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AP EXAM REVIEW

Day 3: Elasticity

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Elasticity: a measure of the responsiveness of consumers or producers to a change in price of a good, the price of a related good, or income.

Important questions relating to elasticity:….

  • 1) Why do buyers of some products respond to price increases by reducing their purchases more than the buyers of other products?

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  • 2) Why do higher market prices for some products cause producers to greatly increase their output while price rises for other products cause only limited increase in output?

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  • 3) Why does the demand for some products rise a great deal when household income increases while the demand for other products rises just a little?

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Price Elasticity of Demand: The responsiveness (or sensitivity) of consumers to a change in price. In other words, how much more or less of a good do consumers demand when the price changes?

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DEMAND ELASTICITY

  • Term used to indicate the extent to which changes in price cause changes in quantity demanded.

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ELASTIC DEMAND

  • Demand is elastic when relatively small changes in price lead to a relatively large change in quantity demanded.

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INELASTIC DEMAND

  • Demand is inelastic when changes in price lead to little change in quantity demanded.

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D2

D1

P1

P2

P

Q

Q1

Q2

Q3

Q4

Cigarettes (D1) and iPhones (D2)

D4

D5

P1

P

Q

Q1

Heart transplants (D3), Watermelons (D4),

Movie Tickets (D5)

D3

P2

Q2

Questions:

1. For which product is demand perfectly inelastic? Perfectly elastic? Unit elastic?

2. What relationship exists between relative slopes of demand curves and elasticity?

3. What are two characteristics of cigarettes that make demand for them inelastic?

4. What are two characteristics of heart transplants that make demand perfectly inelastic?

5. What are the characteristics of a good for which demand is perfectly elastic?

DRAW AND LABEL THE ABOVE.

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DETERMINANTS OF DEMAND ELASTICITY

  • Can the purchase be delayed?

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  • Are adequate substitutes available?

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  • Does the purchase use a large portion of income?

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The Determinants of Price Elasticity of Demand: The following factors determine whether demand for a good or service is elastic, unit elastic, or inelastic.

  • The number of substitutes available. The more substitutes, more elastic demand, as consumers can replace a good whose price has gone up with one of its now relatively cheaper substitutes.

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  • The proportion of income the purchase of a good represents. If a good represent a higher proportion of a consumer's income, their demand tends to be more elastic.

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  • Luxury or necessity? If a good is a necessity, changes in price tend not to affect quantity demand, i.e. demand is inelastic. If it's a luxury that a consumer can go without, consumers tend to be more responsive.

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  • If a product is addictive or habit forming, demand tends to be inelastic.

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  • The amount of time a consumer has to respond to the price change. If prices remain high over a longer period of time, consumers can find substitutes or learn to live without, so demand is more elastic over time.

S

P

L

A

T

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CALCULATING ELASTICITY OF DEMAND

  • 1) Eyeball/Common Sense Test
  • 2) Total Revenue/Receipts Test (Easiest)
  • 3) Midpoint & Arc Formulas

D4

D5

P1

P

Q

Q1

Heart transplants (D3), Watermelons (D4),

Movie Tickets (D5)

D3

P2

Q2

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1) EYEBALL/COMMON SENSE TEST � (BE CAREFUL)

D4

D5

P1

P

Q

Q1

Heart transplants (D3), Watermelons (D4),

Movie Tickets (D5)

D3

P2

Q2

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  • Total Revenue: P x Q

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  • Midpoint Formula:
    • Ignore minus sign; Economists deal in absolute values here to measure the magnitude of change.

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    • Arc Formula:

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EASIEST: HOW TO DETERMINE TOTAL REVENUE

  • Price x Quantity (P x Q = TR)
  • Elastic Demand has larger total receipts at lower prices.
  • Inelastic Demand has larger total receipts at higher prices.
  • Unit Elastic Demand has the same total receipts regardless of price.

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MARKET EQUILIBRIUM

Price

Quantity

Supply

Demand

Pe

Qe

Total Revenue

Pe X Qe = Total Revenue

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DETERMINANTS OF PRICE ELASTICITY OF SUPPLY:�

  • The Determinant: TIME
    • Market (Today, Now) (inelastic)
    • Short-term (little bit more elastic)
    • Long-term (elastic)

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  • Antiques/Art and reproductions:
    • Limited, inelastic supply
    • Strong demand
    • Resulting high price
  • Volatile gold prices:
    • Inelastic supply
    • Shifting demand

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PRICE ELASTICITY OF SUPPLY

P

Q

The Market Period

  • Perfectly inelastic supply

D1

D2

Sm

Q0

Pm

P0

Greatest

Price

Impact

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PRICE ELASTICITY OF SUPPLY

The Short Run

  • Inelastic supply

P

Q

D1

D2

Ss

Q0

Ps

P0

Qs

Lower

Price

Impact

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PRICE ELASTICITY OF SUPPLY

The Long Run

  • Elastic supply

P

Q

D1

D2

Sl

Q0

Pl

P0

Ql

Least

Price

Impact

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INTERPRETATIONS OF ELASTICITY

Elastic Demand

Inelastic Demand

Unit Elasticity

Ed =

.04

.02

= 2

Ed =

.01

.02

= .5

Ed =

.02

.02

= 1

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SUMMARIZING PRICE ELASTICITY OF DEMAND�

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REVIEW OF CROSS AND INCOME ELASTICITY

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VIDEOS AND INTERACTIVE PRACTICE

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Multiple Choice Answers

1.d

2.a

3.b

4.a

5.b

6.a

7.c

8.b

9.b

10.e

11.d

12.d

13.d

14.a

15.d

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END REVIEW DAY 3

  • Which of the above topics do you need to spend more time studying?

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  • What specific steps will you take to study?

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