Topic+3+Elasticity Chapter+5.Ppt

8/3/2019 Topic+3+Elasticity Chapter+5.Ppt

http://slidepdf.com/reader/full/topic3elasticity-chapter5ppt 1/53

© 2007 Thomson South-Western




Outline

• The elasticity of demand and supply the concept

the price elasticity of demand and its

determinants computing the price elasticity of demand

the midpoint method

the variety of demand curves elasticity and total revenue along a linear

demand curve




Elasticity . . .

• … allows us to analyze supply and demand

with greater precision.

• … is a measure of how much buyers and sellers

respond to changes in market conditions




THE ELASTICITY OF DEMAND

• The price elasticity of demand is a measure of how much the quantity demanded of a goodresponds to a change in the price of that good

• The responsiveness of quantity to changes inprice is always measured in percentage terms.

• Specifically, the price elasticity of demand isthe percentage change in quantity demandeddue to a percentage change in the price.




The Price Elasticity of Demand and ItsDeterminants

• Availability of Close Substitutes

• Necessities versus Luxuries

• Definition of the Market

• Time Horizon




The Price Elasticity of Demand and ItsDeterminants

• Demand tends to be more elastic:

• the larger the number of close substitutes.

(because it is easier for consumers to switch from thatgood to others. e.g butter and magarine, eggs

(without close substitutes)• if the good is a luxury.

(necessities tend to have inelastic demands, whereasluxuries have elastic demand. e.g visit to doctor vs

sailboat)• the more narrowly defined the market.

(e.g. Food vs ice-cream)

• the longer the time period.




Computing the Price Elasticity of Demand

• The price elasticity of demand is computed asthe percentage change in the quantity demanded

divided by the percentage change in price.

Price elasticity of demand =Percentage change in quantity demanded

Percentage change in price




Computing the Price Elasticity of Demand

• Example: If the price of an ice cream cone

increases from $2.00 to $2.20 and the amountyou buy falls from 10 to 8 cones, then your

elasticity of demand would be calculated as:

( )

( . . )

.

10 8

10100

2 20 2 00

2 00

100

20%

10%2

Price elasticity of demand =Percentage change in quantity demanded





The Midpoint Method: A Better Way to CalculatePercentage Changes and Elasticities

• The midpoint formula is preferable whencalculating the price elasticity of demand

because it gives the same answer regardless of

the direction of the price change.

2 1 2 1

2 1 2 1

( ) /[( ) / 2]Price elasticity of demand =

( ) /[( ) / 2]

Q Q Q Q

P P P P


http://slidepdf.com/reader/full/topic3elasticity-chapter5ppt 10/53© 2007 Thomson South-Western

The Midpoint Method: A Better Way to CalculatePercentage Changes and Elasticities

• Example: If the price of an ice cream coneincreases from $2.00 to $2.20 and the amount

you buy falls from 10 to 8 cones, then your

elasticity of demand, using the midpoint formula, would be calculated as:

(10 8)

22%(10 8) / 2 2.32(2.20 2.00) 9.5%

(2.00 2.20) / 2



The Variety of Demand Curves

• Inelastic Demand

• Elastic Demand

• Perfectly Inelastic• Perfectly Elastic

• Unit Elastic




• Inelastic Demand

• Quantity demanded does not respondstrongly to price changes.

• Price elasticity of demand is less than one

(Ed <1)

• Elastic Demand

• Quantity demanded responds strongly tochanges in price.

• Price elasticity of demand is greater than one(Ed > 1)




Computing the Price Elasticity of Demand: Example 1

Demand is price elastic.

$54

Demand

Quantity1000 50

3percent22

percent67

5.00)/2(4.005.00)(4.00

50)/2(10050)(100

ED

Price




Example 2

Price

Quantity(Thousands)

0

$1.10

0.90

95 105

●a

●b

D

ED = ∆q X 100 divide ∆p X 100

(q1+ q2)/2 (p1 + p2)/2

= 10,000 X 100 divide (- $0.20) X 100100,000 $1.00

= 10 %

(-20%)

= - 0.5

*Law of demand states that P and Q demanded areinversely related. In elasticity formula, the numerator andthe denominator have opposite signs leaving the priceelasticity of demand with a negative sign.B

e c




• Perfectly Inelastic

• Quantity demanded does not respond to price

changes (Ed = 0)

• Perfectly Elastic

• Quantity demanded changes infinitely with any

change in price ( Ed = )

• Unit Elastic

• Quantity demanded changes by the same percentageas the price (Ed = 1)




• Because the price elasticity of demandmeasures how much quantity demanded

responds to the price, it is closely related to the

slope of the demand curve.

• But it is not the same thing as the slope!




