Post on 11-Jan-2016
Chapter 20:
Demand and Supply Elasticity
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
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Price Elasticity
Price Elasticity of Demand (Ep)
Ep = percentage change in quantity demanded
percentage change in price
The responsiveness of quantity demanded of a commodity to changes in its price
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Price Elasticity
ExamplePrice of oil increases 10 percentQuantity demanded decreases 1 percent
Ep = -1%
+10%= -.1
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Price Elasticity
Relative quantities onlyElasticity is measuring the change in quantity
relative to the change in price Always negative
An increase in price decreases the quantity demanded, ceteris paribus
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Calculating Elasticity
Elasticity formula:
change in Q
sum of quantities/2Ep =
change in P
sum of quantities/2
orchange in Q
(Q1 + Q2)/2Ep =
change in P
(P1 + P2)/2
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Price Elasticity Ranges Elastic Demand
Percentage change in quantity demanded is larger than the percentage change in price
Ep > 1
Unit Elasticity of Demand Percentage change in quantity demanded is equal to
the percentage change in price Ep = 1
Inelastic Demand Percentage change in quantity demanded is smaller
than the percentage change in price Ep < 1
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Price Elasticity Ranges
Extreme elasticitiesPerfectly Inelastic Demand
A demand curve that is a vertical line It has only one quantity demanded for each price No matter what the price, quantity demanded does
not change
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Extreme Price Elasticities
Quantity Demanded per Year(millions of units)
Pric
eD
Perfect inelasticity, or zero elasticity
80
Figure 21-1, Panel (a)
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Price Elasticity Ranges
Extreme elasticitiesPerfectly Elastic Demand
A demand curve that is a horizontal line It has only one price for every quantity The slightest increase in price leads to zero
quantity demanded
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Extreme Price Elasticities
Quantity Demanded per Year(millions of units)
Pric
e (c
ents
)
30
0
Perfect elasticity, or infinite elasticity
D
Figure 21-1, Panel (b)
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Policy Example:Who Pays Gasoline Taxes?
State and federal governments impose gasoline taxes that are assessed as a flat amount per gallon.
Who pays the tax depends on price elasticity of demand.
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Policy Example: Who Pays Gasoline Taxes?
Figure 21-2, Panels (a) and (b)
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Policy Example: Who Pays Gasoline Taxes?
Figure 21-2, Panel (c)
D
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Elasticity and Total Revenues When demand is elastic, a negative relationship
exists between small changes in price and changes in total revenue.
When demand is unit-elastic, changes in price do not change total revenue.
When demand is inelastic, a positive relationship exists between changes in price and total revenues.
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Determinants of Price Elasticity of Demand
Existence of substitutesThe closer the substitutes and the more
substitutes there are, the more elastic is demand.
Share of the budgetThe greater the share of the consumer’s total
budget spent on a good, the greater is the price elasticity.
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Determinants of Price Elasticity of Demand
The length of time allowed for adjustmentThe longer any price change persists, the
greater is the price elasticity of demand. Price elasticity is greater in the long-run than in the
short-run.
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Determinants of Price Elasticity of Demand
How to define the short run and the long runThe short run is a time period too short
for consumers to fully adjust to a price change.
The long run is a time period long enough for consumers to fully adjust to a change in price other things constant.
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Short-Run and Long-RunPrice Elasticity of Demand
In the short run, quantitydemanded falls slightly.However, with more timefor adjustment the demand curve becomesmore elastic and quantitydemanded falls by a greater amount.
D1
Pe
Q2
E
D2
Q1 Qe
P1
Pric
e pe
r U
nit
Quantity Demanded per Period
Figure 21-4
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Short-Run and Long-RunPrice Elasticity of Demand
In the short run, quantitydemanded falls slightly.However, with more timefor adjustment the demand curve becomesmore elastic and quantitydemanded falls by a greater amount.
D1
Pe
Q2
E
D2
Q1 Qe
P1
Q3
D3
Pric
e pe
r U
nit
Quantity Demanded per Period
Figure 21-4
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Example: Real-WorldElasticities of Demand
Table 21-2
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Cross PriceElasticity of Demand
Cross Price Elasticity of Demand (Exy)The percentage change in the demand for
one good (holding its price constant) divided by the percentage change in the price of a related good
The responsiveness of change in demand of one good to the change in prices of related goods
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Cross PriceElasticity of Demand
Formula for computing cross elasticity of demand
% change in demand for good X
%change in price of good YExy =
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Cross PriceElasticity of Demand
SubstitutesExy would be positive
An increase in the price of X would increase the quantity of Y demanded at each price.
ComplementsExy would be negative
An increase in the price of X would decrease the quantity of Y demanded at each price.
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Income Elasticity of Demand
Income Elasticity of Demand (Ei)The percentage change in demand for any
good, holding its price constant, divided by the percentage change in income
The responsiveness of demand to changes in income, holding the good’s relative price constant
refers to a horizontal shift in the demand curve in response to changes in income
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Income Elasticity of Demand
percentage change in demand
percentage change in incomeEi =
Ei for a normal good is positive.
Ei for an inferior good is negative.
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Income Elasticity of Demand Formula:
Change in Quantity ÷ Change in Income Average Quantity Average Income
The income elasticity of demand can be either negative or positive. Remember that, in calculating the income elasticity of demand, the price of the good is
assumed to be constant.
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Elasticity of Supply
Price Elasticity of Supply (Ei)The responsiveness of the quantity supplied
of a commodity to a change in its price The percentage change in quantity supplied
divided by the percentage change in price
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Elasticity of Supply
Formula for computing price elasticity of supply
percentage change in quantity supplied
percentage change in priceES =
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Elasticity of Supply
Classifying supply elasticitiesPerfectly Elastic Supply
Quantity supplied falls to zero when there is any decrease in price.
The supply curve is horizontal at a given price.
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Elasticity of Supply
Classifying supply elasticitiesPerfectly Inelastic Supply
Quantity supplied is constant no matter what happens to price.
The supply curve is vertical at a given price.
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The Extremes in Supply Curves
Q1
Pric
e pe
r U
nit
Quantity Supplied per Period
P1S
S’
Perfect elasticity
Perfect inelasticity
Figure 21-5
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Elasticity of Supply
Price elasticity of supply and length of time for adjustmentThe longer the time allowed for adjustment,
the more elastic is supply. Firms can find ways to increase (or decrease)
output. Resources can flow into (or out of) an industry
through expansion (or contraction) of existing firms.
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Short-Run and Long-Run Price Elasticity of Supply
Pe
Qe
Pric
e pe
r U
nit
Quantity Supplied per Period
Q1
S1
S2
P1
As time passes the
supply curve rotates to S2 then to S3 and quantity supplied rises first to Q1 and then to Q2.
E
S3
Figure 21-6
Q2
Chapter 20:
Demand and Supply Elasticity
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.