Demand and Elasticity. Reviewing arc elasticity A review problem with arc elasticity.
Meet 3 CHAP 5 Elasticity
Transcript of Meet 3 CHAP 5 Elasticity
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5Elasticity and Its
Applications
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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
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THE ELASTICITY OF DEMAND
Price elasticity of demandis a measure of how
much the quantity demanded of a good
responds to a change in the price of that good.
Price elasticity of demand is the percentage
change in quantity demanded given a percent
change in the price.
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The Price Elasticity of Demand and ItsDeterminants
Availability of Close Substitutes
Necessities versus Luxuries
Definition of the Market
Time Horizon
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The Price Elasticity of Demand and ItsDeterminants
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.
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Computing the Price Elasticity of Demand
The price elasticity of demand is computed asthe percentage change in the quantity demanded
divided by the percentage change in price.
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
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Example: If the price of an ice cream cone
increases from $2.00 to $2.20 and the amount
you buy falls from 10 to 8 cones, then your
elasticity of demand would be calculated as:
Computing the Price Elasticity of Demand
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
( )
( . . )
.
10 810
100
2 20 2 00
2 00100
20%
10%2
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The Midpoint Method: A Better Way toCalculate Percentage Changes andElasticities
The midpoint formula is preferable whencalculating the price elasticity of demand
because it gives the same answer regardless of
the direction of the change.
Price elasticity of demand =( ) / [( ) / ]
( ) / [( ) / ]
Q Q Q Q
P P P P
2 1 2 1
2 1 2 1
2
2
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The Midpoint Method: A Better Way toCalculate Percentage Changes andElasticities
Example: If the price of an ice cream coneincreases from $2.00 to $2.20 and the amount
you buy falls from 10 to 8 cones, then your
elasticity of demand, using the midpointformula, would be calculated as:
( )
( ) /( . . )
( . . ) /
..
10 8
10 8 22 20 2 00
2 00 2 20 2
22%9 5%
2 32
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The Variety of Demand Curves
Inelastic Demand
Quantity demanded does not respond strongly to
price changes.
Price elasticity of demand is less than one.
Elastic Demand
Quantity demanded responds strongly to changes in
price. Price elasticity of demand is greater than one.
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Computing the Price Elasticity of Demand
Demand is price elastic
$5
4Demand
Quantity1000 50
-3percent22-
percent67
5.00)/2(4.005.00)-(4.00
50)/2(10050)-(100
ED
Price
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The Variety of Demand Curves
Perfectly Inelastic
Quantity demanded does not respond to price
changes.
Perfectly Elastic Quantity demanded changes infinitely with any
change in price.
Unit Elastic Quantity demanded changes by the same percentage
as the price.
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The Variety of Demand Curves
Because the price elasticity of demandmeasures how much quantity demanded
responds to the price, it is closely related to the
slope of the demand curve.
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Figure 1 The Price Elasticity of Demand
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(a) Perfectly Inelastic Demand: Elasticity Equals 0
$54
Quantity
Demand
1000
1. Anincreasein price . . .
2. . . . leaves the quantity demanded unchanged.
Price
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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
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Figure 1 The Price Elasticity of Demand
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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
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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.
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Figure 1 The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Quantity0
Price
$4 Demand
2. At exactly $4,consumers willbuy any quantity.
1. At any priceabove $4, quantity
demanded is zero.
3. At a price below $4,quantity demanded is infinite.
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Total Revenue and the Price Elasticity ofDemand
Total revenueis the amount paid by buyers andreceived by sellers of a good.
Computed as the price of the good times the
quantity sold.
TR = P x Q
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Figure 2 Total Revenue
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Demand
Quantity
Q
P
0
Price
P Q= $400
(revenue)
$4
100
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Elasticity and Total Revenue along a LinearDemand Curve
With an inelastic demand curve, an increase inprice leads to a decrease in quantity that is
proportionately smaller. Thus, total revenue
increases.
Fig re 3 Ho Total Re en e Changes When Price
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Figure 3 How Total Revenue Changes When PriceChanges: Inelastic Demand
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Demand
Quantity0
Price
Revenue = $100
Quantity0
Price
Revenue = $240
Demand$1
100
$3
80
An Increase in price from $1to $3
leads to an Increase in
total revenue from $100 to$240
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Elasticity and Total Revenue along a LinearDemand Curve
With an elastic demand curve, an increase inthe price leads to a decrease in quantity
demanded that is proportionately larger. Thus,
total revenue decreases.