Figure 1 The Price Elasticity of Demand

(a) Perfectly Inelastic Demand: Elasticity Equals 0

$5

4

Quantity

Demand

100 0

1. An increase in price . . .

2. . . . leaves the quantity demanded unchanged.

Price





(b) Inelastic Demand: Elasticity Is Less Than 1

Quantity 0

$5

90

Demand 1. A 22% increase in price . . .

Price

2. . . . leads to an 11% decrease in quantity demanded.

4

100





2. . . . leads to a 22% decrease in quantity demanded.

(c) Unit Elastic Demand: Elasticity Equals 1

Quantity

4

100 0

Price

$5

80

1. A 22% increase in price . . .

Demand





(d) Elastic Demand: Elasticity Is Greater Than 1

Demand

Quantity

4

100 0

Price

$5

50


2. . . . leads to a 67% decrease in quantity demanded.





(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity 0

Price

$4 Demand

2. At exactly $4, consumers will buy any quantity.

1. At any price above $4, quantity

demanded is zero.

3. At a price below $4, quantity demanded is infinite.



Total Revenue and the Price Elasticity ofDemand

• Total revenue is the amount paid bybuyers and received by sellers of a good.

• Computed as the price of the good times

the quantity sold.

QPTR




Figure 2 Total Revenue

Demand

Quantity

Q

P

0

Price

P × Q = $400

(revenue)

$4

100

When the price is $4,consumers will demand100 units, and spend $400on this good.



Elasticity and Total Revenue along aLinear Demand Curve

• With an inelastic demand curve, anincrease in price leads to a decrease in

quantity that is proportionately smaller.

Thus, total revenue increases.




Figure 3 How Total Revenue Changes When Price

Changes: Inelastic Demand

Demand

Quantity 0

Price

Revenue = $100 Quantity 0

Price

Revenue

= $240 Demand $1

100

$3

80

An Increase in pricefrom $1to $3 …

… leads to an Increase intotal revenue from $100 to$240



Elasticity and Total Revenue along a Linear DemandCurve

• With an elastic demand curve, an increase in the price leads to a decrease in quantity

demanded that is proportionately larger.

Thus, total revenue decreases.




Figure 3 How Total Revenue Changes When Price

Changes: Elastic Demand

Demand

Quantity 0

Price

Revenue

= $200

$4

50

Demand

Quantity 0

Price

Revenue = $100

$5

20

An Increase in price from$4 to $5 …

… leads to an decrease intotal revenue from $200 to$100

Note that with each price increase, the Law of Demand still holds – anincrease in price leads to a decrease in the quantity demanded. It is the

change in TR that varies!




Elasticity of a Linear Demand Curve




Other Demand Elasticities

• Income Elasticity of Demand

• Income elasticity of demand measures

how much the quantity demanded of a

good responds to a change in

consumers’ income.

• It is computed as the percentage changein the quantity demanded divided by the

percentage change in income.





• Computing Income Elasticity

Income elasticity of demand =

Percentage change

in quantity demandedPercentage change

in income

Remember, all elasticities aremeasured by dividing onepercentage change by another





• Income Elasticity

• Types of Goods

• Normal Goods• Inferior Goods

• Higher income raises the quantity

demanded for normal goods but lowersthe quantity demanded for inferior

goods.





• Income Elasticity

• Goods consumers regard as necessitiestend to be income inelastic

• Examples include food, fuel, clothing,utilities, and medical services.

• Goods consumers regard as luxuries

tend to be income elastic.• Examples include sports cars, furs,and expensive foods.





• Cross-price elasticity of demand

• A measure of how much the quantity demanded of one good responds to a change in the price of

another good, computed as the percentage change in

quantity demanded of the first good divided by the

percentage change in the price of the second good

2goodof pricein% change

1goodof demandedquantityin% changedemandof elasticityprice-Cross =




THE ELASTICITY OF SUPPLY

• Price elasticity of supply is a measure of how much the quantity supplied of a

good responds to a change in the price of

that good.

• Price elasticity of supply is the

percentage change in quantity suppliedresulting from a percentage change in

price.




Figure 5 The Price Elasticity of Supply

(a) Perfectly Inelastic Supply: Elasticity Equals 0

$5

4

Supply

Quantity 100 0

1. An increase in price . . .

2. . . . leaves the quantity supplied unchanged.

Price





(b) Inelastic Supply: Elasticity Is Less Than 1

110

$5

100

4

Quantity 0


Price

2. . . . leads to a 10% increase in quantity supplied.

Supply





(c) Unit Elastic Supply: Elasticity Equals 1

125

$5

100

4

Quantity 0

Price



Supply

(If SUPPLY is unitelastic and linear, itwill begin at theorigin.)





