chapter 3 elasticity for economics

37

Upload: deden-as-syafei

Post on 11-Aug-2014

209 views

Category:

Business


2 download

DESCRIPTION

 

TRANSCRIPT

Page 1: Chapter 3 elasticity for economics
Page 2: Chapter 3 elasticity for economics

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

• Rate of change of the quantity demanded or quantity supplied due to change in a variable.

Page 3: Chapter 3 elasticity for economics

THE ELASTICITY OF DEMAND• The price elasticity of demand is a measure of

how much the quantity demanded of a good responds to a change in the price of that good.

• When we talk about elasticity, that responsiveness is always measured in percentage terms.

• Specifically, the price elasticity of demand is the percentage change in quantity demanded due to a percentage change in the price.

Page 4: Chapter 3 elasticity for economics
Page 5: Chapter 3 elasticity for economics

The Price Elasticity of Demand and Its Determinants

• Availability of Close Substitutes• Necessities versus Luxuries• Definition of the Market• Time Horizon

© 2011 Cengage South-Western

Page 6: Chapter 3 elasticity for economics

The Price Elasticity of Demand and Its Determinants

• Demand tends to be more elastic:• the larger the number of close substitutes.• if the good is a luxury.• the more narrowly defined the market.• the longer the time period.

Page 7: Chapter 3 elasticity for economics

Computing the Price Elasticity of Demand

• The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

P rice e las tic ity o f d em an d = P ercen tag e ch an g e in q u an tity dem an d edP ercen tag e ch an g e in p rice

Page 8: Chapter 3 elasticity for economics

Computing the Price Elasticity of Demand

• Example: If the price of an ice cream cone increases from RM2.00 to RM2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:

( )

( . . ).

1 0 810

10 0

2 2 0 2 0 02 00

10 0

20 %10 %

2

P rice e las tic ity o f dem an d = P ercen tage chang e in q uan tity dem andedP ercen tage ch an ge in p rice

Page 9: Chapter 3 elasticity for economics

The Variety of Demand Curves

• Inelastic Demand, Ep < 1• Quantity demanded does not respond strongly to

price changes.• Price elasticity of demand is less than one.

• Elastic Demand, Ep >1• Quantity demanded responds strongly to changes in

price.• Price elasticity of demand is greater than one.

Page 10: Chapter 3 elasticity for economics

Computing the Price Elasticity of Demand

Demand is price elastic.

RM54

Demand

Quantity1000 50

3percent 22

percent 67

5.00)/2(4.005.00)(4.00

50)/2(10050)(100

ED

Price

Page 11: Chapter 3 elasticity for economics

The Variety of Demand Curves

• Perfectly Inelastic, Ed = 0• Quantity demanded does not respond to price

changes.• Perfectly Elastic, 1 < Ed <1

• Quantity demanded changes infinitely with any change in price.

• Unit Elastic, Ed=1• Quantity demanded changes by the same percentage

as the price.

Page 12: Chapter 3 elasticity for economics

Figure 1 The Price Elasticity of Demand

(a) Perfectly Inelastic Demand: Elasticity Equals 0

5

4

Quantity

Demand

1000

1. Anincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price

Page 13: Chapter 3 elasticity for economics

Figure 1 The Price Elasticity of Demand

(b) Inelastic Demand: Elasticity Is Less Than 1

Quantity0

5

90

Demand1. A 22%increasein price . . .

Price

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

4

100

Page 14: Chapter 3 elasticity for economics

Figure 1 The Price Elasticity of Demand

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

(c) Unit Elastic Demand: Elasticity Equals 1

Quantity

4

1000

Price

5

80

1. A 22%increasein price . . .

Demand

Page 15: Chapter 3 elasticity for economics

Figure 1 The Price Elasticity of Demand

(d) Elastic Demand: Elasticity Is Greater Than 1

Demand

Quantity

4

1000

Price

5

50

1. A 22%increasein price . . .

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

Page 16: Chapter 3 elasticity for economics

Figure 1 The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

4 Demand

2. At exactly RM4,consumers willbuy any quantity.

1. At any priceabove RM4, quantitydemanded is zero.

3. At a price below RM4,quantity demanded is infinite.

Page 17: Chapter 3 elasticity for economics

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 change in the quantity demanded divided by the percentage change in income.

