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Elasticity and its Application
EconomicsP R I N C I P L E S O FP R I N C I P L E S O F
N. Gregory N. Gregory MankiwMankiw
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5
ELASTICITY AND ITS APPLICATION 2
Calculating Percentage Changes• So, we instead use the midpoint method:
end value – start valuemidpoint
x 100%
The midpoint is the number halfway between the start & end values, the average of those values.
It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way!
ELASTICITY AND ITS APPLICATION 3
Calculating Percentage Changes• Using the midpoint method, the % change
in P equals
$250 – $200$225
x 100% = 22.2%
The % change in Q equals
12 – 810
x 100% = 40.0%
The price elasticity of demand equals
40/22.2 = 1.8
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
Calculate an elasticityCalculate an elasticity
4
Use the following information to calculate the price elasticity of demand for hotel rooms:
if P = $70, Qd = 5000
if P = $90, Qd = 3000
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
AnswersAnswers
5
Use midpoint method to calculate % change in Qd
(5000 – 3000)/4000 = 50%
% change in P
($90 – $70)/$80 = 25%
The price elasticity of demand equals50%25%
= 2.0
ELASTICITY AND ITS APPLICATION 6
Price Elasticity and Total Revenue
• If demand is elastic, then price elast. of demand > 1 % change in Q > % change in P
• The fall in revenue from lower Q is greater than the increase in revenue from higher P, so revenue falls.
Revenue = P x Q
Price elasticity of demand
=Percentage change in QPercentage change in P
ELASTICITY AND ITS APPLICATION 7
Price Elasticity and Total RevenueElastic demand(elasticity = 1.8) P
Q
D$200
12
If P = $200, Q = 12 and revenue = $2400.
When D is elastic, a price increase causes revenue to fall.
$250
8
If P = $250, Q = 8 and revenue = $2000.
lost revenue due to lower Q
increased revenue due to higher P
Demand for your websites
ELASTICITY AND ITS APPLICATION 8
Price Elasticity and Total RevenueNow, demand is inelastic: elasticity = 0.82 P
Q
D
$200
12
If P = $200, Q = 12 and revenue = $2400. $250
10
If P = $250, Q = 10 and revenue = $2500.
When D is inelastic, a price increase causes revenue to rise.
lost revenue due to lower Q
increased revenue due to higher P
Demand for your websites
Supply, Demand, and Government Policies
EconomicsP R I N C I P L E S O FP R I N C I P L E S O F
N. Gregory N. Gregory MankiwMankiw
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A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
Price controlsPrice controls
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
Determine effects of:
A. $90 price ceiling
B. $90 price floor
C. $120 price floor
10
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
A. $90 price ceilingA. $90 price ceiling
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
The price falls to $90.
Buyers demand 120 rooms, sellers supply 90, leaving a shortage.
shortage = 30
Price ceiling
11
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
B. $90 price floorB. $90 price floor
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
Eq’m price is above the floor, so floor is not binding.
P = $100, Q = 100 rooms. Price floor
12
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
C. $120 price floorC. $120 price floor
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
The price rises to $120.
Buyers demand 60 rooms, sellers supply 120, causing a surplus.
surplus = 60
Price floor
13
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
Effects of a taxEffects of a tax
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
Suppose govt imposes a tax on buyers of $30 per room.
Find new Q, PB, PS, and incidence of tax.
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
AnswersAnswers
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
Q = 80
PB = $110
PS = $80
Incidencebuyers: $10sellers: $20
Tax
PB =
PS =
Consumers, Producers, and the Efficiency of Markets
EconomicsP R I N C I P L E S O FP R I N C I P L E S O F
N. Gregory N. Gregory MankiwMankiw
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17
05
10152025
303540
4550
0 5 10 15 20 25
P
Q
demand curve
A. Find marginal buyer’s WTP at Q = 10.
B. Find CS for P = $30.
Suppose P falls to $20.How much will CS increase due to… C. buyers entering
the marketD. existing buyers paying
lower price
$
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
Consumer surpConsumer surpluslus
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
AnswersAnswers
18
05
10152025
303540
4550
0 5 10 15 20 25
P$
Q
demand curve
A. At Q = 10, marginal buyer’s WTP is $30.
B. CS = ½ x 10 x $10 = $50
P falls to $20.
C. CS for the additional buyers = ½ x 10 x $10 = $50
D. Increase in CS on initial 10 units= 10 x $10 = $100
0
5
1015
20
25
30
3540
45
50
0 5 10 15 20 25
P
Q
supply curve
A. Find marginal seller’s cost at Q = 10.
B. Find total PS for P = $20.
Suppose P rises to $30.Find the increase in PS due to… C. selling 5
additional unitsD. getting a higher price
on the initial 10 units19
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
Producer surplusProducer surplus
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
AnswersAnswers
0
5
1015
20
25
30
3540
45
50
0 5 10 15 20 25
P
Q
supply curve
A. At Q = 10, marginal cost = $20
B. PS = ½ x 10 x $20 = $100
P rises to $30.
C. PS on additional units= ½ x 5 x $10 = $25
D. Increase in PS on initial 10 units= 10 x $10 = $100
20
Application: The Costs of Taxation
EconomicsP R I N C I P L E S O FP R I N C I P L E S O F
N. Gregory N. Gregory MankiwMankiw
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A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
Answers to AAnswers to A
22
D
S
CS = ½ x $200 x 100= $10,000
0
50
100
150
200
250
300
350
400
0 25 50 75 100 125
P
Q
$
Total surplus= $10,000 + $10,000= $20,000
PS = ½ x $200 x 100= $10,000
P =
The market for airplane tickets
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
Answers to BAnswers to B
23
D
S
CS = ½ x $150 x 75= $5,625
0
50
100
150
200
250
300
350
400
0 25 50 75 100 125
P
Q
$
Total surplus = $18,750
PS = $5,625
Tax revenue= $100 x 75= $7,500
DWL = $1,250
PS =
PB =
A $100 tax on airplane tickets
Application:International Trade
EconomicsP R I N C I P L E S O FP R I N C I P L E S O F
N. Gregory N. Gregory MankiwMankiw
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A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
Analysis of tradeAnalysis of trade
25
Without trade,PD = $3000, Q = 400
In world markets, PW = $1500
Under free trade, how many TVs will the country import or export?
Identify CS, PS, and total surplus without trade, and with trade.
P
Q
D
S
$1500
200
$3000
400 600
Plasma TVs
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
AnswersAnswers
26
Under free trade, domestic
consumers demand 600
domestic producers supply 200
imports = 400
P
Q
D
S
$1500
200
$3000
600
Plasma TVs
imports
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11
AnswersAnswers
27
Without trade, CS = APS = B + CTotal surplus
= A + B + C
With trade, CS = A + B + DPS = CTotal surplus
= A + B + C + D
P
Q
D
S
$1500
$3000
Plasma TVs
A
B D
C
gains from trade
imports