### Ch 6 PPT - Elasticity

Total Revenue Test
Uses elasticity to show how changes in price will
affect total revenue (TR).
(TR = Price x Quantity)
Elastic Demand• Price increase causes TR to decrease
• Price decrease causes TR to increase
Inelastic Demand• Price increase causes TR to increase
• Price decrease causes TR to decrease
Unit Elastic• Price changes and TR remains unchanged
Ex: If demand for milk is INelastic, what will happen to
expenditures on milk if price increases?
Is the range between A and B, elastic,
inelastic, or unit elastic?
10 x 100 =\$1000 Total Revenue
5 x 225 =\$1125 Total Revenue
A
50%
B
125%
Price decreased and TR increased,
so…
Demand is ELASTIC
You Should Now Get This
• Elastic and Inelastic Demand Baby
– Winner 2013 Econ video contest
3
Total Revenue Test
Total Revenue Test
}
inelastic
} unit elastic
}elastic
Elasticity Practice
8
• Graph the following chart
• Calculate the Ed using the top set of numbers
and prices rising
• This is what your graph should look like
• Ed = % change in quantity demanded of product X
% change in price of product X
% Change in quantity =
nqd – iqd
initial quantity demanded
% Change in price =
New Price – Initial Price
Initial price
Ed =
(90 – 100) ÷ 100
(\$2 - \$1.00) ÷ \$1.00
• Ed =
-.10 = -.1
1
Drop the negative: Ed is < 1 therefore the demand for is
INelastic
• Calculate the TR and determine if Total
Revenue increased or decreased with a price
increase
• What is gain or loss on
price move?
• \$3 * 70 = \$210
• \$2 * 90 = \$180
• Total Revenue increased \$30
What Happens If --• Graph the following chart
• Calculate the Ed using the bottom two numbers
and prices rising
• Ed = % change in quantity demanded of product X
% change in price of product X
% Change in quantity =
nqd – iqd
initial quantity demanded
% Change in price =
New Price – Initial Price
Initial price
Ed =
(40 – 70) ÷ 70
(\$4 - \$3.00) ÷ \$3.00
• Ed =
-.4285
.3333
or 42.85% = 1.28
or 33.33%
Drop the negative: Ed is > 1 therefore the demand for is elastic
Ed & TR Test “quiz”
Practice Problem
• See handout
Consumer and Producer
Surplus
• Consumer Surplus
– Difference between maximum price willing
to pay and the actual price producers charge
– Think of it as a “willing to pay” curve
18
Marginal Benefit & Surplusses
• Marginal Benefit
– What you gain when you get one more unit
– Measured by what you are willing to give up
– Everyday life we say “getting value for our
money”
– There is a difference between value and price
Value vs. Price
• Value is what we get
• Price is what we pay
• Everyday idea of value is marginal benefit
OR
• The measure of the maximum price what
consumers are willing to pay for another
unit of a good or service
Pizza Sales Per Slice
Consumer Surplus
P
Consumer
surplus from
10th slice of
pizza
2
Willing to pay
1.5
Market Price
\$1
.5
Amount Paid
D
10
20
30
40
Voluntary Exchange
In the free-market, buyers and sellers
voluntarily come together to seek mutual
benefits.
22
Voluntary Exchange
In the free-market, buyers and sellers voluntarily
come together to seek mutual benefits.
23
Voluntary Exchange
In the free-market, buyers and sellers voluntarily
come together to seek mutual benefits.
24
Voluntary Exchange
In the free-market, buyers and sellers voluntarily
come together to seek mutual benefits.
25
Example of Voluntary Exchange
Ex: You want to buy a truck so you go to the local
dealership. You are willing to spend up to \$20,000 for a
new 4x4. The seller is willing to sell this truck for no less
than \$15,000. After some negotiation you buy the truck
for \$18,000.
Analysis:
Sellers Minimum- \$15,000
Price- \$18,000
Consumer’s Surplus-\$2,000
Producer’s Surplus- \$3,000
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Voluntary Exchange Terms
Consumer Surplus is the difference
between what you are willing to pay
and what you actually pay.
