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DESCRIBING SUPPLY AND DEMAND: ELASTICITIES

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Chapter 6 DESCRIBING SUPPLY AND DEMAND: ELASTICITIES Question A newspaper recently lowered its price from 50 cents to 30 cents. As it did, the number of newspapers ... – PowerPoint PPT presentation

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Title: DESCRIBING SUPPLY AND DEMAND: ELASTICITIES


1
DESCRIBING SUPPLY AND DEMAND ELASTICITIES
  • Chapter 6

2
Todays lecture
  • Elasticity
  • The Price Elasticity of Demand
  • The Price Elasticity of Supply
  • Calculate elasticity graphically and numerically.

3
The Concept of Elasticity
  • Elasticity is a measure of the responsiveness of
    one variable to another.
  • The greater the elasticity, the greater the
    responsiveness.
  • In economics, elasticity is used to describe the
    responsiveness of quantity supplied or quantity
    demanded to price.

4
The Price Elasticity of Demand
  • The price elasticity of demand measures how much
    the quantity demanded responds to a change in
    price.

Price elasticity of demand (ED)
5
Example
  • Suppose that a 10-percent increase in the price
    of an ice-cream cone causes the amount of ice
    cream you buy to fall by 20 percent.
  • The related price elasticity of demand
  • -20 percent / 10 percent 2

6
The Price Elasticity of Supply
  • The price elasticity of supply measures how much
    the quantity supplied responds to a change in
    price.

Price elasticity of supply (ES)
7
Example
  • Suppose a 10 percent increase in the price of an
    ice-cream causes a 5 percent increase in the
    supply of ice-cream.
  • The related price elasticity of supply
  • 5 percent/ 10 percent 0.5

8
Classifying Demand and Supply as Elastic or
Inelastic
  • Demand or supply is elastic if the percentage
    change in quantity is greater than the percentage
    change in price.
  • Egt1
  • Demand or supply is inelastic if the percentage
    change in quantity is less than the percentage
    change in price.
  • Elt1

9
Unit Elastic Demand or Supply
  • Demand or supply is unit elastic if the
    percentage change in quantity is the same as the
    percentage change in price.
  • E1

10
Elasticities and Supply and Demand Curves
Perfectly inelastic demand curve
P
Quantity
11
Elasticity is Not the Same as Slope, But
  • The steeper the curve at a given point, the less
    elastic is supply or demand.
  • Perfectly elastic supply or demand
  • The curves are flat
  • The quantity responds enormously to a change in
    price (E 8)
  • Perfectly inelastic supply or demand
  • The curves are vertical
  • The quantity does not response to a change in
    price (E0).

12
Example
  • A diabetic, who will die without insulin, would
    be willing to pay any price for the life-saving
    quantity of insulin.
  • ----The diabetic has a perfectly inelastic demand
    of insulin.

13
Example
  • In agriculture individual producers generally
    have no control over the price because she or he
    will not be able to sell any of the crop if she
    or he raise the price slightly above the market
    price.
  • ---- The demand of crop is perfectly elastic.

14
Question
  • The elasticity of demand is same along the demand
    curve?
  • ----To find out the answer, we just calculate
    them by ourselves.

15
Calculating Elasticity of Demand Between Two
Points
Elasticity of demand between A and B
26
B
24
22
midpoint
C
Price
20
A
18
16
Demand
14

0
10
12
14
Quantity of software (in hundred thousands)
16
Question
  • A major cereal producer decides to lower price
    from 3.60 to 3 per 15-ounce box.
  • Q If quantity demanded increases by 18 percent,
    what is the price elasticity of demand?

17
Calculating Elasticity at a Point
To calculate elasticity at a point determine a
range around that point and calculate the arc
elasticity.
18
Calculating Elasticity along the Demand Curve
The elasticity at point C (16-24)/20/(6-4)/5
0.4/0.41
G
F
The elasticity at point F (16-0)/8/(6-10)/84
E
D
The elasticity at point A (28-20)/24/(3-5)/4
0.65
16
8
12
19
Elasticity Along a Demand Curve
Ed 8
Elasticity declines along demand curve as we move
toward the quantity axis
10
9
8
7
6
Ed 1
Price
5
4
3
2
1
0
1
2
3
4
5
6
7
8
9
10
Quantity
20
Question
  • If a good have several substitutes, the demand of
    this good is elastic or inelastic?
  • Substitutes are often pairs of goods that are
    used in place of each other and an increase in
    the price of one leads to an increase in the
    demand for the other.
  • If a good is necessary, such as salt, the demand
    of this good is elastic or inelastic?

