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# 05 price elasticity of demand and supply

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### 05 price elasticity of demand and supply

1. 1. Chapter 5 Price Elasticity ofDemand and Supply • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2000 South-Western College Publishing
2. 2. In this chapter, you will learn to solve these economic puzzles:Can total revenuethe sales Steel What happens to from a of How sensitive is the Mercedes, BMW’s and remain Porcupines of cigarettes quantity concert Jaguars in demandedCongress prevents the U.S. if to changes in unchanged, Japanese cars in regardless of sales of luxury changes in of cigarettes? the price country? price? this the ticket 2
3. 3. How is the percent increase or decrease oftwo numbers calculated? Percent change is the difference between the two numbers divided by the original number 3
4. 4. Suppose the price of a rock concert increasesby 10%, what effect will this have on sales?That all depends on the price elasticity of demand for this rock concert 4
5. 5. What is Elasticity?A term economists use to describe responsiveness, or sensitivity, to a change in price 5
6. 6. What is Price Elasticity of Demand?The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price 6
7. 7. Price Elasticity of Demand % ∆ in Q demandedEd = % ∆ in price 7
8. 8. Supposing a university’senrollment drops by 20% because tuition rises by 10%, what is the Price Elasticity of Demand? 8
9. 9. -20% -.20Ed = +10% = +.10 = 2 9
10. 10. Why is Elasticity 2 in the previous example and not -2?Economists drop the negative sign because we know from the law of demand that quantity demanded and price are inversely related 10
11. 11. If there is an increasefrom 3 units to 5, what isthe percentage increase? 2/3 = 66% 11
12. 12. If there is a decreasefrom 5 units to 3, what isthe percentage decrease? 2/5 = 40% 12
13. 13. Problem - When wemove along a demand curvebetween two points, we getdifferent answers to elasticitydepending on whether we aremoving up or down thedemand curve 13
14. 14. P A 2 B D 3 Q 14
15. 15. Economists can solve thisproblem of different base pointsby using the midpoints as thebase points of changes in pricesand quantity demanded 15
16. 16. Price elasticity equals the ∆ in quantity demanded sum of quantities/2 divided by ∆ in price sum of prices/2 16
17. 17. What is Elastic Demand?A condition in which the percentage change in quantity demanded is greater than the percentage change in price 17
18. 18. P Elastic Demand Ed > 1\$40 A\$30 B\$20\$10 10 20 30 40 18 Q
19. 19. Why is the Demand curve in the previous slide Elastic?The percentage change in the quantity demanded is greater than the percentage change in price 19
20. 20. Elastic Demand Increase in total revenuePrice decrease 20
21. 21. % change in Q = 10 .66 = 15% change in P = 10 .40 = 25Ed = % change in Q .66 = % change in P .40Ed = 1.65 21
22. 22. Inelastic Demand Ed < 1\$40 A\$30\$20 B\$10 10 20 30 40 22
23. 23. Why is the Demand curve in the previous slide Inelastic?The percentage change in the quantity demanded is less than the percentage change in price 23
24. 24. Inelastic Demand Decrease in total revenuePrice decrease 24
25. 25. 5% change in Q = = .38 13 10% change in P = = .40 25 % change in Q .38Ed = = % change in P .40 25
26. 26. What is a UnitaryElastic Demand Curve?The percentage change in the quantity demanded is equal to the percentage change in price 26
27. 27. Unitary Elastic Demand Ed = 1\$40\$30 E F\$20 D\$10 10 20 30 40 27
28. 28. Unitary Elastic Demand No change in total revenuePrice decrease 28
29. 29. What is a PerfectlyElastic Demand Curve? A condition in which a small percentage change in price brings about an infinite percentage change in the quantity demanded 29
30. 30. \$40\$30\$20 Perfectly Elastic Demand Ed = 8\$10 10 20 30 40 30
31. 31. Perfectly Elastic Demand Infinite change in quantity demanded Price change 31
32. 32. What is a PerfectlyInelastic Demand Curve? A condition in which the quantity demanded does not change as the price changes 32
33. 33. Perfectly Inelastic Demand Ed = 0\$40\$30\$20\$10 10 20 30 40 33
34. 34. Perfectly Inelastic Demand Zero change in quantity demanded Price change 34
35. 35. If a college raises tuition,what happens to revenue? If demand is elastic - total revenue goes down If demand is inelastic - total revenue goes up 35
