foreign we're going to begin talking about a topic called elasticity suppose Starbucks raised its price 10 10 percent the law of demand says that consumption will go down how much right we haven't really Quantified anything like for the most part we just sort of said it's demand slopes down sometimes we kind of looked at the shape but we haven't really gotten into it and thought about what it means when uh when a demand curve is steeper what if the price goat of gasoline goes up ten percent and we could sort of tell ourselves a story here right maybe if the price of Starbucks goes up 10 might be easier to cut back on Starbucks right you just make coffee at home you go to Big B you just decide not to drink coffee today whereas with gasoline you know I might not have that option right you got to get you've got to get to work either way so maybe you're um you're not gonna you're gonna reduce your quantity of Starbucks a lot not gonna reduce your consumption of gasoline very much elasticity answers the question if one thing changes how much will another thing change notice this is a very broad definition the first type of elasticity we'll cover if the price of one good changes how much will the quantity of that good demanded change this is the kind of question so this topic right here is covering these sorts of issues right how much will the consumption of Starbucks change how much more consumption of gas change if the price of one good so coffee changes how much will the quantity of that good coffee demanded change so here I'll illustrate uh this this idea with two demand curves so we'll say that initially gallon of gas cup of Starbucks coffee both cost three dollars and there are 80 units sold then there is a one dollar price increase for both Goods so gasoline goes from three bucks to four Starbucks Coffee goes from three bucks to four so this is why demand curves exist right the whole point of a demand curve is to tell us what happens to quantity of gasoline demanded quantity of coffee demanded when price increases so what do we do we just got to move along the demand curve and so for gasoline we see that the price increase moves our quantity from here over to here or so so we'll say it takes our quantity from 80 down to 75. so the price increase causes a small decrease in the quantity demanded for gasoline whereas it causes and if we look at the demand curve for coffee so here's our demand curve for coffee again we just move up into the left on our demand curve from three dollars to four and that's going to take our quantity of coffee consumed all the way down to 20. so it causes a big decrease in quantity demand for copies this is sort of that story we were telling ourselves right Starbucks brings coffee up above up up a dollar you'll find something else to do they'll probably have a big impact on how much coffee you gasoline goes up a dollar not gonna make that big of a difference and maybe you still have to drive to work or drive to school well we want to weigh a way of quantifying how responsive demand is to a price change so we want to be able to quantify what we just said of well when the price changes are demand for coffee is more responsive than our demand for gasoline our demand for coffee changes a lot more it responds a lot to a change in the price okay well one option is you know it seems that there's a uh that slope is closely related to that right this idea of elastic right slope of gasoline the Steep quantity doesn't change much coffee is much flatter so we get a price increase we get a big decrease in quantity while slope is equal to rise over one which in our graphs the rise y-axis is price x-axis is quantity cellos slopes equal to Delta p over Delta Q the inverse of that that's Delta Q divided by Delta p that gives the change in the number of units sold per dollar right this is say and that's what we just did if we were to calculate the slope will we calculate the slope if we do change in quantity which here is 60 divided by change in price well that gives us sort of that's what we were wanting right when we change the price by a buck how much is quantity change so can we just do that and just do Delta Q divided by Delta p and call that our elasticity well there's a couple issues with that the first is that Delta Q will vary greatly depending on whether we are discussing a person a country or the world right are we thinking about your consumption of gasoline or are we thinking of world consumption of gasoline Delta P gives the change in dollars per unit right we're thinking about the price what we mean is the price per unit so probably we were talking about it was price per cup of coffee price per gallon of gas well the elasticity of demand for eggs will vary greatly based on whether we are talking about individual eggs or a carton of a dozen eggs that we're talking about gallons of gas or liters of gas right and so what we'd like to do is sort of think if there's some way that we can avoid these issues right not make it so you have to specify every time well our elasticity is giving if you talk about the number of eggs purchased by one individual person well let's look at percentage changes in price and quantity so if we have a 10 change in quantity it doesn't matter if we're talking about each person consuming 10 more or a country consuming 10 percent more 10 change either way similarly a 10 change in price it doesn't matter if we're talking about a Single A or a dozen eggs right if if each a goes up by 10 the Dozen A's also goes up by 10 so that's why we like to use percentages so price elasticity of demand is this formula I'll go through it we've got a lot of symbols and subscripts here so um yeah it might look like a lot we'll I'll talk through it I think once we start doing problems with it won't seem so bad so e is elasticity we usually use this lowercase D when we're talking about price elasticity of demand um we do it this way because e means the elasticity and like I said we'll have lots of different elasticities to cover so we use this little D so we know we're talking about price elasticity of demand so the top of it is percent change in quantity demanded again we have the D here for demand just because we want to make sure we're thinking about this the shape or the slope of the demand curve a percentage of quantity demanded divided by percent change in price all right well we have these percent Deltas here how do we calculate that well this is should just be reviewed probably something you did in middle school or high school