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Chapter 6: Extensions of Supply, Demand, and Supply Analysis

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Price Elasticity Coefficient Formula. Ed = % change in quantity demanded of product X % change in price of product X. Change in price = New Price Initial Price – PowerPoint PPT presentation

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Title: Chapter 6: Extensions of Supply, Demand, and Supply Analysis


1
Chapter 6 Extensions of Supply, Demand, and
Supply Analysis
2
Supply and Demand Review
  1. Define the Law of Demand
  2. Define the Law of Supply
  3. What is the difference between a change in demand
    and a change in quantity demanded?
  4. What happens if price is above equilibrium?
  5. What happens if price is below equilibrium?
  6. Define Consumers and Producers Surplus
  7. Identify the rule for double shifts in SD
  8. Explain the results of an excise tax

3
THE LAW OF DEMAND SAYS...
Consumers will buy more when prices go down and
less when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?
4
Elasticity
Elasticity shows how sensitive quantity is to a
change in price.
5
4 Types of Elasticity
  1. Elasticity of Demand
  2. Elasticity of Supply
  3. Cross-Price Elasticity (Subs or Comp)
  4. Income Elasticity (Norm or Inferior)

6
Total Revenue
  • Total revenue total amount the seller receives
    from the sale of a product or service
  • In a particular time period
  • Formula
  • TR P Q
  • TR total revenue
  • P Price
  • Q quantity

7
Total Revenue
  • Formula
  • TR P X Q
  • TR total revenue
  • P Price
  • Q quantity
  • Example
  • Price is 3.50 per gallon
  • Quantity 10 gallons
  • 3.5 10 35 Total Revenue

8
What Happens If---
  • What happens to total revenue if
  • Prices go up?
  • Prices go down?
  • We know about the Supply and Demand Curve
  • Does not tell us what happens if---
  • Brings us to elasticity

9
Elasticity
  • Measure of the responsiveness of the quantity
    demanded to a good or service
  • To change in price
  • When all other factors remain the same

10
1. Elasticity of Demand
  • Elasticity of Demand-
  • Measurement of consumers responsiveness to a
    change in price.
  • What will happen if price increase? How much will
    it affect Quantity Demanded
  • Who cares?
  • Used by firms to help determine prices and sales
  • Used by the government to decide how to tax

11
Elasticity of Demand
  • In the previous section, supply and demand curves
    were drawn as straight lines.
  • This is a simplification,
  • we assuming rate of change of demand or supply
    is the same for all prices in the market.
  • At some prices, a small change in price may
  • cause a large change in the quantity demanded.

12
This shown in the diagram as the movement from Pe
to Pe1 a small change in price which causes an
even larger percentage decrease in quantity
demanded (from Qe to Qe1.
At other prices, a large increase in price may
see a much smaller decrease in demand. This shown
in the diagram as the movement from Pe2 to Pe3 a
large change in price which causes a smaller
percentage decrease in quantity demanded (from
Qe2 to Qe3.
13
Inelastic Demand
14
Inelastic Demand
INelastic Quantity is INsensitive to a change
in price.
  • If price increases, quantity demanded will fall a
    little
  • If price decreases, quantity demanded increases a
    little.
  • In other words, people will continue to buy it.

20
5
A INELASTIC demand curve is steep! (looks like an
I)
  • Examples
  • Gasoline
  • Milk
  • Diapers
  • Chewing Gum
  • Medical Care
  • Toilet paper

15
Inelastic Demand
  • If percentage change in price produces a smaller
    percentage change in quantity demanded

16
Inelastic Demand
  • General Characteristics of INelastic Goods
  • Few Substitutes
  • Necessities
  • Small portion of income
  • Required now, rather than later
  • Elasticity coefficient less than 1

20
5
17
Elastic Demand
18
Elastic Demand
Elastic Quantity is sensitive to a change in
price.
  • If price increases, quantity demanded will fall a
    lot
  • If price decreases, quantity demanded increases a
    lot.
  • In other words, the amount people buy is
    sensitive to price.