Figure 4 How Total Revenue Changes When Price
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Figure 4 How Total Revenue Changes When PriceChanges: Elastic Demand
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Demand
Quantity0
Price
Revenue = $200
$4
50
Demand
Quantity0
Price
Revenue = $100
$5
20
An Increase in price from $4to $5
leads to an decrease in
total revenue from $200 to$100
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Elasticity of a Linear Demand Curve
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Income Elasticity of Demand
Income elasticity of demandmeasures howmuch the quantity demanded of a good
responds to a change in consumers income.
It is computed as the percentage change in thequantity demanded divided by the percentage
change in income.
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Computing Income Elasticity
Income elasticity of demand =
Percentage changein quantity demanded
Percentage changein income
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Income Elasticity
Types of Goods Normal Goods
Inferior Goods
Higher income raises the quantity demanded fornormal goods but lowers the quantity demanded
for inferior goods.
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Income Elasticity
Goods consumers regard as necessities tend tobe 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 expensivefoods.
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THE ELASTICITY OF SUPPLY
Price elasticity of supplyis a measure of howmuch the quantity supplied of a good responds
to a change in the price of that good.
Price elasticity of supply is the percentagechange in quantity supplied resulting from a
percent change in price.
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Figure 6 The Price Elasticity of Supply
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(a) Perfectly Inelastic Supply: Elasticity Equals 0
$5
4
Supply
Quantity1000
1. Anincreasein price . . .
2. . . . leaves the quantity supplied unchanged.
Price
f S
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Figure 6 The Price Elasticity of Supply
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(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
Fi 6 Th P i El ti it f S l
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Figure 6 The Price Elasticity of Supply
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(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
Fi 6 Th P i El ti it f S l
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Figure 6 The Price Elasticity of Supply
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(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
Fi 6 Th P i El ti it f S l
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Figure 6 The Price Elasticity of Supply
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(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Quantity0
Price
$4 Supply
3. At a price below $4,quantity supplied is zero.
2. At exactly $4,producers willsupply any quantity.
1. At any priceabove $4, quantitysupplied is infinite.
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Determinants of Elasticity of Supply
Ability of sellers to change the amount of thegood they produce.
Beach-front land is inelastic.
Books, cars, or manufactured goods are elastic.
Time period.
Supply is more elastic in the long run.
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Computing the Price Elasticity of Supply
The price elasticity of supply is computed asthe percentage change in the quantity supplied
divided by the percentage change in price.
Price elasticity of supply =
Percentage changein quantity supplied
Percentage change in price
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THREE APPLICATIONS OF SUPPLY,DEMAND, AND ELASTICITY
Can good news for farming be bad news forfarmers?
What happens to wheat farmers and the market
for wheat when university agronomists discovera new wheat hybrid that is more productive
than existing varieties?
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THREE APPLICATIONS OF SUPPLY,DEMAND, AND ELASTICITY
Examine whether the supply or demand curveshifts.
Determine the direction of the shift of the
curve. Use the supply-and-demand diagram to see how
the market equilibrium changes.
Figure 8 An Increase in Supply in the Market for Wheat
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Figure 8 An Increase in Supply in the Market for Wheat
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Quantity of
Wheat
0
Price of
Wheat
3. . . . and a proportionately smaller
increase in quantity sold. As a result,
revenue falls from $300 to $220.
Demand
S1S2
2. . . . leads
to a large fall
in price . . .
1. When demand is inelastic,an increase in supply . . .
2
110
$3
100
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Compute the Price Elasticity of Supply
ED
100 110
100 110 2
300 2 00300 2 00 2
0095
0 40 24
( ) /
. .( . . ) /
.
..
Supply is inelastic
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Summary
The income elasticity of demand measures howmuch the quantity demanded responds to
changes in consumers income.
The cross-price elasticity of demand measureshow much the quantity demanded of one good
responds to the price of another good.
The price elasticity of supply measures howmuch the quantity supplied responds to changes
in the price. .
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Summary
In most markets, supply is more elastic in thelong run than in the short run.
The price elasticity of supply is calculated as
the percentage change in quantity supplieddivided by the percentage change in price.
The tools of supply and demand can be applied
in many different types of markets.