about learning about percentage changes the percent change in quantity demanded is equal to the change in quantity so Q2 minus q1 second quantity minus first quantity how much coffee we drank when it was four dollars minus how much we drank it was three dollars divided by the initial quantity this gives us a rate and then we have the times 100 here if you just as a reminder if you want to take it from 0.2 to 20 percent multiply 100 similarly for the change in price it's P2 minus P1 you price of four dollars minus old price of three dollars divided by our original price and again you can multiply it by a hundred to get a two percentages uh one quick note the textbook uses a more complicated method called the midpoint formula you don't need to know that method for this class it's just a little more arithmetic than we need to deal with all right next question which of the following is true the answer here is a the elasticity of demand is always negative because of the law of demand and let's see what we mean here well law of demand just says demand slows down so we have our downward sloping demand curve well that means that price and quantity move in opposite directions right when you learned about slopes of lines um a negative or downward slope means that when one of them is moving up the other is moving down so when price goes down quantity demanded goes up and again this is just the law of demand when price goes up quantity demanded goes down so they're always moving in opposite directions well if they're moving in opposite directions that means that percent change in quantity demanded and percent change in price always have opposites opposite sides right if when we say they're moving in opposite direction that means when one is increasing the other is decreasing so quality man it is increasing it must be that I'm sorry a change in quantity demanded is positive it must mean that change in price is negative right that means this is going up so this is going down one is negative and one is positive well a negative divided by a positive is a negative and a positive divided by a negative is a negative so this means that e d elasticity of demand is always negative to simplify things economists sometimes use absolute values I really try not to do it unless I say this is absolute value this is the absolute value um because if it's negative I want to make it clear that we're thinking about price elasticity of demand which is negative so you can think of this as a pretty standard straightforward type of problem you can see on a homework or anything the price of a good is originally ten dollars and decreases to nine dollars as a result quantity increases from 20 to 25. what is the price elasticity the answer here is B negative 2.5 notice the negative let's see how we get there so down here I showed the original problem just sort of so we can see all the numbers together here I have the formulas we've learned let's go ahead and calculate it so again elasticity and percent change in quantity demanded you see here divided by percent change in price which we see here so let's do the top first in blue percent change of quantity demand and all we're doing is plugging these numbers into here so we have new minus old divided by old so 25 divided by 20 is 5 divided by 20 which is 1 over 4 so 0.25 which is 25 percent change in price that's 9 minus 10. Nu minus all divided by old so 9 minus 10 is one negative 1 negative 1 divided by 10 is negative 110 negative 0.1 which is negative 10 percent step is we take as we put these numbers into the fraction so I show it here as 0.25 divided by negative 0.1 it's easier for me to not do the percentage signs but if you were to do 25 divided by negative 10 so 25 divided by negative 10 it's the same thing because both the top and bottom of them multiply my hundreds this is the same 0.25 divided by negative 0.1 is negative 2.5 divided by negative 0.1 is the same as and this also is a good example of the kind of arithmetic you could be asked to do I generally do not allow people to use calculators on exams um and so notice I did all this arithmetic without using a calculator so this is again sort of the type of arithmetic you could expect from each now all right next thing we are going to learn about is interpreting elasticity so what do these numbers mean right I told you how to calculate them what can we get out of it other than some other number all right so here when we talk about elasticity think about the term elastic stretchy and can move easily right the Slinky Dog very elastic you pull it apart you push back together rigid or inelastic means rigid and unable to change right that is not stretchy you can't pull it apart or push it together so elasticity is stretchiness or springiness think about when a high price weighs down consumption how much does it pull consumption down right so if you imagine if we had Slinky Dog and plug them down like this with the spring and we put a one pound weight at the bottom stretch way out the uh the Bulldog carved out of metal or whatever that was you tie a pound weight to that it's not doing anything so the Slinky Dog is stretchier or more elastic so anything about a high price weighing down consumption how much is it pulling or sorry weighing down with you how much is it pulling consumption down so if the app value is greater than one so notice again I very specifically said absolute value I just do that because absolute value is greater than one which means the value here is is less than negative one to the reminder less than negative one is a number like negative Q so if that's the case then a change in price causes a more than proportionate change in quantities this is a small change in price with a big change in quantity so you imagine a I'm Super Bowl it's very bouncy ball it's even higher than you started at first so this is elastic you know the absolute value is greater than one so we call it elastic demand so a small change in price leads to a big change in quantity if the absolute value of the elasticity demand is less than one then a change in price causes a less than proportionate change in one so this is a big change in price or only a small change in quantity so from our story we might think of gasoline might be something like this where you can change the price a lot but people aren't going to adjust their consumption that much because that's something they sort of need to live there daily life and get to work and get to school and so that could be dropping a bowling ball I see it