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More precious than a Flu Shot The U.S. supply of the flu vaccine for the 2004–2005 flu season was suddenly cut in half. As news of it spread, there was a rush to get the shots. Some pharmaceutical distributors detected a profit - making opportunity in the frenzy. Consumers of the vaccine were relatively unresponsive to price; that is, the large increase in the price of the vaccine left the quantity demanded by consumers relatively unchanged. In this chapter we will show how the price elasticity of demand is calculated and why it is the best measure of how the quantity demanded responds to changes in price.
Chapter objectives
- What is elasticity? a) Price elasticity of demand b) Cross-price elasticity of demand c) Income elasticity of demand d) Price elasticity of supply
- The effects of taxes on supply and demand
- What determines who bears the burden of a tax
- The costs and benefits of taxes, and why taxes impose a cost that is larger than the tax revenue they raise
Defining and measuring elasticity The price elasticity of demand is the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve.
Drop the minus sign - Price elasticity of demand is always negative because of the inverse relationship between price and quantity demanded- so drop the minus sign and use Absolute Value
The price elasticity of demand
Demand for Vaccinations When price rises to $21 per dose, demand falls to 9.9 million doses per day (point B).
Calculating the price elasticity of demand
The midpoint method Percentage change can vary depending on which variables are used to measure. To alleviate this problem: The midpoint method is a technique for calculating the percent change using averages of starting and final values (midpoints)
Two extreme cases of price elasticity of demand Perfectly Inelastic Demand: Price Elasticity of Demand = 0
- Demand is elastic if the price elasticity of demand is greater than 1 Price Elasticity of Demand > 1
- Demand is inelastic if the price elasticity of demand is less than 1 Price Elasticity of Demand < 1
- Demand is unit-elastic if the price elasticity of demand is exactly 1 Price Elasticity of Demand = 1
Two extreme cases of price elasticity of demand Price Elastic Demand: Price Elasticity of Demand = ∞
Unit-Elastic Demand, Inelastic Demand, and Elastic Demand Demand is unit-elastic if the price elasticity of demand is exactly 1
Demand is inelastic if the price elasticity of demand is less than 1
Demand is elastic if the price elasticity of demand is greater than 1
Elasticity and Total Revenue If demand for a good is elastic (the price elasticity of demand > 1), an increase in price reduces total revenue. The quantity effect is stronger than the price effect. If demand for a good is inelastic (the price elasticity of demand < 1), a higher price increases total revenue. The price effect is stronger than the quantity effect. If demand for a good is unit-elastic (the price elasticity of demand = 1), an increase in price does not change total revenue. The sales effect and price effect exactly offset each other.
Price Elasticity of Demand and Total Revenue
Demand Schedule and Total Revenue
What Factors Determine the Price Elasticity of Demand?
- Price Elasticity of Demand is determined by:
- Whether Close Substitutes Are Available
- Whether the Good Is a Necessity or a Luxury
- Share of Income Spent on the Good
- Time
Cross-price elasticity The cross-price elasticity of demand between two goods measures the effect of the change in one good’s price on the quantity demanded of the other good. Equal to the percent change in the quantity demanded of one good divided by the percent change in the other good’s price.
- Goods are substitutes when the cross-price elasticity of demand is positive.
- Goods are complements when the cross-price elasticity of demand is negative.
Income elasticity of demand The income elasticity of demand is the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in the consumer’s income.
Normal Goods and Inferior Goods When the income elasticity of demand is positive, the good is a normal good. That is, the quantity demanded at any given price increases as income increases. When the income elasticity of demand is negative, the good is an inferior good. That is, the quantity demanded at any given price decreases as income increases.
Price Elasticity of Supply The price elasticity of supply is a measure of the responsiveness of the quantity of a good supplied to the price of that good. It is the ratio of the percent change in the quantity supplied to the percent change in the price as we move along the supply curve.
