Elasticity, Supply & Demand, and Government Policy Microeconomics Lecture #2.
1 Microeconomics – 2008 Topic 3 Chapter 6 Elasticity and its Applications.
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Transcript of 1 Microeconomics – 2008 Topic 3 Chapter 6 Elasticity and its Applications.
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1
Microeconomics – 2008
Topic 3
Chapter 6
Elasticity and its Applications
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2
Learning Objectives
Introduce the concept of price elasticity of demand and discuss its determinants.
Relate price elasticity of demand to the changes in total revenue that result from a change in market price.
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Learning Objectives (cont.)
Introduce the concept of the elasticity of supply and its relationship to time.
Define the cross-price and income elasticities of demand.
Survey some applications of supply and demand analysis.
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Price Elasticity of Demand
The price elasticity of demand is the measure of the responsiveness of the quantity demanded to a change in price of a product
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Price Elasticity is...
Q
P
P1
P2
Q1Q2
D
As price increases fromP1 to P2, quantity decreases
from Q1 to Q2
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Price Elasticity is... (cont.)
Q
P
P2
P1
Q2Q1
D
As price decreases fromP1 to P2, quantity increases
from Q1 to Q2
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Price Elasticity is... (cont.)
Q
P
P1
P2
Q1Q2
D
But what percentage did price change and what percentage did quantity
change?
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Formula for Elasticity
Originalquantity
demanded
Ed =
Change inquantity
Change inprice
Originalprice
The percentage change in price
The percentage change in quantityEd =
÷
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Price Elasticity of Demand
Use of percentages choice of units product comparison
Ignore the minus sign the absolute value of the coefficient is what is
important
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Price Elasticity of Demand (cont.)
Elastic Demand a given percentage change in price results in a
larger percentage change in quantity demanded
Ed > 1
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Price Elasticity of Demand (cont.)
Inelastic Demand a given percentage change in price results in a
relatively smaller percentage change in quantity demanded
Ed < 1
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Price Elasticity of Demand (cont.)
Unit elasticity a given percentage change in price results in an
equal percentage change in quantity demanded
Ed = 1
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Perfectly Inelastic Demand
Q
P DD11 Perfectlyinelasticdemand
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Perfectly Elastic Demand
Q
P DD11 Perfectlyinelasticdemand
DD22
Perfectlyelastic
demand
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Midpoints Formula
Ed ==
Change inquantity
Sum ofQuantities/2
Change inprice
Sum ofprices/2
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4
0 2 4 6 7 8 10 12 14
1
2
3
4
5
Pric
e (p
er u
nit)
0 2 4 6 7 8 10 12 14
Tot
al R
even
ue
Units of X (thousands per week)
Price Elasticity
of Demand
and Revenue
8
12
16
20
TR
Ed > 1
16
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4
0 2 4 6 7 8 10 12 14
1
2
3
4
5
Pric
e (p
er u
nit)
0 2 4 6 7 8 10 12 14
Tot
al R
even
ue
Units of X (thousands per week)
Price Elasticity
of Demand
and Revenue
8
12
16
20
Ed > 1
Ed = 1
17
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18
4
0 2 4 6 7 8 10 12 14
1
2
3
4
5
Pric
e (p
er u
nit)
0 2 4 6 7 8 10 12 14
Tot
al R
even
ue
Units of X (thousands per week)
Price Elasticity
of Demand
and Revenue
8
12
16
20
TR
Ed < 1
Ed > 1
Ed = 1
18
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Total Revenue Test
Elastic demand a change in price will cause total revenue to change in the
opposite direction
Inelastic demand a change in price will cause total revenue to change in the
same direction
Unit elasticity a change in price leaves total revenue unchanged
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Determinants of Price Elasticity of Demand
Substitutability Proportion of income Luxuries versus necessities Time
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Elasticity of Demand: Some Applications
Bumper crops Automation Excise taxes Heroin and crime
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Price Elasticity of Supply
Es=
Percentage change in quantitysupplied of product X
Percentage change in the price of product X
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Price Elasticity of Supply (cont.)
Immediate market period
PPoo
PP
QQDD11
SSmm
PPmm
DD11
DD22
DD22
Qo
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DD22
Price Elasticity of Supply (cont.)
PPoo
PPss
PP
DD11
Qo
SSss Short run
Qs
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Price Elasticity of Supply (cont.)
PPoo
PPLL
PP
DD11Qo
SSLL
Long run
DD22
SS′′LLSS′′LL
Qo QLQ′L
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Exy =
Percentage change in quantitydemanded of good X
Percentage change in the price of good Y
•Substitute goods—Positive sign
•Complementary goods—Negative sign
•Independent goods—Zero or near-zero value
Cross Elasticity of Demand
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Income Elasticity of Demand
EEi i ==
Percentage change inquantity demanded
Percentage changePercentage changein in income
Normal goods—Positive sign
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Income Elasticity of Demand (cont.)
Ei =
Percentage change inquantity demanded
Percentage changein income
Normal goods—Positive sign
Inferior goods—Negative sign