all and if elasticity is equal to one then a change in price causes an exactly proportionate change in point right so it bounces up exactly as high as you started it to sort of continue our facility analogy that's the absolute value is equal to all you think about that as percent change in quantity is equal to percent change in price the price of a good increases from 100 to 110. quantity decreases from 200 to 190. demand is elastic inelastic per unit elastic B demand is inelastic and the important thing to remember here is what we care about our crisis all right sorry what we care about are percentages price went up 10 right 100 to 110 that's 10 percent quantity decreased by five percent because the quantity change of 10 units 10 units divided by our initial value of 200 10 divided by 200 is 5 over 100 so our quantity decreased by five percent a 10 change in price led to a five percent decrease in quantity sold price five percent sold thus the price change LED to a less than proportionate change in quantity what we're going to do next is think of some sort of extreme examples regarding elasticity um they are not going to be because we think they're especially realistic or you know likely to turn up in the real world but they are going to help us gain some useful insights so here's our first extreme what if people are willing to pay literally any price for a good so the example that I the textbook authors use is the price of snake anti-venom per dose so in this situation you are walking by yourself and you are bit by a poisonous snake fortunately for you someone walks up next to you and has the snake anti-venom to sell you and you are going to die unless you get a dose of the snake antibenom so presumably you're going to be willing to pay any price right and I try to negotiate with this person because you're about to die well what does that look like in terms of a demand curve well you're going to buy how many doses are you going I'm not sure why this says thousands so maybe a thousand people were bit by a snake very unlucky a thousand people so in any case what this is saying is all right you're only going to buy one dose you know you're hoping not to not to be fit again 0 to buy one dose and if the price is five dollars you will buy one unit the price is four dollars you will buy one unit and keep going if the price is ten thousand dollars you will buy one unit so this is an example of what of what we're going to call perfectly inelastic domain so an increase in price leaves quantity demanded unchanged right because so inelastic is quantity doesn't change very much when price change right we still got to buy gasoline so we don't reduce our consumption that much perfectly inelastic says that an increase in price causes no decrease in quantity at all this is a perfectly inelastic demand curve so if we think about calculating our elasticity here if our quantity does not change at all that means that our change in quantity is zero and our change in price is some number greater than zero right we're increasing the price by a dollar two dollars three dollars so on and it really doesn't matter what the number on the bottom of the fraction is because the top is zero I guess that the change in price was Zero we'd get undefined but if the price is what whether the price is positive or negative our quantity changes Pro with our price change is positive or negative our quantity change is zero perfectly inelastic to me all right now let's look at the other extreme what if people are not willing to accept any price increase so in our previous example people will accept any price increase and not change their quantity at all here people are not willing to accept any price increase so any price increase your plot your quantity goes to zero so the way we show it is it looks like this at a dollar ex consumers will buy any quantity so this is sort of silly but the price that the sort of example I thought of is let's think of the price for four quarters if the price is a dollar you'll buy you'll buy whatever right you're just changing four quarters for a dollar but if the price goes anything above a dollar you will not purchase any right you're not gonna pay a dollar twenty you know a dollar twenty five for four quarters so notice at any price above a dollar quantity demanded is zero at any price below a dollar quantity demanded is infinite so I guess this would be if someone was selling four quarters for 75 cents you would be willing to you know you do that all day you'll buy as many dollars as you can if you could pay 75 cents for them so we call this a perfectly inelastic demand the customers will accept any price increase what do you mean they're not willing to accept it what they what that means that if you increase the price fine I'm not buying anything so let's look at what this comes out to so here our change in quantity is a hundred percent is negative a hundred percent right I will decrease all it's a hundred percent reduction in how many I'm buying divided by any change in price this could be very small and so as we get smaller and smaller changes in price the bottom of the fraction gets smaller and smaller and smaller which means that the number gets bigger and bigger and so we just it's actually it goes to Infinity because we can always come up with a smaller value on the bottom for which we still lose 100 of buyers foreign ers so to summarize this is a nice way of sort of uh showing everything we talked about today elastic inelastic perfectly inelastic perfectly elastic so we're going to have this number line here and we start at zero and go to negative figure we start at negative infinity and go to zero so here it's again it's getting greater as we move to the right as we think of a number line doing and for a given change in price this gives us a large change in quantity right so very stretchy springy this gives us a small change in quantity and then we have the other significant Point here is negative one negative one is unit elastic sort of our Baseline beyond that to the left is elastic so anything less than negative one is elastic that is stretchy right Small Change in price bigger change in quantity anything to the right of this so net greater than negative one which means between 0 and negative one negative point five negative 0.25 that is inelastic that means we have a big change in price and only a small reduction in quantity and our extremes then are perfectly elastic right the largest possible change in quantity which is that you lose all the