An ELASTIC demand curve is flat!
  • Examples
  • Soda
  • Boats
  • Beef
  • Real Estate
  • Pizza
  • Gold

19
Elastic Demand
  • General Characteristics of Elastic Goods
  • Many Substitutes
  • Luxuries
  • Large portion of income
  • Plenty of time to decide
  • Elasticity coefficient greater than 1

20
Price Elasticity Coefficient Formula
  • Ed change in quantity demanded of product X
  • change in price of product X
  • Calculating change
  • Change in quantity nqd iqd

  • initial quantity demanded
  • Example Change in quantity
  • 100,000 nqd - 110,000 iqd - 10,000
  • -10,000 .10 or 10
  • 100,000

21
Price Elasticity Coefficient Formula
  • Ed change in quantity demanded of product X
  • change in price of product X
  • Change in price New Price Initial Price
  • Initial price
  • New Price 4
  • Initial Price 3
  • 4 np - 3 ip 1 .33 or 33
  • 3 ip 3

22
Price Elasticity Coefficient Formula
  • Ed change in quantity demanded of product X
  • change in price of product X
  • 10 .30 or 30
  • 33

23
Graph
  • Graph the previous example
  • Is it elastic or inelastic? WHY?
  • Inelastic because change in change in quantity
    demanded is less than change in price
  • Or a 33 change in price created a 10 drop in
    quantity demanded
  • Calculated price elastic is lt 1 therefore price
    is inelastic

24
You Solve
  • Decide the price elasticity of demand for a slice
    of pizza at 2.00 by examining a price decrease
    from 2.00 to 1.50 per slice. In this case, the
    demand pizza would increase from 7 million slices
    to 10 million slices. You can use these figures
    to calculate the price elasticity of demand

25
  • Ed change in quantity demanded of product X
  • change in price of product X
  • Ed (10M 7M) 7M (DN-OO)
  • (1.50 - 2.00) 2.00 (PN-OO)
  • Ed .43 -1.72
  • - 0.25
  • Drop the negative Ed is gt 1 therefore the
    demand for pizza slices is elastic

26
Negative Numbers
  • If price increases by 10 and consumers respond
    by decreasing purchases by 20
  • the equation computes the elasticity coefficient
    as -2.
  • The result is negative because an increase in
    price (a positive number)
  • leads to a decrease in purchases (a negative
    number).
  • Because the law of demand says it will always be
    negative, many economists ignore the negative sign

27
Elastic or Inelastic?
Beef- 1.27 Gasoline-
.20 Real Estate- 1.6 Medical Care- .31
Electricity- .13 Gold- 2.6
Elastic INelastic Elastic INelastic
INelastic Elastic
What about the demand for insulin for diabetics?


What if change in quantity demanded equals
change in price?

Perfectly INELASTIC (Coefficient 0)
Unit Elastic (Coefficient 1)
28
2. Price Elasticity of Supply
  • Elasticity of Supply-
  • Elasticity of supply shows how sensitive
    producers are to a change in price.
  • Elasticity of supply is based on time
    limitations.
  • Producers need time to produce more.
  • INelastic Insensitive to a change in price
    (Steep curve)
  • Most goods have INelastic supply in the short-run
  • Elastic Sensitive to a change in price (Flat
    curve)
  • Most goods have elastic supply in the long-run
  • Perfectly Inelastic Q doesnt change (Vertical
    line)
  • Set quantity supplied

29
  • Elasticity of supply is influenced by a number of
    factors. These include
  • the length of the production period. In the late
    1990's, demand for Australia wines overseas has
    reached all time records. Vines take three years
    to grow to a point where they yield adequate
    amounts of fruit. Increases in demand for
    Australian wine has seen prices rise (from Po to
    P1), and returns to existing grape growers are
    excellent. Those who wish to buy grapes face a
    market where supply can only increase marginally
    (from Qo to Q1), in the short term.
  • However, many new stands of vines are being
    planted, and in a few years, returns to growers
    may stabilise, as supply increases. Prices will
    fall from P1 to P2 as the supply of grapes
    increases from Q1 to Q2.

