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Lecture 6

Lecture 6-Elasticity of Demand

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Jack Carr

Thursday, October 1st, 2009. Elasticity of Demand Insight: If the choice is between A or B, you need information about A and B. If you have decided on A, information about B (only) is required to identify the opportunity cost of A if B is the next best alternative to A. Total Revenue ± Price x Quantity Questions: 1) If Toronto Transit commission wished to increase Total Revenue, should it increase price (fare)? 2) You own one of the 5 toll bridges across a river, each of which sets the price (toll) at $5.00. If you wish to increase Total Revenue, should you increase price (toll)? Fare increase: (1) For those who continue to ride the TTC, fares will be higher, BUT (2) There will be fewer riders (per the law of downward-sloping demand) Result:Law of downward-sloping demand is not sufficient to answer question. (Price) Elasticity of Demand Definition: Percent change in quantity demanded / Percent change in price % ¨" D ¨! (Ignore minus sign) Measures responsiveness of quantity demanded to a change in price. Mid-point Convention ¨" = ¨" Q (Q = Average quantity) ¨! ¨! P (P = average price) Example: Situation Price Quantity Demanded A 0.90 1100 B 1.10 900 ¨":,39L9\02,3/0/ = 200 x 100 (1100 + 900)/2 = 200 x 100 1000 = 20% ¨!7L.0 = 0.2 x 100 (0.9 + 1.10)/2 = 0.20 x 100 1.00 = 20% ELASTICITY = 20% = 1.0 20% Insight: same result if go up demand curve from A to B or down demand curve from B to A! Terminology: perfectly inelastic: elasticity = 0 inelastic: 0 < elasticity < 1 unit elastic: elasticity = 1 elastic: 1 < elasticity < ’ perfectly elastic0O,89L.L9\’ #1 % ¨! ¨"
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