customers on this end we have perfectly inelastic which is the smallest possible change of quantity which is zero next we're going to discuss the relationship between elasticity of demand and total revenue for a company firms face a trade-off when setting prices higher prices mean fewer customers lower prices mean less Revenue per sale and this is closely related to elasticity of demand how much does the price increase affect quantity sold so I had this joke that this little kid told was like Hey I'm going to start selling pencils it's Grandpa's like oh that's a good idea how much are you going to sell them for so it's a million dollars each and grandma says well you're not going to celebrate any pencils that way and if it says I only need to sell one the jokes in this class aren't great higher so that's the trade-off here right well I'm going to set a high price of a million dollars I know I'm gonna get fewer customers but on that one sale I get I'm gonna sell a lot I'm gonna make a lot of money right and Eli says new band is telling us all right when you increase your pencil price you know maybe you know 25 cents 50 cents 75 cents a million dollars how many units are you losing how many how much quantity sold are you using so let's think about Netflix and we'll think about Netflix is trying to decide if they want to change their prices and they determine that if they increase their price by 10 percent they will lose 20 of their business if a percentage increase in price is more than offset by a percentage decrease in sales you should lower your price if you want to raise revenues because you're saying here is if you raise price you'll lose revenues well the other way we can look at this is that if you lower your price by 10 percent you would gain 20 percent more customers so this is saying Netflix hey you're actually um you're charging too much and so what you should do is if you cut the price just a little you will get a lot more customers a small price decrease would result in many more customers now let's think of an alternative scenario maybe they find that a 20 increase in price would only result in a 10 decrease in quantity so what they're saying here is actually you know a lot of people the who have Netflix most of them really like it and are willing to pay a higher price in fact we're getting price 20 percent and only 10 percent of our customers will leave for another service or just not have any streaming service if a percentage increase in price is not fully offset by a percentage decrease in sales you should raise your price if you want to raise revenue so this right here is a scenario where Netflix should increase their price because a large price increase would result in only a small reduction in the number of customers so what does that look like in terms of what we in terms of looking at a number line well if elasticity is between zero and negative one a decrease in price would reduce revenues to provide this is inelastic right big change in price only a small change in quantity on this side over here we have if an increase in price would reduce Revenue that happens when we have elastic demand so elasticity is more negative than negative one negative two negative three and so on when that happens you should decrease your price to increase Revenue because when you cut your price you will increase your number of customers by a lot illustrate that here and then I guess before we go on unitary elastic right in the middle is where revenue is maximized right here you should increase prices here you should decrease prices here you're right in the middle and so you if you don't want to do anything your price you have maximized Revenue elastic over here remind ourselves a small decrease in price big or increase in quantity because people are very responsive to price changes so you think about we talked about copy as the example so maybe it's the case that we said if you raise your prices you lose a lot of customers who aren't willing to pay a high price for coffee well maybe if you cut your price you will win a lot of new customers right you'll get they were going to Big B and then Starbucks cut through prices a lot of them move over with inelastic this is people really like your product people really need your product like gasoline or smoking if you're addicted to smoking and then a big increase in price only results in a small decrease in quantity I like this graph because um it sort of is a really good summary of what we've done so far uh today where we see we learn about elastic inelastic unitary perfectly inelastic we just sort of see everything together and in fact if we want to do so really finish this off zero I'm here zero would be perfectly inelastic negative Infinity is perfectly elastic let's see what this looks like on a graph it's I think it's kind of cool we can graph stuff that correspond to what we've sort of intuitively learned or what we've learned using arithmetic so here we have a demand graph and let's suppose that we have a price of about 28 a quantity of about two units so that's this point right here all right well we want to think about Revenue how do we how can we think about maximizing Revenue well notice this is not a graph of Revenue here it's a graph of price and quantity well here's something cool revenue is equal to price times quantity right how many units did you sell how much did you sell them for that's your Revenue right how many subscribers does Netflix have how much do they pay per month okay well this is price this is quantity to get the area of a rectangle we multiply base times height so the area of a rectangle the area of this rectangle price times quantity gives us total revenue so that's what I'm graphing down here then our total relevant so our total revenue in this case if we sell whatever this is about three units 28 or so our total revenue comes out to looks like around 100. okay then what happens well if we cut our price our Revenue goes up notice the the rectangle gets bigger we're only we're losing a few customers are regaining lot sorry we're losing a few dollars per sale right this we're moving downward but we're gaining a lot of customers so our rectangle gets bigger right and you can tell this rectangle has a smaller area than this one and so we calculate it and we see our Revenue graph here is higher and then if we keep cutting our price then what we're going to see is here it actually Peaks and the scale is a little off so it doesn't look that big but um if you actually do the arithmetic this