30
Elasticity Over Time - Supply
31
Elasticity Over Time - Supply
32
Elasticity Over Time - Supply
33
2.Price Elasticity of Supply Over Time
34
Price Elasticity of Supply Over Time
  • How would you graph the supply elasticity of Gas
    over time?
  • Lets see

35
3. Cross-Price Elasticity of Demand
  • Cross-Price elasticity shows how sensitive a
    product is to a change in price of another good
  • It shows if two goods are substitutes or
    complements

change in quantity of product b
change in price of product a
P increases 20
Q decreases 15
  • If coefficient is negative (shows inverse
    relationship) then the goods are complements
  • If coefficient is positive (shows direct
    relationship) then the goods are substitutes

36
Think
  • Pizza and Burgers are elastic and substitutes of
    each other
  • If the price of pizza declines
  • 1. What happens to the sale of pizza?
  • 2. What happens to the sale of burgers?
  • 2. Soda is a compliment to pizza. What happens
    to the sale of soda?
  • Lets Graph

37
4. Income-Elasticity of Demand
  • Income elasticity shows how sensitive a product
    is to a change in INCOME
  • It shows if goods are normal or inferior

change in quantity
change in income
Income increases 20, and quantity decreases 15
then the good is a
INFERIOR GOOD
  • If coefficient is negative (shows inverse
    relationship) then the good is inferior
  • If coefficient is positive (shows direct
    relationship) then the good is normal
  • Ex If income falls 10 and quantity falls 20

38
Total Revenue Test
  • Uses elasticity to show how changes in price will
    affect total revenue (TR).
  • (TR Price x Quantity)
  • Elastic Demand-
  • Price increase causes TR to decrease
  • Price decrease causes TR to increase
  • Inelastic Demand-
  • Price increase causes TR to increase
  • Price decrease causes TR to decrease
  • Unit Elastic-
  • Price changes and TR remains unchanged
  • Ex If demand for milk is INelastic, what will
    happen to expenditures on milk if price increases?

39
Is the range between A and B, elastic, inelastic,
or unit elastic?
10 x 100 1000 Total Revenue
5 x 225 1125 Total Revenue
A
Price decreased and TR increased, so Demand is
ELASTIC
50
B
125
40
Total Revenue Test
41
Total Revenue Test
inelastic unit elastic elastic
42
Password
  1. Demand
  2. Substitute
  3. Inferior Good
  4. Elastic
  5. Total Revenue Test

43
Terms
  1. Subsidy
  2. Supply
  3. Excise Tax
  4. Inelastic
  5. Elasticity Coefficient

44
Elasticity Practice
44
45
  • Graph the following chart
  • Calculate the Ed using the top set of numbers
    and prices rising

46
Answers -Graph
  • This is what your graph should look like

47
Answers - Ed
  • Ed change in quantity demanded of product X
  • change in price of product X
  • Change in quantity nqd iqd

  • initial quantity demanded
  • Change in price New Price
    Initial Price

  • Initial price
  • Ed (90 100) 100
  • (2 - 1.00) 1.00
  • Ed -.10 -.1
  • 1
  • Drop the negative Ed is lt 1 therefore the
    demand for is INelastic

48
  • Calculate the TR and determine if Total Revenue
    increased or decreased with a price increase
  • What is gain or loss on
  • price move?

49
Answers
  • 3 70 210
  • 2 90 180
  • Total Revenue increased 30

50
What Happens If ---
  • Graph the following chart
  • Calculate the Ed using the bottom two numbers
    and prices rising

51
Answers - Ed
  • Ed change in quantity demanded of product X
  • change in price of product X
  • Change in quantity nqd iqd

  • initial quantity demanded
  • Change in price New Price
    Initial Price

  • Initial price
  • Ed (40 70) 70
  • (4 - 3.00) 3.00
  • Ed -.4285 or 42.85
    1.28
  • .3333
    or 33.33
  • Drop the negative Ed is gt 1 therefore the
    demand for is elastic

52
Ed TR Test quiz
53
Practice Problem
  • See handout

54
Consumer and Producer Surplus
  • Consumer Surplus
  • Difference between maximum price willing to pay
    and the actual price producers charge
  • Think of it as a willing to pay curve

