION,31,A.Pharmaciesraisethepriceofinsulinby10%.Doestotalexpenditureoninsulinriseorfall?
B.Asaresultofafarewar,thepriceofaluxurycruisefalls20%.Doesluxurycruisecompaniestotalrevenueriseorfall?
ACTIVELEARNING2Elasticityandexpenditure/revenue,32,ACTIVELEARNING2Answers,33,A.Pharmaciesraisethepriceofinsulinby10%.Doestotalexpenditureoninsulinriseorfall?
Expenditure=PxQSincedemandisinelastic,Qwillfalllessthan10%,soexpenditurerises.,ACTIVELEARNING2Answers,34,B.Asaresultofafarewar,thepriceofaluxurycruisefalls20%.Doesluxurycruisecompaniestotalrevenueriseorfall?
Revenue=PxQThefallinPreducesrevenue,butQincreases,whichincreasesrevenue.Whicheffectisbigger?
Sincedemandiselastic,Qwillincreasemorethan20%,sorevenuerises.,ELASTICITYANDITSAPPLICATION,35,APPLICATION:
DoesDrugInterdictionIncreaseorDecreaseDrug-RelatedCrime?
Onesideeffectofillegaldruguseiscrime:
Usersoftenturntocrimetofinancetheirhabit.Weexaminetwopoliciesdesignedtoreduceillegaldruguseandseewhateffectstheyhaveondrug-relatedcrime.Forsimplicity,weassumethetotaldollarvalueofdrug-relatedcrimeequalstotalexpenditureondrugs.Demandforillegald
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