right around here at 20 units is where our our revenue is maximized beyond that what's going on is you are cutting your price you're losing a large percentage of your price so a larger percentage of your Revenue per sale and not gaining enough buyers to make up for it so our Revenue starts going back down and so this is what we see here is this shape which is that if you're charging a really high price you can cut your Revenue you can cut your price to gain revenue you charge a low price you raise your price to get revenue and we're not going to talk too much about that but what that means is that actually a Wendy when you have linear demand elasticity changes along the demand curve right and that's why there's some parts where we should cut our price to raise revenue there are some price places where we should raise our price to raise revenue next question Jan has determined that her Serenity by Jan candles have an elasticity of demand of negative 0.35 which of the following is true the answer here is a increasing price would increase revenues let's see how we get there well we go back to my number line that I like we are here between 0 and negative one negative 0.35 which means we are in the inelastic part of the domain curve so you should increase price to increase Revenue why is that well a big increase in price will only change quantity by a small amount where at the not stretchy part of demand where quantity is not very responsive to price next question how do we determine elasticity or what what are the factors that affect elasticity what is it that makes gasoline be more inelastic than coffee so elasticity of demand how does a change in price affect the number of units sold what are some of the factors that determine the answer to this question so the first is substitutes so think about it this way think about if I wanted to know the elasticity of Cinnamon Toast Crunch probably my favorite cereal well this is going to be relatively elastic right because how responsive are you going to be well if the price of Cinnamon Toast Crunch grows up there are plenty of other cereals that you can switch to maybe you don't like them as much but you know there's they're there there's other cinnamony sweet cereals you can get next what if I thought about the elasticity of demand of breakfast cereal so here if we're thinking about the price of every cereal going up now it's harder for you to substitute right you can't substitute Frosted Flakes for cinnamon toast crunch you've got to find you know Pop-Tarts or something else something something considerably different and then if we were to go further and say what about the elasticity of demand of breakfast fruit break all breakfast food and so now it's all the things you think of being breakfast food what if they all go up 10 when then again you're gonna have a hard time subsidy at this point you're going to be you know eating a hamburger for breakfast or something so the more substitutes the good has the more elastic it will be so because as prices increase people will consume less of the good and more of its substitutes so how easy is that how how painless is it to switch from one good to another and searching from Cinnamon Toast Crunch to Frosted Flakes is probably easier than switching from Cinnamon Toast Crunch to a hamburger uh here's an example from the Transportation industry so if we of Transportation transportation is a large segment that it's hard to it's hard to substitute away from Transportation right because you know if you wanted to go see your parents and you can't no transportation is going to get either you have to walk or something is your substitute so that's inelastic right elasticity is between zero and negative one then if we go to Motor Vehicles now we have greater phone price elasticity because then you know maybe you could substitute for riding an airplane riding the bus um and then if we go one further to luxury automobiles that's even more elastic because obviously luxury automobiles very specific good and you can go from a luxury automobile to a non-luxury automobile much easier than you can go from a luxury automobile to no Transportation which is what we'd be talking to up here similarly if we uh go down to another example which relates to food the demand for food is inelastic again it's not really any great substitutes it's you know instead of eating a hamburger I did nothing you know I ate nothing um that's a much harder substitute to me versus Cereal where again you know you can substitute from cereal to pop Drops next is price of the good cheaper Goods tend to be more inelastic since an increase in price will not cause the consumer's budget to break so here's what I mean by this if the price of if I'm house shopping and there's a bigger the housing market has some sort of shock to it and something happens to increase real estate prices and real estate prices go up 20 percent well that is probably going to have a big effect on how big of a house I can buy because the I was probably you know I had figured out my housing budget it's going to be a lot of a large percentage of my outlays and you know if I find out that my housing is 20 going to be 20 more expensive I probably can't afford to just buy the same house it's going to cause me to buy a smaller house and because elasticity is all about percentages what we're comparing this to a 20 increase in house price too is a 20 increase in the price of peanut butter M M's my favorite candy right if I was paying a dollar from M M's before I can probably afford to pay a dollar twenty for M M's now demand for items that are considered to be Necessities tends to be inelastic so um medicine you know think about the snake anti-venom uh gasoline we talked about electricity shampoo these are things where it's hard to substitute away from right if you need some medicine in order to you know stay healthy stay alive you can't easily substitute away from it there's not a great substitute for electricity right we our family lost power a couple of weeks ago and there were no great substitutes for electricity our substitute was sitting around in the dark driving places to charge things and hoping the electricity came back on uh shampoo and this is also related to Inc refer to the prices right um if you you know the price of shampoo goes up ten percent you're probably not going to stop washing your hair or wash your hair less demand for luxury items tends to be elastic designer clothes pretty easy to substitute from designer clothes to regular clothes