Spring, 2017
Elasticity of Demand and SupplyEconomic Department, Saint Louis University
Instructor: Xi Wang
RoadMap
• Background
• Motivation of Elasticity
• Elasticity, Demand curve
• Elasticity, Supply curve
• Why do we care about Elasticity?
• Background: Motivation of Elasticity
• Elasticity, Demand curve
• Elasticity, Supply curve
• Why do we care about Elasticity?
Demand law
• The law of demand states that a fall in the price of a good raises the quantity demanded.
• Let me ask a question: how much will demand quantity fall if I decrease the price by $1?
• Is it a meaningful question?
Example
• Price of Audi R8 is $226,898 now
• How will the demand quantity change if I decrease the price by $1?
• Price of Small lattie is $1.95
• How will the demand quantity change if I decrease the price by $1?
• Comparable? Can we state that demand of R8 is more stable?
Example continue
• No, since $1 is so trivial when compared to $226,898
• And $1 is significant when compared to $1.95
• Which means, if I decrease the price of lattie by $1, I reduce the price by 51.28%.
Example continue
• Which means, if I decrease the price of R8 by $1, I reduce the price by 0.04%. Almost nothing.
• Hence I should not ask this question what if I reduce the price by $1
• I should ask the question what if I reduce the price by 1%?
Demand law
• Ok, let me try again
• What happens to demand quantities of R8, if I reduce the price by 1%?
• What happens to demand quantities of Lattie, if I reduce the price by 1%?
• Is it meaningful then? Or can we compare the number?
Example
• Audi R8, now at the price of $226,898, can sell 20,000/year in U.S.
• Lattie, now at the price of $1.5, can sell 1,000,000,000 cups/year in U.S
• When we reduce the price, yes, of course, the demand quantity will increase.
• Say R8 got 2000 more sold. Lattie got 30,000,000 more sold
Example
• Can we comprare these two numbers?
• No, again, we should check how much in percent does this discount improve the sale.
• 2000/20,000= 10%
• 30,000,000/1,000,000,000= 3%
• Background: Motivation of Elasticity
• Elasticity, Demand curve
• Elasticity, Supply curve
• Why do we care about Elasticity?
Demand Elasticity
• Demand Elasticity = pricein change Percentagedemandedquantity in change Percentage
Demand Elasticity
• Demand Elasticity R8 =
• Demand Elasticity Lattie =
• Necessities tend to have inelastic demands, where as luxuries have elastic demands. When the price of a doctor’s visit rises, people will not dramatically reduce the number of times they go to the doctor, although they might go somewhat less often.
101%10%
31%3%
Details: How to calculate a Demand Elasticity
• Suppose we have two point on Demand curve
• Point A: Price : $4 , Quantity : 120
• Point B: Price : $6 , Quantity : 80
From A to B, Price increases $2, so increases 50%.
Quantity Decreases 40, so decreases 33%
Elasticity= 66.0%50%33
Details: How to calculate a Demand Elasticity
• Suppose we have two point on Demand curve
• Point A: Price : $4 , Quantity : 120
• Point B: Price : $6 , Quantity : 80
From B to A, Price decrease $2, so increases 33%.
Quantity increases 40, so increases 50%
Elasticity= 51.1%33%50
Details: middle point
• Suppose we have two point on Demand curve
• Point A: Price : $4 , Quantity : 120
• Point B: Price : $6 , Quantity : 80
From A to B, Price changes $2, so averagely changes
Quantity changes 40, so averagely changes
Elasticity= 1%40%40
%4052
%4010040
What does Elasticity Represent?
4743.05.4/1
95/10
35.4/1
75/50
What does Elasticity Represent?
What is the elasticity? 1?
• Background: Motivation of Elasticity
• Elasticity, Demand curve
• Elasticity, Supply curve
• Why do we care about Elasticity?
Supply Elasticity
• Supply Elasticity will be defined in a smilar way.
• Demand Elasticity =
• Middle point method applies again.
pricein change Percentagesuppliedquantity in change Percentage
Supply Elasticity
0.42865.4/1
105/10
Exercise
• Background: Motivation of Elasticity
• Elasticity, Demand curve
• Elasticity, Supply curve
• Why do we care about Elasticity?
Why shall we care about Elasticity?
• Is good news good for farmers?
• Good seeds comes out
• Reduce the production cost
• Push supply curve to the right
• How much are the revenues of these equilibria? Why?
Why shall we care about Elasticity?
• Let's compare two demand curve
What is the elasticity of this demand curve?
What is the elasticity of this demand curve?
Why shall we care about Elasticity?
• Let's compare two demand curve. Elasticity < or > 1?
238.0105/10
5.2/1 3.2857
130/605.2/4.0
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