55
Marginal Benefit Surplusses
  • Marginal Benefit
  • What you gain when you get one more unit
  • Measured by what you are willing to give up
  • Everyday life we say getting value for our
    money
  • There is a difference between value and price

56
Value vs. Price
  • Value is what we get
  • Price is what we pay
  • Everyday idea of value is marginal benefit
  • OR
  • The measure of the maximum price what consumers
    are willing to pay for another unit of a good or
    service

57
Pizza Sales Per Slice
2 1.5 1 .5
Consumer Surplus
Consumer surplus from 10th slice of pizza
P
Willing to pay
Market Price

Amount Paid
D
20 30 40
10
58
Voluntary Exchange
In the free-market, buyers and sellers
voluntarily come together to seek mutual
benefits.
59
Voluntary Exchange
In the free-market, buyers and sellers
voluntarily come together to seek mutual
benefits.
60
Voluntary Exchange
In the free-market, buyers and sellers
voluntarily come together to seek mutual
benefits.
61
Voluntary Exchange
In the free-market, buyers and sellers
voluntarily come together to seek mutual
benefits.
62
Example of Voluntary Exchange
Ex You want to buy a truck so you go to the
local dealership. You are willing to spend up to
20,000 for a new 4x4. The seller is willing to
sell this truck for no less than 15,000. After
some negotiation you buy the truck for 18,000.
Analysis Buyer Maximum- Sellers
Minimum- Price- Consumers Surplus- Producers
Surplus-
20,000
15,000
18,000
2,000
3,000
63
Voluntary Exchange Terms
Consumer Surplus is the difference between what
you are willing to pay and what you actually pay.
CS Buyers Maximum Price Producers Surplus
is the difference between the price the seller
received and how much they were willing to sell
it for. PS Price Sellers Minimum
64
Pearl Exchange Activity
64
65
Voluntary Exchange Activity
65
66
Consumer and Producers Surplus
P
  • Calculate the
  • Consumer Surplus
  • Producer Surplus
  • Total Surplus

10 8 6 5 4 2 1
S
CS
PS
D
10
2 4 6 8
Q
67
Calculating Consumer SurplusIn Dollars
Max Willing to pay Actual price (E) Calculate CS
9 5 9 5 4
8 5 8 5 3
7 5 7 5 2
6 5 6 5 1
5 5 5 5 0
Sum CS 10
68
Calculating Producer SurplusIn Dollars
Min Price charged Actual price (E) Calculate PS
2 5 5 2 3
3 5 5 - 3 2
4 5 5 - 4 1
5 5 5 5 0

Sum PS 6
69
Surpluses
  • Could be calculated in Quantity

70
Summary
Consumption Inefficiency
Production Inefficiency
71
Practice Problem
Name of Consumer Price willing to pay
Matt 20
Don 15
Sarah 8
George 12
Ann 7
Q. If dinner sells for 10, what is the value of
Dons consumer surplus?
72
Practice Problem
Name of Consumer Price willing to pay
Matt 20
Don 15
Sarah 8
George 12
Ann 7
Q. If dinner sells for 10, what is the value of
Dons consumer surplus?
A. Willing to pay is 15. Market price is 10.
Willing to pay (15) Actual Price (10) 5
73
Practice Problem
Name of Consumer Price willing to pay
Matt 20
Don 15
Sarah 8
George 12
Ann 7
Q. If dinner sells for 11, what is the TOTAL
value of consumer surplus?
74
Practice Problem
Name of Consumer Price willing to pay
Matt 20
Don 15
Sarah 8
George 12
Ann 7
Q. If dinner sells for 11, what is the TOTAL
value of consumer surplus?
  • 20 11 9, 15 11 4, 12 11 1
  • 9 4 1 15 consumer surplus

75
  • For a given linier demand curve, the value of
    consumer surplus does what as market price
    increases?

76
  • For a given linier demand curve, the value of
    consumer surplus does what as market price
    increases?
  • Decreases as market price increases
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