expensive dinners Netflix these are all things where it's not if you um stop uh consuming these things or reduce your consumption it's probably not going to have that much of an impact on your life relative to if you significantly cut back your electricity case next we have time so the more time a consumer has to plan her purchase the more elastic that good will be so let's think about what happens if the price of gasoline goes up maybe it goes up quite a bit in the short run maybe you can make some changes where you um watch Netflix instead of going to the movies you ride the bus instead of driving but you might think of both of these as um you know things that you don't really love doing right like if you don't live somewhere that's commutable by bus or if you live somewhere where it's a pain you know the bus ride takes a long time this is going to be a very difficult substitute for you to make and that's what happens in the short run in the short run you don't have a ton of options you're either buying gasoline or figuring out a way to avoid driving in the longer run you can go buy a more fuel efficient car once you buy the more fuel efficient car the gasoline you know you can still drive as much as you were before you're just spending Less on gasoline and then finally you can do something like move closer to the city right and this didn't take some time usually it's usually kind of a pain in the neck to move takes the plan ahead but when this over time then our demand for gasoline is getting more expensive in the short run my substitute is I'm going to ride the bus instead of taking it driving my car in the long run it's oh I live right by work I could just walk there anyway foreign next we have consumer search here's what we mean by that Goods where consumers are willing to search for a low-cost alternative are more elastic the more you search the more likely you are to find a good lower priced substitutes so you can think about maybe you when you're at home and you're deciding you need gas you kind of know where all the gas stations are close to you maybe you use one of those apps to find out yeah and then it's pretty much think of it as relatively low cost for you to find the closest gas station you know maybe you drive by four gas stations on the way to work and on your way home you just pick whichever one was the cheapest compare that you're on vacation you kind of pull off at a rest stop and you're low on gas you don't know the area you're kind of worried about running out of gasoline you don't know how how far it's going to be to another gas station you don't bother a search the first gas station you see you pull out and pay when should you spend time searching on the marginal benefit of searching is high I think about marginal benefit and marginal costs so the example we just talked about the marginal benefit of searching might be the benefit might be you don't run out of gas in the middle of nowhere someplace you're not familiar with that's a pretty big benefit um you think about um this right here is an example of a place where you can do some pretty low cost comparison shopping which is interest rate for houses and when you are borrowing money for a house typically you'll have a 30-year mortgage saving a percent you know a half a percent of Interest over 30 a 30-year mortgage several have several hundred thousand dollars that's a huge change in the total price you're paying for the house so here the marginal benefit of searching is very high because there is a huge price difference over the course of your mortgage if you can save just a few if you can save half a percent right so it's worth a few minutes it's you you spend looking online at different interest rates or when the marginal cost of searching is low and so this is uh something that's definitely become more prevalent with the internet right it used to be if you were deciding you wanted to buy a telephone nice television the way you would search is you would drive to Best Buy and drive to Walmart and drive to the electronics stores near you that would be a pain you need to spend time and gas money driving between the places whereas now with Google shopping Marshall cost is very low you type in the name of the model number of the television you want and you get prices from every store you can think of so to summarize it's all about substitutability how easy is it to substitute to another good how close of a substitute is another good right it's easy to substitute from a TV at Best Buy to a TV at Walmart if you can if if you uh know the prices for each of it's easy to find the price for each if it's not easy to find the price for each then it's hard to substitute to another good because you don't want to spend the effort finding the other good in the price of the other good important next we will discuss cross price elasticity of demand so far we've learned about own price or price elasticity of demand percent change in quantity demanded divided by percent change in price so this is what we call own price elasticity quantity of Netflix price of Netflix right we're thinking about the same good you're thinking about the change in quantity of Netflix change in price of Netflix what we can also think about another way and not something else that could affect the quantity of Netflix number of Netflix subscribers which is the price of a competing good like Hulu so how are Netflix's sales affected by the price of Hulu seems likely that a Hulu for example runs a sale and cuts their prices they might win some business away from Netflix so Netflix could lose some of their customers so we have here is let's think about let's calculate the change in quantity of Netflix divided by the change in price of Hulu next one let's see what you think about is how are Netflix's sales affected by the price for broadband internet service so these are things that you consume together right there's no point in having Netflix if you don't have high-speed internet so quantity of Netflix change in the quantity of Netflix divided by the change in the price of the internet and both of these are examples of cross price elasticity cross price elasticity is when we want to calculate the percent change in the quantity of good X divided by the percent change in the price of good y okay well think about that now let's uh try to get some Intuition or what what kind of numbers or what size or magnitudes of the numbers we expect if two goods are substitutes cross price elasticity will be negative positive or zero how about