Principles of Microeconomics - Lecture - Elasticity
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Transcript of Principles of Microeconomics - Lecture - Elasticity
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Elasticity
Dr. Katherine Sauer
Principles of Microeconomics
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I. Evaluating Elasticity
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Extreme Cases:
There are some goods that no matter what the price is,
consumers demand the same quantity.
perfectly inelastic demandd = 0
There are some goods that when theprice changes even a
little, consumers completely change their buyingbehavior.perfectly elastic demand
d =
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Examples of estimated price elasticities:
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B. Rules for Evaluating Price Elasticity of Supply
When s > 1, we say supply isELASTIC
- large change in Qs in response to a price change
When s=1, we say supply isUNIT ELASTIC
-proportional change in Qs in response to a price
change
When s
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Extreme Cases:
There are some goods that no matter what the price is,
there is only a fixed quantity.perfectly inelastic supply
d = 0
There are some goods that when theprice changes evena little, producers completely change the quantity.
perfectly elastic supply
d =
Note: firms often have capacity constraints. That is,
they may be elastic at low levels of production and then
very inelastic at high levels of production.
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Ex: Consider the milk industry.
- in the short run a farmer has a certain size of dairy and
number of cows- in the long run, the farmer could expand the herd and size of
the dairy
It is estimated that a 10% increase in the selling price of milkwill result in a
1.2% increase in quantity supplied in the short run.
25% increase in quantity supplied in the long run.
Short Run s=? Long Run s=?
s= 1.2 % / 10% = 0.12
inelastic supply
s= 25 % / 10% = 2.5
elastic supply
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C. Rules for Evaluating Income Elasticity
I > 0 normal good
I < 0 inferior good
Necessities have small income elasticities.
Luxuries have large income elasticities.
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D. Rules for Evaluating Cross Price Elasticity
1,2 > 0 substitutes1,2 < 0 complements
1,2 = 0 not related
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Go back to the worksheet and evaluate each elasticity.
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II. Elasticity
Graphically
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A. Demand
quantity
price
quantity
price
D
D
Inelastic Demand Elastic Demand
P1
P2
P1
P2
Q1 Q2 Q2Q1
small change in quantity large change in quantity
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quantity
price
quantity
price
D
D
Perfectly Perfectly
Inelastic Demand Elastic Demand
P2
P1
P2
P1
Q1 Q2 Q1
no change in quantity total change in quantity
D =0
D =
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B. Supply
quantity
price
quantity
priceS
S
Inelastic Supply Elastic Supply
P2
P1
P2
P1
Q1 Q2 Q2Q1
small change in quantity large change in quantity
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quantity
price
quantity
price
S
S
Perfectly Perfectly
Inelastic Supply Elastic Supply
P2
P1
P2
P1
Q1 Q2 Q1
no change in quantity total change in quantity
S =0s =
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C.Applications: Supply, Demand, and Elasticity
Example 1: The demand for basic food commodities (e.g.wheat, corn) tends to be fairly inelastic. The supply of such
commodities is fairly inelastic as well.
S
D
quantity
price
P
Q
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Suppose a new hybrid of wheat is developed that is more productive
than those used in the past. What happens?
- supply increases, price falls, and quantity rises-because demand is inelastic, the change in quantity
demanded is less than the change in price
S
D
quantity
price
P
Q
S2
P2
Q2
Farmers receive a lower
price, but only sell alittle more.
Revenue for farmers
falls.
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Example 2: The demand and supply of oil tend to both be fairly
inelastic in the short run. They tend to both be more elastic in the
long run.
In the 1970s and 1980s, OPEC restricted the supply of oil in order
to increase prices (and revenues).
S
D
quantity
price
P
Q
S2
P2
Q2
Because demand for oil isinelastic, even though the
price increased, quantity
only fell a little.
Revenues for OPECincreased.
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Over the long run, consumers switched to more fuel efficient cars
and carpooled. Non-OPEC oil producers respond to the higher
price of oil and increase drilling. When OPEC decreases supply,
the effect on quantity is much more dramatic.
S
D
quantity
price
P
Q
S2
P2
Q2
When demand is elastic,
revenues for OPEC
decrease when supply isreduced.
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quantity
price
D
P2
P1
Q2 Q1
S2
Example 3: The war on drugs: reducing supply vs reducing demand
The demand for illegal drugs tends to be somewhat inelastic relative
to supply .
S
When the government focuses on
decreasing the supply of drugs
entering the nation:
- supply falls
-price rises- quantity demanded falls,
but not much
The higher price often leads to
higher crime.
Also, higher revenues for drug
suppliers.
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quantity
price
D
P2
P1
Q2 Q1
When the government instead pursues better drug education, the
demand for drugs falls.
S
The price and quantity will fall.
Also, revenues for drug suppliers
will fall.
D2
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III
. Elasticity and a Firms Revenue
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On a linear demand curve, the elasticity changes as you
move down the curve.
- the slope is constant- the elasticity changes
quantity
price
D
ELASTIC
INELASTIC
UNIT ELASTIC
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The Price Elasticity of DemandAffects a Firms Revenue
Total Revenue (TR) = Price x Quantity Sold
Recall that forconsumers, quantity is inversely related to
price.
When a firm raises prices, the quantity sold falls.
When a firm lowers prices, the quantity sold rises.
- elasticity tells us how much quantity rises or falls
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If demand is elastic (d > 1), consumers are quite
responsive to a price change:
- an increase in price by 5% will reduce quantity
by more than 5%
- total revenue will fall when price is increased
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If demand is inelastic (d < 1), consumers are not very
responsive to a price change:
- an increase in price by 5% will reduce quantityby less than 5%
- total revenue will rise when price is increased
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If demand is unit elastic (d = 1), consumers have a
proportional response to a price change:
- an increase in price by 5% will reduce quantity
by exactly 5%
- total revenue will be unchanged when price is
increased
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Information on price elasticity of demand is very
useful for businesses.