21
Elasticity and Demand
  • As a general rule, the more substitutes a good
    has, the more elastic is its supply and demand.
  • The larger the time interval considered, the more
    elastic is the demand curve.
  • The less a good is a necessity, the more elastic
    is its demand curve.
  • Demand becomes more elastic as the definition of
    the good becomes more specific.
  • Demand for goods that represent a large portion
    of ones budget are more elastic.

22
Elasticity and Supply
  • The longer the time period considered, the more
    elastic the supply.
  • There are three time periods relevant to supply
  • The instantaneous period supply is fixed,
    perfectly inelastic.
  • The short run supply is somewhat elastic.
  • The long run supply is very elastic.

23
Elasticity and Total Revenue
Unit Elastic Demand E 1
TRE 4x624 TRF 6x424
TR constant
C
E
O
A
B
24
Elasticity and Total Revenue
Elastic Demand E gt 1
10
9
C
TR falls if price increases. TR rises if price
decreases.
8
TRJ 8 x 2 16 TRK 9 x 1 9
6
A
Price
4
2
0
Quantity
1
2
3
4
5
6
7
8
9
25
Elasticity and Total Revenue
Inelastic Demand E lt 1
10
TR rises if price increases
8
TRG 1 x 9 9
TRH 2 x 8 16
6
Price
4
H
2
C
G
A
B
Quantity
0
1
2
3
4
5
6
7
8
9
26
Total Revenue Along a Demand Curve
A
Elastic ED gt 1
ED 1
C
Inelastic ED lt 1
B
Total revenue
0
Quantity
27
Question
  • If you find that in California where vanity
    plates cost 28.75, the elasticity of demand is
    0.52. In Massachusetts where vanity plates cost
    50, the elasticity of demand is 3.52.
  • Q What recommendation would you have for each
    state to maximize revenue?

28
Question
  • A newspaper recently lowered its price from 50
    cents to 30 cents. As it did, the number of
    newspapers sold increased from 240,000 to
    280,000.
  • What was the newspapers elasticity of demand?
  • Given that elasticity, did it make sense for the
    newspaper to lower its price?

29
Question
  • Comparing a rich person and a poor guy, for a
    given good, which person has a more elastic
    demand of the good?
  • If you can charge different price for different
    person, you will charge a higher price or lower
    price to the person who has a more elastic demand
    of the good?

30
Elasticity of Individual and Market Demand
  • Price discrimination occurs when a firm separates
    the people with less elastic demand from those
    with more elastic demand.
  • Firms charge more to the individuals with
    inelastic demand and less to individuals with
    elastic demand.
  • Examples of price discrimination
  • Airlines Saturday stay-over specials
  • Sales of new cars
  • Almost-continual sales

31
Income Elasticity of Demand
  • Income elasticity of demand measures the
    responsiveness of demand to changes in income.

32
Income Elasticity of Demand
  • Normal goods are those whose consumption
    increases with an increase in income.
  • Normal goods can be luxuries or necessities
  • Luxuries are goods that have an income elasticity
    greater than one.
  • A necessity has an income elasticity less than 1.
  • Inferior goods are those whose consumption
    decreases when income increases.
  • Inferior goods have income elasticities less than
    zero.

33
Cross-Price Elasticity of Demand
  • Cross-price elasticity of demand measures the
    responsiveness of demand to changes in prices of
    other goods.

34
Complements and Substitutes
  • Substitutes are goods that can be used in place
    of another.
  • Substitutes have positive cross-price
    elasticities.
  • Complements are goods that are used in
    conjunction with one another.
  • Complements have negative cross-price
    elasticities.
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