that the answer here is B positive so if we go to our example if the price of Hulu goes up the quantity of Netflix goes up so what that means is this is a positive change this is a positive change right Hulu increased their price people switched over to Netflix they are substitutes positive divided by positive is a positive or maybe Hulu runs a sale if the price of Hulu goes down goes to the disappearing if the price of Hulu goes down the quantity of Netflix goes down right here it's Hulu runs a sale people first down here Hulu runs a sale lowers their price and people respond by switching from Netflix to the substitute Goods which is hold on Hulu so negative price change negative change in the quantity of Netflix negative divided by a negative is a positive all right next one if two goods are complements cross price elasticity will mean negative positive or zero so actually try to solve this don't just base it on you know must not be the last the answer the last one so the answer here is a negative percent change in the quantity of Netflix divided by the percent change in the price of the internet well if the price of the internet goes up the quantity of Netflix goes down these are complements so you consume them together and so if the internet gets more expensive and leads people to you know fewer subscribers of high-speed internet then the quantity of Netflix goes down because again if you're canceling your internet you're going to be canceling your Netflix as well so price internet goes up fewer people get Netflix negative the price of the internet goes down so and this the the quantity of Netflix goes up so this is a good story of what's happened over the last 10 or 15 years so when I was younger I remember it was like a big deal to stream video it took viewed it was always buffering it would it was very it was low quality like there was no such thing as screaming a movie in HD and so the price of the internet has gone down so more people are subscribing to Netflix now so we can summarize if cross price elasticity is positive the goods are substitutes if cross-price elasticity is negative the goods are compliments this allows economists to determine if Goods or substitutes or compliments right so this is an actual quantitative way if you calculate cross-price elasticity the sign will tell you if the two goods or substitutes or complements the cross price elasticity of butter and margarine is 0.6 if the price of butter increases 20 percent how does the quantity of margarine change the answer here is B it will increase by 12 percent how do we get there well elasticity percent change in quantity of good x divided by percent change in price of good y so we just got to plug in our numbers here what we have is elasticity of 0.6 change in price of 20 percent we just need to calculate the time so this is often how these questions are going to go is the elasticity calculation is usually the last test equals one thing divided by another thing so I will give you two of these three numbers and ask you to solve for the third so here I give you elasticity give you a price change ask you for the quantity change so here that's going how do we calculate this multiply both sides by 20 percent 0.6 times 20 percent equals the percent change in the quantity of margarine versus point six times twenty percent is twelve percent so that's a positive number they are substitutes quantity of margin increases by 12 percent a couple more examples first we have income elasticity income elasticity of demand remember we talked about normal and inferior Goods we said when we as we get richer we buy more of goods like designer clothes restaurant meals expensive cell phones these are all normal Goods right get a raise at work you go buy yourself some nice clothes like with substitutes and complements we can quantify the size of that change that's for example a moderate increase in income results in me buying a few more hamburgers but doubling my state consumption right so I was already eating a lot of hamburgers small increase in income I'll eat some more whereas I was very rarely eating steak and so now that I have more income I can eat a lot more I can double my state because you know maybe I'm going from two steaks a month to four how do we calculate so we can calculate this the and quantify this this idea of how your change in income affects your change in consumption with the income elasticity of demand notice we have this one as e subscript I her income percent change in quantity divided by percent change in income once again our top is a change in quantity the bottom is a change in something else right so for a normal good income elasticity of demand is positive or negative the answer here is a positive because let's look at our formula if your income goes up then you buy more right this is steak gotta raise what bought some more States increase in income so a positive number led to an increasing quantity positive number or lost my job so my income went down the percent change is negative because I lost my job I'm not buying as many Stakes percent change in quantity is negative by reducing my quantity that's a negative divided by a negative which is also a positive so the normal good elasticity is positive with inferior good it's going to work the opposite way so I lose my job I go buy more ramen noodles this could be this negative or a positive divided by a negative or my income goes up so I get a raise at work I'm able to stop buying ramen noodles and buy hamburgers instead that's a negative divided by positive either way elasticity is negative or inferior Goods all right elasticity of supply so we've only talked about elasticity of demand so far we've got a different a few different types of things where we thought about change in quantity demanded now we're going to think about how about elasticity of supply what changes the quantity supplied you can also think about the effect of a price change on producers how much more gasoline will Chevron produce if the price of gasoline goes up 10 percent so with the price elasticities of Supply we use e subscript s s for supply and this is the first time our to the top of our fraction is changing a little bit it's now percent change in Qs that's the change in quantity supplied divided by the percent change in price um and we can use these same terms elastic and inelastic if our line is steep here then that means a big increase of price results in only a small change in quantity supplied so this is inelastic quantity is relatively