36. 36. If price increases and therevenue gained is greaterthan the revenue lost, thedemand curve is priceinelastic, < 1 36
37. 37. If price increases andthe revenue gained isless than the revenuelost, the demand curveis price elastic, > 1 37
38. 38. If total revenue doesnot change whenprice increases, thedemand curve isunitary elastic,value equals 1 38
39. 39. Price Elasticity of\$40 El Demand Ranges\$35 as tic\$30\$25 In\$20 ela Un sti\$15 ela ita c\$10 sti ry \$5 c 5 10 15 20 25 30 35 40 45 39
40. 40. Total Revenue Curve\$400 c\$350 sti In\$300 ela Ela\$250 s t ic\$200 Unitary\$150 Elastic\$100 \$50 5 10 15 20 25 30 35 40 45 40
41. 41. What factors influence Demand sensitivity?• Availability of substitutes• Share of budget on the product• Adjustment to a price change over time 41
42. 42. What do Substitutes haveto do with a price change? The more substitutes a product has, the more sensitive consumers are to a price change, and the more elastic the demand curve 42
43. 43. P A P B D D0 Q 0 QWhich demand curve is for a vitalmedicine and which is for candy? 43
44. 44. Why is A the DemandCurve for medicine?Because medicine is a necessity with few substitutes, and the price can change with little effect on the quantity demanded 44
45. 45. Why is B the Demand curve for candy?Because candy has many substitutes, a price change can bring about a big change in the quantity demanded 45
46. 46. What does the Share ofOne’s Budget have to do with a price change?The larger the purchase is to one’s budget, the more sensitive consumers are to a price change, and the more elastic the demand curve 46
47. 47. What does Time have to do with sensitivity?The longer consumers have to adjust, the more sensitive they are to a price change, and the more elastic the demand curve 47
48. 48. What are other Elasticity measures?Income elasticity of demandCross-elasticity of demand 48
49. 49. What is Income Elasticity of Demand?The ratio of the percentage change in the quantity demanded of a good to a given percentage change in income 49
50. 50. Income Elasticity of Demand % ∆ in Q demanded Ed = % ∆ in income 50
51. 51. What is Cross-elasticity of Demand?The ratio of the percentage change in quantity demanded of a good to a given percentage change in price of another good 51
52. 52. Cross-elasticity of Demand % ∆ Q demanded of good AEc = % ∆ price of good B 52
53. 53. What is the Price Elasticity of Supply?The ratio of the percentage change in the quantity supplied of a product to the percentage change in its price 53
54. 54. Price Elasticity of Supply % ∆ in Q supplied Es = % ∆ in price 54
55. 55. \$40\$30\$20 Perfectly Elastic Supply = 8\$10 10 20 30 40 55
56. 56. \$40 Perfectly Inelastic Supply Es = 0\$30\$20\$10 10 20 30 40 56
57. 57. Unit Elastic Supply Es = 1\$40\$30 S .5%\$20 .5%\$10 10 20 30 40 57
58. 58. Who pays the tax levied on sellers of goods such as gasoline, cigarettes,and alcoholic beverages?It all depends; the corporation pays all, some, or very little of the tax 58
59. 59. What decides whopays what part of the tax increase?The more elastic the demand, the more the corporation pays; the less elastic the demand, the more the consumer pays 59
60. 60. Partially shifted tax to buyers\$2.00\$1.75\$1.50 s2\$1.25 Buyers s1\$1.00 \$.75 Sellers \$.50 \$.25 D 5 10 15 20 25 30 35 40 45 60
61. 61. Consumers and suppliers share burden of tax Decrease in supplyIncrease ingasoline tax 61
62. 62. Fully shifted tax to buyers\$2.00\$1.75\$1.50 s2\$1.25 Buyers s1\$1.00 \$.75 \$.50 \$.25 D 5 10 15 20 25 3035 40 45 62
63. 63. Consumers bear full burden of tax Decrease in supplyIncrease ingasoline tax 63
64. 64. Key Concepts 64
65. 65. Key Concepts• What is Elasticity?• What is Price Elasticity of Demand?• What is Elastic Demand?• What is a Unitary Elastic Demand Curve?• What is a Perfectly Elastic Demand Curve?• What is a Perfectly Inelastic Demand Curve? 65
66. 66. Key Concepts cont.• What factors influence Demand sensitivity?• What are other Elasticity measures?• What is Income Elasticity of Demand?• What is Cross-elasticity of Demand?• What is the Price Elasticity of Supply? 66
67. 67. Summary 67
68. 68. Price elasticity of demand is ameasure of the responsiveness of thequantity demanded to a change in price.Specifically, price elasticity of demandis the ratio of the percentage change inquantity demanded to the percentagechange in price. 68
