ECON 351 Elasticity of Demand & Supply Week 4.1 September 17, 2013.
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Transcript of ECON 351 Elasticity of Demand & Supply Week 4.1 September 17, 2013.
ECON 351Elasticity of Demand & Supply
Week 4.1
September 17, 2013
Review
• Markets are the interaction of buyers and sellers.
• Focus on buyers and sellers separately.
• Ceteris paribus: look at one thing at a time; All other things held equal.
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10
Demand x
Demand shows the amounts purchased at alternative prices (horizontal distances at each price)
Qtyx /T
Dx
Dx
Demand for X
Supply Curve$Price
$10
8
6
4
2
2 4 6 8 10 12 14 16 Qty x/ T
$Price
$ 4
3
2.50
2.00
1.50
1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Demand
Supply
Surplus at this $ Price
$Price
$ 4
3
2.50
2.00
1.50
1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Demand
Supply
Shortage at this $ Price
$Price
4
3
2.50
2.00
1.50
PePe 1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T QeQe
Demand Supply
Market EquilibriumMarket Equilibrium
Qty D = Qty S
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SupplyDemand
Dx
Pe
Qe
Total Revenue = P X Q
$6x5 = $30
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SupplyDo
Do
Sx
Effects of Increase in Demand on Price and Quantity
Increases Price and Quantity
Pe
Qe
D1
D1
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
Demand
DxS0
Effects of an Increase in Supply on Price and Quantity
Price decreases and Quantity increases
Pe
Qe
S0
S1
S1
What causes an increase in price?
Increase in Demand or Decrease in Supply
$ P
S2
$ P
Q/T
D1
Q2Q1 Q1
P2
P1Demand
S1
Q2
P1
P2
D2
Supply
Q/T
(if you know quantity increased) (if you know quantity decreased)
What causes an decrease in price?
Decrease in Demand or
Increase in Supply
$ P
S2
$ P
Q/T
D1
Q2 Q1Q1
P2
P1
Demand
S1
Q2
P1
P2D2
Supply
Q/T
(if you know quantity decreased) (if you know quantity increased)
$ P x
109 8 7 6 5 43 2 1
Qtyx /T
Supply
D3
Sx
Market Demand Determines Price
P1
Q2
D2
D1
Q1 Q3
P3
P2
A B
PxPx
Qx/T Qx/T
P0
Q0
P0
Q0
Slope of Supply Shows responsiveness of quantity to a change
in Price
P1
Q1
P1
Q1
Slope Shows Responsiveness of Quantity to a Change in Price
A B
Px Px
Qx/T Qx/T
P0 P0
Dx
Dx
Q0Q1 Q0
P1P1
Q1
A B
PxPx
Qx/T Qx/T
P0
Q0
P0
Q0
Problems using Slope as a measure of responsiveness: Slope depends on the units of measure on the vertical and horizontal axis.
P1
Q1
P1
Q1
Price Elasticity: a Measure of responsiveness of Quantity to a Change in Price
Ed = % Δ Qd
% Δ Price
Es = % Qs
% Price
Computing the Point Price Elasticity of demand
Ed = % Δ Qd
% Δ P
% Δ Qd = (Δ Qd/ Q0)
% Δ P = (Δ P/ P0)
Ed = (Δ Qd/ Q0)
(Δ P/ P0)
Problem with measures of Point Elasticity:
• Evaluate elasticity between two points on the demand curve
• Point A: Price = $4 Quantity = 120
• Point B: Price = $6 Quantity = 80
• From A to B: Ed = (-33% / 50%) = -.66
• From B to A: Ed= (50% / -33%) = -1.5
• Measuring from either endpoint (P0, Q0) gives different estimates
Arc or midpoint price elasticityInstead of using one end of the price, quantity change as the reference point, use the midpoint.
Ed = (Δ Qd/( (Q1 + Q2)/2 ) / (Δ P/)/ ( (P1 + P2)/2 )
Ed= (- 40/100) / ($2/$5) = - 40% / 40% = -1
By using the midpoint formulation the answer will be the same for a price increase or a price decrease and is therefore an unbiased measure of the responsiveness of quantity to a change in price.
Measures of Elasticity
• Demand is ElasticElastic : %Δ Qd > %Δ P;
ie |Ed| >1. A decrease in Price an increase in Total Revenue.
• Demand is Unitary ElasticUnitary Elastic: %ΔQd = %ΔP;
ie |Ed| = 1. A Change in price no change in Total Revenue.
• Demand is InelasticInelastic: %ΔQd < %ΔP;i.e. |Ed| < 1. An increase in Price an increase in Total Revenue.
Elasticity varies on a straight line demand curve
$Price
Qty/T
Demand
Ed > 1
Ed < 1
Ed = 1
Elasticity, Price Change & Total Revenue
$Px $PxElastic (upper half)
Inelastic(lower half)
Q1Qty/T
P0
P1
Q0
P1
P0
Q0Q1
Increased Demand with elastic Supply$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
Sx
Dx
Dx
Sx
Pe
Qe
Dx`
Qe`
Pe`
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx
Pe
Qe
Dx’
Qe’
Pe’
Increased Demand , Inelastic Supply
Decrease in Supply, Elastic Demand$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx’
Pe
QeQe`
Pe`
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx’
Pe
QeQe’
Pe’
Decrease in Supply, Inelastic Demand
Determinants of Price Elasticity of Demand
• Number & Closeness of Substitutes.
• Information about price change and availability of substitutes.
• Percentage of Income Spent on good.
• Period of time: Second Law of DemandSecond Law of Demand: Demand is more elastic over a longer period of time.
Factors creating increased elasticity over time
1. More information about price change and substitutes (Beef & Chicken)
2. More substitutes over time (More Hybrids)
3. Increased opportunity to change the complementary basket of goods (Buy a car with higher MPG. Move closer to work.)
Other Elasticity's
A Measure of responsiveness of Quantity to a Change in some other factor
Income Elasticity: Measure of responsiveness of Quantity to a Change in Income
• EdI = % Δ Qd
% Δ income
• Normal Goods: Positive
• Clothing: .95: 10% income → 9.5%
• Stereo: 2.72: 10% income → 27.2%
• Increase may be Quantity or Quality
• Inferior Goods: Negative
Cross Price Elasticity: Measure of responsiveness of Quantity to a Change Price of other good
• Exy = % Δ Qx
% Δ Py
• Substitutes: Positive
• Complements: Negative
Uses of Cross Price Elasticity
• Magnitude of cross price elasticity reflects closeness of substitutes or complements
• Able to identify your closest competitors
• Courts use cross-price to measure monopoly power
Transaction Costs of Exchange
• Information Costs– Search Costs– Quality Identification Cost
• Negotiating Costs: Cost of agreeing on what and how much will be exchanged
• Transportation Costs: Cost of moving goods between parties
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