CS = Buyer’s Maximum – Price
Producer’s Surplus is the difference
between the price the seller received
and how much they were willing to sell
it for.
PS = Price – Seller’s Minimum
27
Consumer and Producer’s Surplus
P
Calculate the :
1. Consumer Surplus
2. Producer Surplus
3. Total Surplus
\$10
S
8
6
\$5
4
CS
PS
2
1
D
2 4 6 8 10
Q
30
Calculating Consumer Surplus
In Dollars
Max
Willing to
pay
Actual
price
(E)
Calculate
CS
\$9
\$5
9–5=
\$4
\$8
\$5
8–5=
\$3
\$7
\$5
7–5=
\$2
\$6
\$5
6–5=
\$1
\$5
\$5
5–5=
\$0
Sum = CS
= \$10
31
Calculating Producer Surplus
In Dollars
Min Price
charged
Actual
price
(E)
Calculate
PS
\$2
\$5
5–2=
\$3
\$3
\$5
5-3=
\$2
\$4
\$5
5-4=
\$1
\$5
\$5
5–5 =
\$0
Sum = PS
= \$6
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Surpluses
• Could be calculated in Quantity
33
Summary
Consumption
Inefficiency
Production
Inefficiency
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
\$20
\$15
\$8
George
\$12
Ann
\$7
Q. If dinner sells for \$10, what is the value of Dons’
consumer surplus?
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
\$20
\$15
\$8
George
\$12
Ann
\$7
Q. If dinner sells for \$10, what is the value of Dons’
consumer surplus?
A. Willing to pay is \$15. Market price is \$10.
Willing to pay (\$15) – Actual Price (\$10) = \$5
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
\$20
\$15
\$8
George
\$12
Ann
\$7
Q. If dinner sells for \$11, what is the TOTAL value of
consumer surplus?
Practice Problem
Name of Consumer
Price willing to pay
Matt
Don
Sarah
\$20
\$15
\$8
George
\$12
Ann
\$7
Q. If dinner sells for \$11, what is the TOTAL value of
consumer surplus?
A. 20 – 11 = 9, 15 – 11 = 4, 12 – 11 = 1
9 + 4 + 1 = \$14 consumer surplus
• For a given linier demand curve, the
value of consumer surplus does what as
market price increases?
• For a given linier demand curve, the
value of consumer surplus does what as
market price increases?
• Decreases as market price increases
(1)
Price
(2)
QA
(3)
(4)
QB
(5)
(6)
QC
(7)
\$10
9
8
7
6
100
111
125
143
167
\$_____
_____
_____
_____
_____
100
130
170
220
280
\$_____
_____
_____
_____
_____
100
110
120
130
140
\$_____
_____
_____
_____
_____
5
200
_____
350
_____
150
_____
15.
A marketing firm has done a study of market demand for
DVDs of three different movies. Calculate the total revenue for each
movie in columns 3, 5, and 7.
Without calculating the price elasticity of demand, indicate
whether demand for each movie is elastic, inelastic or unit-elastic. For
which movie would a reduction in price produce the greatest increase
in revenue?
41
(1)
Price
(2)
QA
(3)
(4)
QB
(5)
(6)
QC
(7)
\$10
100
\$1000
100
\$1000
100
\$1000
9
111
999
130
1170
110
990
8
125
1000
170
1360
120
960
7
143
1001
220
1540
130
910
6
167
1002
280
1680
140
840
5
200
1000
350
1750
150
750
Without calculating the price elasticity of demand, indicate whether demand for
each movie is elastic, inelastic or unit-elastic. For which movie would a
reduction in price produce the greatest increase in revenue?
Applying the total revenue test, we see that total revenues remain
approximately constant for movie A, meaning that demand is unit-elastic. Total
revenues for movie B are increasing as price decreases, meaning that demand
for movie B is elastic. Total revenues for movie C are decreasing as price
decreases, meaning the demand for movie C is inelastic. [text: E pp. 77-80;
MA pp. 77-80; MI pp. 77-80]
42