69. 69. Price Elasticity of Demand % ∆ in Q demandedEd = % ∆ in price 69
70. 70. What is the midpoint formula forthe price elasticity of demand? 70
71. 71. Price elasticity equals the ∆ in quantity demanded sum of quantities/2 divided by ∆ in price sum of prices/2 71
72. 72. Elastic demand is a change ofmore than one percent in quantitydemanded in response to a one percentchange in price. Demand is elasticwhen the elasticity coefficient is greaterthan one and total revenue (price timequantity) varies inversely with thedirection of the price change. 72
73. 73. Elastic Demand\$40\$30\$20\$10 10 20 30 40 73
74. 74. Inelastic demand is a change ofless than one percent in quantitydemanded in response to a onepercent change in price. Demand isinelastic when the elasticitycoefficient is less than one and totalrevenue varies directly with thedirection of the price change. 74
75. 75. Inelastic Demand\$40\$30\$20\$10 10 20 30 40 75
76. 76. Unitary elastic demand is a onepercent change in quantity demanded inresponse to a one percent change inprice. Demand is unitary elastic whenthe elasticity coefficient equals one andtotal revenue remains constant as theprice changes. 76
77. 77. Unitary elastic Demand\$40\$30\$20\$10 10 20 30 40 77
78. 78. Perfectly elastic demand is adecline in quantity demanded to zerofor even the slightest rise or fall inprice. This is an extreme case in whichthe demand curve is horizontal and theelasticity coefficient equals infinity. 78
79. 79. \$40\$30\$20 Perfectly Elastic Supply = 8\$10 10 20 30 40 79
80. 80. Perfectly inelastic demand is nochange quantity demanded in responseto price changes. This is an extremecase in which the the demand curve isvertical and the elasticity coefficientequals zero. 80
81. 81. \$40 Perfectly Inelastic Supply Es = 0\$30\$20\$10 10 20 30 40 81
82. 82. Determinants of price elasticity ofdemand include (a) the availability ofsubstitutes, (b) the percentage ofbudget spent on the product, and (c) thelength of time allowed for adjustment.Each of these factors is directly relatedto the elasticity coefficient. 82
83. 83. Income elasticity of demand is thepercentage change in quantitydemanded divided by the percentagechange in income. For a normal goodor service, income elasticity of demandis positive. For an inferior good orservice, income elasticity of demand isnegative. 83
84. 84. Cross elasticity of demand is thepercentage change in the quantitydemanded of one product caused by achange in the price of another product.When the cross-elasticity of demand isnegative, the two products arecomplements. 84
85. 85. Price elasticity of supply is ameasure of the responsiveness of thequantity demanded to a change inprice. Price elasticity of supply is theratio of the percentage change inquantity supplied to the percentagechange in price. 85
86. 86. Tax incidence is the share of atax ultimately paid by buyers andsellers. Facing a downward-slopingdemand curve and an upward-sloping supply curve, sellers cannotraise the price by the full amount ofthe tax. If the demand curve isvertical, sellers will raise the priceby the full amount of a tax. 86
87. 87. Fully shifted tax to buyers\$2.00\$1.75\$1.50 s2\$1.25 Buyers s1\$1.00 \$.75 \$.50 \$.25 D 5 10 15 20 25 3035 40 45 87
88. 88. Partially shifted tax to buyers\$2.00\$1.75\$1.50 s2\$1.25 Buyers s1\$1.00 \$.75 Sellers \$.50 \$.25 D 5 10 15 20 25 30 35 40 45 88
89. 89. Chapter 5 Quiz ©2000 South-Western College Publishing 89
90. 90. 1. If an increase in bus fares in Charlotte, North Carolina reduces total revenue of the public transit system, this is evidence that demand is a. price elastic. b. price inelastic c. unitary elastic d. perfectly elasticA. When price increases and the total revenue decreases, by definition, this represents an elastic demand curve. The revenue lost from selling fewer units is not offset by the revenue gained by charging a higher price. 90
91. 91. 2. Which of the following is the result of an increase in total revenue? a. Price increases when demand is elastic. b. Price decreases when demand is elastic. c. Price increases when demand is unitary elastic. d. Price decreases when demand is inelastic. B. When price decreases and the total revenue increases, the revenue gained by the increase in sales more than offsets the revenue lost from the lower price. By definition, this represents an elastic demand curve. 91