Page 18: Chapter 3 elasticity for economics

Other Demand Elasticities

• Computing Income Elasticity

In com e e la s tic ity o f d em an d =

P ercen tag e ch an g e in q u an tity dem an d ed

P ercen tag e ch an g e in in com e

Remember, all elasticities are measured by dividing one percentage change by another

Page 19: Chapter 3 elasticity for economics

Other Demand Elasticities

• Income Elasticity• Types of Goods

• Normal Goods• Inferior Goods

• Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

Page 20: Chapter 3 elasticity for economics

Other Demand Elasticities

• Income Elasticity• Goods consumers regard as necessities tend 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.

Page 21: Chapter 3 elasticity for economics

Other Demand Elasticities

• 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

2 good of pricein %change1 good of demandedquantity in %changedemand of elasticity price-Cross

Page 22: Chapter 3 elasticity for economics

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 supplied resulting from a percentage change in price.

Page 23: Chapter 3 elasticity for economics

Figure 5 The Price Elasticity of Supply

(a) Perfectly Inelastic Supply: Elasticity Equals 0

5

4

Supply

Quantity1000

1. Anincreasein price . . .

2. . . . leaves the quantity supplied unchanged.

Price

Page 24: Chapter 3 elasticity for economics

Figure 5 The Price Elasticity of Supply

(b) Inelastic Supply: Elasticity Is Less Than 1

110

5

100

4

Quantity0

1. A 22%increasein price . . .

Price

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

Supply

Page 25: Chapter 3 elasticity for economics

Figure 5 The Price Elasticity of Supply

(c) Unit Elastic Supply: Elasticity Equals 1

125

5

100

4

Quantity0

Price

2. . . . leads to a 22% increase in quantity supplied.

1. A 22%increasein price . . .

Supply

(If SUPPLY is unit elastic and linear, it will begin at the origin.)

Page 26: Chapter 3 elasticity for economics

Figure 5 The Price Elasticity of Supply

(d) Elastic Supply: Elasticity Is Greater Than 1

Quantity0

Price

1. A 22%increasein price . . .

2. . . . leads to a 67% increase in quantity supplied.

4

100

5

200

Supply

Page 27: Chapter 3 elasticity for economics

Figure 5 The Price Elasticity of Supply

(e) Perfectly Elastic Supply: Elasticity Equals Infinity

Quantity0

Price

4 Supply

3. At a price below RM4,quantity supplied is zero.

2. At exactly RM4,producers willsupply any quantity.

1. At any priceabove RM4, quantitysupplied is infinite.

Page 28: Chapter 3 elasticity for economics

The Price Elasticity of Supply and Its Determinants

• 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.

Page 29: Chapter 3 elasticity for economics

• Technology improvement-with the improvement of technology producers

are able to produce more-more elastic supply

• Perishability-supply is inelastic for products that are not long

last such as agricultural products.-change in price do not affect supply much

because cannot store it in longer period.

Page 30: Chapter 3 elasticity for economics

Computing the Price Elasticity of Supply

• The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

P rice e las tic ity o f sup p ly =

P ercen tag e ch an g e in q uan tity sup p lied

P ercen tage ch an g e in p rice

Page 31: Chapter 3 elasticity for economics

THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY• Can good news for farming be bad news for

farmers?• What happens to paddy farmers and the

market for paddy when university agronomists discover a new paddy hybrid that is more productive than existing varieties?

Page 32: Chapter 3 elasticity for economics

Can Good News for Farming Be Bad News for Farmers?

• Examine whether the supply or demand curve shifts.

• Determine the direction of the shift of the curve.

• Use the supply-and-demand diagram to see how the market equilibrium changes.

Page 33: Chapter 3 elasticity for economics

Figure 7 An Increase in Supply in the Market for Rice

Quantity ofRice

0

Price ofRice

3. . . . and a proportionately smallerincrease in quantity sold. As a result,

revenue falls from RM300 to RM220.

Demand

S1 S2

2. . . . leadsto a large fallin price . . .

1. When demand is inelastic,an increase in supply . . .

2

110

3

100

Page 34: Chapter 3 elasticity for economics

Compute the Price Elasticity of Demand When There Is a Change in Supply

ED

1 0 0 11 01 0 0 11 0 2

3 0 0 2 0 03 0 0 2 0 0 2

0 0 9 50 4

0 2 4

( ) /. .

( . . ) /

..

.

Demand is inelastic.

Page 35: Chapter 3 elasticity for economics

Summary

• Price elasticity of demand measures how much the quantity demanded responds to changes in the price.

• Price elasticity of demand is calculated as the percentage 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.

Page 36: Chapter 3 elasticity for economics

Summary

• The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income.

• The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good.

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

Page 37: Chapter 3 elasticity for economics

Summary

• In most markets, supply is more elastic in the long run than in the short run.

• The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price.

• The tools of supply and demand can be applied in many different types of markets.