(d) Elastic Supply: Elasticity Is Greater Than 1

Quantity 0

Price



4

100

$5

200

Supply





(e) Perfectly Elastic Supply: Elasticity Equals Infinity

Quantity 0

Price

$4 Supply

3. At a price below $4, quantity supplied is zero.

2. At exactly $4, producers will supply any quantity.

1. At any price above $4, quantity

supplied is infinite.




The Price Elasticity of Supply and ItsDeterminants

• Ability of sellers to change the amount of the good they produce.

• Beach-front land is inelastic.

• Books, cars, or manufactured goods are

elastic.

• Time period• Supply is more elastic in the long run.




Computing the Price Elasticity of Supply

• The price elasticity of supply is computed asthe percentage change in the quantity supplied

divided by the percentage change in price.

Price elasticity of supply =

Percentage change

in quantity supplied





THREE APPLICATIONS OF SUPPLY,

DEMAND, AND ELASTICITY• Can good news for farming be bad news

for farmers?

• What happens to wheat farmers and themarket for wheat when university

agronomists discover a new wheat hybrid

that is more productive than existing

varieties?




Can Good News for Farming Be Bad Newsfor Farmers?

• Examine whether the supply or demand

curve shifts.

• Determine the direction of the shift of thecurve.

• Use the supply-and-demand diagram to

see how the market equilibrium changes.

Figure 7 An Increase in Supply in the Market for




Figure 7 An Increase in Supply in the Market for

Wheat

Quantity of

Wheat

0

Price of

Wheat

3. . . . and a proportionately smaller increase in quantity sold. As a result,

revenue falls from $300 to $220.

Demand

S 1 S 2

2. . . . leads to a large fall in price . . .

1. When demand is inelastic,

an increase in supply . . .

2

110

$3

100




Compute the Price Elasticity of Demand When

There Is a Change in Supply

ED

100 110

100 110 2

3 00 2 003 00 2 00 2

0 0950 4

0 24

( ) /

. .( . . ) /

..

.

Demand is inelastic.

Wh Did OPEC F il K h P i f




Why Did OPEC Fail to Keep the Price ofOil High?

• Supply and Demand can behave differently inthe short run and the long run

• In the short run, both supply and demand for

oil are relatively inelastic• But in the long run, both are elastic

• Production outside of OPEC

• More conservation by consumers

Figure 9 A Reduction in Supply in the World




Price of Oil

Quantity of Oil

Price of Oil

Quantity of Oil

a) The Oil Market in theShort Run

b) The Oil Market in theLong Run

D1

D1

S

2

S1

S1

Figure 9 A Reduction in Supply in the WorldMarket for Oil

P1

P2

S2

P1

P2

In short run, SS and DD relativelyinelastic.

When SS falls – S1 shift to S2 – leadsto price increase substantially from P1to P2

In long run, SS and DD relativelyelastic.

When SS falls – S1 shift to S2 – leads to a smaller price increase

from P1 to P2

D D I di i I




Does Drug Interdiction Increase orDecrease Drug-Related Crime?

• Drug interdiction impacts sellers rather thanbuyers.

• Demand is unchanged.

• Equilibrium price rises although quantity falls.

• Drug education impacts the buyers rather than

sellers.

• Demand is shifted to left.• Equilibrium price and quantity are lowered.

Figure 9 Policies to Reduce the Use of Illegal Drugs




Price of Drugs

Quantity of Drugs

Price of Drugs

Quantity of Drugs

Drug Interdiction Drug Education

D2

D1

D1

S2

S1S1

Figure 9 Policies to Reduce the Use of Illegal Drugs

Drug interdiction reduces supply fromS1 to S2

If demand for drug is inelastic, theamount paid by drug users increase

from P1 to P2

Meanwhile drug education reducesthe demand for drugs from D1 to D2

Because both price and quantity fallthe amount paid by drug users falls.



Summary


• The concept of elasticity of demand andsupply

• Cross-elasticity of demand and income-

elasticity of demand• The calculation and interpretations

• The relationship between elasticity and

and total revenue



Summary


• Price elasticity of demand measures how much the

quantity demanded responds to changes in the price.

• Price elasticity of demand is calculated as thepercentage change in quantity demanded divided by

the percentage change in price.

– If a demand curve is elastic, total revenue falls when the

price rises.

– If it is inelastic, total revenue rises as the price rises.



Summary


• The income elasticity of demand measures how muchthe quantity demanded responds to changes inconsumers’ income.

• The cross-price elasticity of demand measures howmuch the quantity demanded of one good responds tothe price of another good.

• The price elasticity of supply measures how much thequantity supplied responds to changes in the price.



Summary

• In most markets, supply is more elastic in the

long run than in the short run.

• The tools of supply and demand can be applied

in many different types of markets.

Topic+3+Elasticity Chapter+5.Ppt

Documents

Transcript of Topic+3+Elasticity Chapter+5.Ppt