Elasticity of Supply and Demand

1
Elasticity of Supply and Demand

• p140-p160

2
Elasticity

• Elasticity shows us how responsive the amount we
  want to buy to a change in price level.
• Sensitivity.

3
Price Elasticity of Demand

• A measure that indicates the degree of consumer
  response to a price change.
• percentage change in quantity demanded divided by
  percentage change in price

4
Percentage change

• So if the initial Quantity demanded is 95, and
  new Quantity demanded is 105, how should we
  calculate the percentage change here?
• If the initial price is 55 and the new price is
  45, how should we calculate the percentage change
  here?

5
4.1.2 Elasticity Calculation
Ed is typically negative for goods that follow
the law of demand
6
How to interpret the elasticity coefficient

• if ?E? 1, demand (supply) is elastic
• if ?E?
• if ?E? 1, demand (supply is unitary elastic

7
Figure 4 Elasticity and Straight-Line Demand
Curves
3
2
1
D
8
Question Which is more elastic, the demand for
cigarettes or the demand for potato chips?
(b)
D
D
9
(No Transcript)
10
Determinants of price elasticity

• The availability of substitutes
• Narrowness of Market
• The Time Horizon
• Importance in the Buyers Budget

11
4.3 Elasticity and total revenue

• Total revenue (TR) of all firms in the market is
  defined as
• TR P x QD
• As P and QD change, TR changes
• Change in TR Change in Price Change in
  Quantity Demanded

12
Elasticity and total revenue

• if ?ED? 1, demand is elastic
• ??Q? ??P?
• Change in TR Change in Price Change in
  Quantity Demanded
• as P increases TR decreases, as P falls, TR
  increases.
• e.g. When JC-Penny has a sale, they hope that
  demand is elastic

13
Elasticity and total revenue

• if ?ED?
• ??Q?
• Change in TR Change in Price Change in
  Quantity Demanded
• as P increases TR increases, as P falls, TR
  decreases.
• e.g. Industry of laptop, drugs

14
Figure 6 Elasticity and Total Revenue
B
A
D
15
Elasticity and total revenue

• if ?ED? 1, demand is unitary elastic
• ??Q? ??P?
• Change in TR Change in Price Change in
  Quantity Demanded
• So the change in price is offset by the
• change in quantity.

16
How Total Revenue Changes Along a Demand Curve
Elastic range ED 1
ED 1
Inelastic range ED Q0
Q0
(b)
(a)
17
4.4 Price Elasticity of Supply

• Percentage change in quantity of a good supplied
  that is caused by a 1 change in the price of the
  good
• With all other influences on supply held constant

18
(No Transcript)
19
Price Elasticity of Supply

• Similarly, we say
• if ?ES? 1, supply is elastic
• if ?ES?
• if ?ES? 1, supply is unitary elastic

Be careful, ES is always be positive. That is,
as P increases, quantity supplied increases
20
Income Elasticity of Demand

• Percentage change in quantity demanded divided by
  the percentage change in income
• With all other influences on demandincluding the
  price of the goodremaining constant

Interpret this number as percentage increase
in quantity demanded for each 1 rise in income
21
(No Transcript)
22
Normal v.s. inferior

• EY 0 As Y increases, Q increases (NORMAL
  GOOD)
• EY GOOD)

23
Income Elasticity of Demand

• Economic necessity
• Good with an income elasticity of demand between
  0 and 1
• Economic luxury
• Good with an income elasticity of demand greater
  than 1

24
MATCHING packet p111

• Tobacco Products 2.6
• New Furniture -.6
• Macaroni Noodles 3.4
• Mink Coats .21

25

• An implication follows from these definitions
• As income rises, proportion of income spent on
  economic necessities will fall
• While proportion of income spent on economic
  luxuries will rise
• But, it is important to remember that economic
  necessities and luxuries are categorized by
  actual consumer behavior
• Not by our judgment of a goods importance to
  human survival

26
Cross-Price Elasticity of Demand

• Cross-price elasticity of demand
• Percentage change in quantity demanded of one
  good caused by a 1 change in price of another
  good
• While all other influences on demand remain
  unchanged

• the sign of the cross-price elasticity helps us
  distinguish substitutes and complements among
  related goods

27
(No Transcript)
28
Cross-Price Elasticity of Demand

• If EXZ0, as the price of the related good
  increases, the demand of X increases
• Substitutes in consumption
• If EXZ increases, the demand of X decreases
• Complements in consumption
• Its size tells us how closely the two goods are
  related
• A large absolute value for EXZ suggests that the
  two goods are close substitutes or complements
• While a small value suggests a weaker
  relationship

29
Guess it!

• EXZ between heroin and cocaine
• (EXZ 0 substitutes)
• EXZ between heroin and marijuana
• (almost 0 no relationship)
• EXZ between cigarettes and marijuana
• (EXZ
• EXZ between cigarettes and alcohol
• (EXZ

30
Example for cross-price elasticity of supply p112

• The price of apple juice increases from 2.50
  to 5.00 and the demand of apple Sauce rises from
  500 to 600 units. What is EXZ?

• Since EXZ0, the goods are substitutes in
• consumption. Since EXZ
• inelastic

31
Comparison of Elasticity