unresponsive so the same story this right here is not the Slinky Dog this is that dog made out of metal where you pull it up you try to pull it by changing the price and it just doesn't Bend whereas this green line yeah something where we have the same price change going from two up to three we get a big change of quantity I had to stretch out the graph even all the way up to there so this is elastic Supply quantity is relatively responsive so this is a small change in price you get a big increase in quantity supplied so uh the example I have here I I think I made these slides and my kids are watching a lot of Frozen um Bullock's job is that he sells ice and so he harvests ice and sells it I would guess that his Supply is probably relatively inelastic because whatever the price is the ice is there there's as much ice as he wants and he goes and you know he goes and harvests it and spends however you know however many hours a day grabbing the ice and so probably that doesn't depend very much on the Press so let's find this thing about some less silly examples what determines the price elasticity of supply first is inventories make Supply more elastic so if you uh have huge warehouses full of something so I actually once uh hash job one on a tour of a Whirlpool Warehouse which is this massive building floor-to-ceiling packed with washing machines and dishwashers and things like that and this makes Supply more elastic because if you're whirlpool and you see the price of dishwashers is going up well you can easily increase your quantity Supply just by emptying out your inventory foreign next easily available inputs make Supply more elastic so if you think about Spotify Premium let's suppose that Spotify you know has served some server space so that they've dedicated to Spotify Premium there's some costs involved in that well then there's an increase in demand for streaming music it is pretty easy for Spotify Premium to increase their quantity Supply right they just buy a few more servers if they even need to uh because most of these these inputs for Spotify Premium are just digital right if Spotify owns the right to a Taylor Swift song then they can stream that to an infinite number of people extra capacity makes Supply more elastic so if we think about um a airplane so let's think about if there's a flight route that initially the planes were usually kind of half empty that was more than half empty there's a lot of extra capacity there and if there's an increase in the price of this route this is uh Lansing the Washington DC it would have flown a couple of times and initially there's not many people on the plane price goes up um and Airline wants to sell more tickets not too difficult right those tickets is easy for them to add seats when they're seated for them to sell more tickets with their seats available on the other hand if this plane is totally full then uh Delta does not have extra capacity right in order for that and at that point in order to increase their uh quantity of airplane ticket Supply they're going to have to get another airplane which is a lot more expensive foreign easy entry and exit makes Supply more elastic so when prices rise new businesses may enter the market so if you think about something like uber these startup costs for a company like uber pretty low in terms financially because all it is is an app right Uber doesn't own any of their own cars they don't have very many employees most of the people are just paid um you know they're contractors who paid by the app so pretty easy for new ride share businesses to enter the market yeah when prices fall some businesses May exit the market now the one thing with Uber that's a little tricky is even though the financial cost is low it's not easy to enter Because if you remember we talked about Network Goods Uber is an example right if you're starting off a new ride share company well if I'm telling people hey come use my ride share I open it up and there's no drivers not really get a lot of using similarly if I'm telling drivers hey stop driving Uber try for my company and they open it up and nobody's looking for a ride then they're going to have you I'm going to have a hard time getting people to join but if you think about um the financial cost to Uber how expensive it is just to set it up relatively low cost pretty easy to enter and exit the industry next is overtime Supply becomes more elastic so in the short run if you want to produce you have to just produce you can purchase more variable inputs so Corvette this new Corvette came out there was this huge long waiting list and Corvettes are made in one Factory um and over time there's just a limp in the short run there's just a limit to how many Corvettes General Motors can make right they have the they have the assembly line they can run you know they operate the assembly line as fast as they can but there's a limit there whereas in the long run General Motors think there's going to continue be to be this big demand for their coordinate they could build a new Corvette factory the main thing we note here is this is all about flexibility right how easy is it for you to crank up your supply when the price is higher right is it take a lot of effort take a lot of time expensive or is it something where you can yep a few more people want my air I want to fly on my airplane all I got to do is print more tickets price elasticity of supply is always positive always negative or it depends the answer here is a it is always positive that is because Supply slopes up so any last icity of Supply equals percent change in quantity supplied divided by percent change in price well if the price goes up so if this is a positive number quantity supplied goes up how do we know this because Supply slopes up price goes up we Supply more units price goes down Supply fewer units which would be a negative divided by a negative both of these negative divided by a negative positive over positive negative over negative both of those are positive numbers we can use these same terms elastic inelastic or unilastic for elasticity of supply the only difference is we no longer have those negative signs so a small change in price big change in quantity of supplies elastics this is when you know when you have extra seats on your plane with inelastic you need a big change in price for it to be worth it for you to add just a small head to have a small change in quantity and then unit elastic is they move at the same amount all right that's all we have for elasticity thank you