92. 92. 3. You are on a committee that is considering ways to raise money for your city’s symphony program. You would recommend increasing the price of symphony tickets only if you thought the demand curve for these tickets was a. inelastic. b. elastic. c. unitary elastic. d. perfectly elastic.A. When the demand curve is inelastic, the revenue gained from the higher price more than offsets the revenue lost from the decline in sales. 92
93. 93. 4. The price elasticity of demand for a horizontal demand curve is a. perfectly elastic. b. perfectly inelastic. c. unitary elastic. d. inelastic.A. Ae.perfectly elastic demand curve exists elastic. when any increase in price leads to zero sales. The only curve that would illustrate this would be a horizontal line at the beginning price. 93
94. 94. 5. Suppose the quantity of steak purchased by the Jones family is 110 pounds per year when the price is \$2.10 per pound and 90 pounds per year when the price is \$3.90 per pound. The price elasticity of demand coefficient for this family is a. 0.33. b. 0.50. c. 1.00. d. 2.00.A. 20/100 divided by \$1.80/\$6.00 = .33 94
95. 95. 6. If a 5 percent reduction in the price of a good produces a 3 percent increase in the quantity demanded, the price elasticity of demand over this range of the demand curve is a. elastic. b. perfectly elastic. c. unitary elastic. d. inelastic. e. perfectly inelastic.D. Since the percentage change in quantity demanded is less than the percentage change in price, this range is defined inelastic 95
96. 96. 7. A manufacturer of Beanie Babies hires an economist to study the price elasticity of demand for this product. The economist estimates that the price elasticity of demand coefficient for a range of prices close to the selling price is greater than 1. The relationship between changes in price and quantity demanded for this segment of the demand curve is a. elastic. e. unitary elastic. b. inelastic. c. perfectly elastic. d. perfectly inelastic. A. Elasticity > 1 = elastic demand 96
97. 97. 8. A downward-sloping demand curve will have a a. higher price elasticity of demand coefficient along the top of the demand curve. b. lower price elasticity coefficient along the top of the demand curve. c. constant price elasticity of demand coefficient throughout the length of the demand curve. d. positive slope. A. The quantity demanded by consumers is more sensitive to a price change at higher prices than at lower prices. 97
98. 98. 9. The price elasticity of demand coefficient for a good will be less a. if there are few or no substitutes available. b. if a small portion of the budget will be spent on it. c. in the short run than in the long run. d. all of the above are true. D. A low elasticity of demand means that there is a low sensitivity to a change in price. When the good has few substitutes, or the purchase represents a small portion of one’s budget, or they do not have much time to adjust to the price change, price elasticity of demand is inelastic. 98
99. 99. 10. The income elasticity of demand for shoes is estimated to be 1.50. We can conclude that shoes a. have a relatively steep demand curve. b. have a relatively flat demand curve. c. are a normal good. d. are an inferior good. C. If the income elasticity coefficient is a positive number, then the good or service is a normal good. 99
100. 100. 11. To determine whether two goods are substitutes or complements, an economist would estimate the a. price elasticity of demand. b. income elasticity of demand. c. cross-elasticity of demand. d. price elasticity of supply. C. Cross-elasticity of demand shows what will happen to the demand for one good if the price of a complementary good, or a good that is a substitute, changes. 100
101. 101. 12. If the government wanted to raise tax revenue and shift most of the tax burden to the sellers, it would impose a tax on a good with a a. steep (inelastic) demand curve and a steep (inelastic) supply curve. b. steep (inelastic) demand curve and a flat (elastic) supply curve. c. flat (elastic) demand curve and a steep (inelastic) supply curve. d. flat (elastic) demand curve and a flat (elastic) supply curve. C. An elastic demand curve would mean that a leftward shift in the supply curve would lead to a big decrease in quantity demanded and little change in price, so the business would lose total revenue. 101
102. 102. Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises 102
103. 103. END