chapter 7 demand & supply elasticities & government-set...

7 - 1 Copyright McGraw-Hill/Irwin, 2005

Price Elasticity of Demand

Price Elasticity and Total Revenue

Determinants of Price Elasticity of Demand

Price Elasticity of Supply

Cross Elasticity of Demand

Income Elasticity of Demand

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Elasticity of Demand & Supply

7 C H A P T E R








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HOW MUCH MORE OR LESS? DOES IT MATTER?

to whom?

Think About It... THE LAW OF DEMAND SAYS...

PRICE ELASTICITY OF DEMAND

Consumers will buy more when prices go down and less when prices go up

Price Elasticity Provides an Answer

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The percentage change in price The percentage change in quantity

.01

.02

Elasticity is .5 Q

P

P1

P2

Q1 Q2

D

Measures Responsiveness to Price Changes









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The percentage change in price The percentage change in quantity

Q

P

P1

P2

Q1 Q2

D

Commonly Expressed as… PRICE ELASTICITY OF DEMAND

∆ % P % ∆ Q d

Elasticity is .5








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The Price-Elasticity Coefficient and Formula PRICE ELASTICITY OF DEMAND

Ed = Percentage change in quantity

demanded of product X Percentage change in price

of product X

Or equivalently…

Ed = Percentage change in quantity demanded of X

Original quantity demanded of X

Change in price of X ÷ Original price of X

Elimination of the Minus Sign








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Interpretations of Ed


Elastic Demand

Ed = .04 .02

= 2

Inelastic Demand

Ed = .01 .02

= .5

Unit Elasticity

Ed = .02 .02

= 1








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Extreme Cases


Perfectly Inelastic Demand

Perfectly Elastic Demand P

0

P

0

D1

Ed = 0

D2 Ed = ∞

Q

Q








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Refinement – The Midpoint Formula


Ed =

Change in quantity

Sum of Quantities/2

Change in price

Sum of prices/2

÷








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Q

P

D

When prices are low,

TR

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

So is total revenue

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Q

P

D

Total revenue rises with price to a

point... TR

Quantity Demanded










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Q

P

D


point...

then declines TR

Quantity Demanded










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Q

P

D


point...

then declines TR

Quantity Demanded


Total Revenue Test









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Q

P

D


point...

then declines

Inelastic Demand

Inelastic Demand

TR

Quantity Demanded










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Q

P

D


point...

then declines

Elastic Demand

Elastic Demand

Inelastic Demand

TR

Quantity Demanded


Inelastic Demand









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Q

P

D


point...

then declines

Elastic Demand

Elastic Demand

Inelastic Demand

TR

Quantity Demanded


Inelastic Demand

Unit Elastic









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Inelastic from 0 to 1 Typical of necessities one must have

Typical of luxuries one wants Elastic from 1 to ∞

Unit elastic when exactly = 1 Price change does not reduce total revenue

Price Elasticity is... PRICE ELASTICITY & TOTAL REVENUE








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DETERMINANTS OF PRICE ELASTICITY OF DEMAND

•Substitutability •Proportion of Income •Luxuries versus Necessities •Time Applications... Large Crop Yields Excise Taxes Decriminalization of Illegal Drugs Minimum Wage








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Now, compare the immediate market period, the short-run, and long run.

PRICE ELASTICITY OF SUPPLY

Es= Percentage change in quantity

supplied of good X

Percentage change in the price of good X

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Po

P

Q

D1

Qo

An increase in demand without enough time to change supply causes…

Sm

Immediate Market period PRICE ELASTICITY OF SUPPLY








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Po

Pm

P

Q

D1

Qo

D2

An increase in demand without enough time to change supply causes… an increase in price

Sm

Immediate Market period PRICE ELASTICITY OF SUPPLY








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Po

P

Q

D1

Qo

Short Run PRICE ELASTICITY OF SUPPLY

An increase in demand with less intensity supply use causes...

Ss








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Po

P

Q

D1

Qo

D2

Short Run PRICE ELASTICITY OF SUPPLY

Ps

An increase in demand with less intensity supply use causes...a lower increase in price

Ss

Qs








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Po

P

Q

D1

Qo

Long Run PRICE ELASTICITY OF SUPPLY

An increase in demand in the long run allows greater change causing...

SL








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Po

P

Q

D1

Qo

D2

Long Run PRICE ELASTICITY OF SUPPLY

PL

An increase in demand in the long run allows greater change causing...

SL

QL

Even more elastic response - less price increase








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Applications of Price Elasticity of Supply Antiques and Reproductions Volatile Gold Prices

PRICE ELASTICITY OF SUPPLY








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CROSS ELASTICITY OF DEMAND

Exy = Percentage change in quantity

demanded of good X

Percentage change in the price of good y

Positive Sign Goods are Substitutes Negative Sign Goods are Complementary Zero or Near-Zero Value Goods are Independent








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INCOME ELASTICITY OF DEMAND

Ei = Percentage change in quantity

demanded

Percentage change in income

Positive Sign Goods are Normal or

Superior Negative Sign Goods are Inferior

price elasticity of demand elastic demand inelastic demand unit elasticity perfectly inelastic demand perfectly elastic demand total revenue (TR)

total-revenue test price elasticity of supply market period short run long run cross elasticity of demand income elasticity of demand

END BACK Copyright McGraw-Hill/Irwin, 2005








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Next: Chapter 8

Consumer Behavior and

Utility Maximization

chapter 7 demand & supply elasticities & government-set...

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