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Chapter 20 elasticity of demand and supply


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Chapter 20 elasticity of demand and supply

  1. 1. A. Elasticity of demand measures how much the quantity demanded changes with a given change in price of the item, change in consumer’s income, or change in price of a related product.B. Price elasticity is a concept that also relates to supply. 2
  2. 2. A. The law of demand tell us that consumers will respond to a price decrease by buying more of a product (other things remaining constant), but it does not tell us how much more.B. The degree of responsiveness or sensitivity of consumers to a change in price is measured by the concept of price elasticity of demand. 3
  3. 3. 1. If consumers are relatively responsive to price changes, demand is said to be elastic.2. If consumers are relatively unresponsive to price changes, demand is said to be inelastic.3. Note that with both elastic and inelastic demand, consumers behave according to the law of demand; that is, they are responsive to price changes. The terms elastic or inelastic describe the degree of responsiveness. 4
  4. 4.  5
  5. 5. 1. Using the two price-quantity combinations of a demand schedule, calculate the percent change in quantity by dividing the absolute change in quantity by one of the two original quantities. Then calculate the percentage change in price by dividing the absolute change in price by one of the two original prices. 6
  6. 6. 2. If we calculate the elasticity using the other original quantity and price, the resulting elasticity would be different. To eliminate this problem, economists use the mid-point formula, which uses the average of the quantities and the prices as denominators. 7
  7. 7. 3. Remember: what is being compared are the percentage changes not the absolute changes. That is because the absolute changes depend on the choice of units (a change in price of a $10,000 car by $1 is very different from a change in price of $10 shirt by $1. 8
  8. 8. Percentages also make it possibleto compare elasticities of demandfor different products. 9
  9. 9. 4. Because of the inverse relationship between price and quantity demanded, the actual elasticity of demand will be a negative number. However, we will ignore the minus sign and use the absolute value of both percentage changes. 10
  10. 10. 5. The Coefficient of Elasticity: If the coefficient of elasticity of demand is a number greater than one (Ed›1), we say demand is elastic. In other words, the quantity demanded is “relative responsive” when Ed is greater than 1, and “relatively unresponsive” when Ed is les than 1. A special case is if the coefficient equals one, it is called unit elasticity. 11
  11. 11. NOTE: Inelastic demand does not mean thatconsumers are completely unresponsive. Thisextreme situation is called perfectlyinelastic demand, and would be very rare. Inthis case, the demand curve would bevertical, as the quantity demanded would notchange at all at any price. 12
  12. 12. Likewise, an elastic demand does not meanthat consumers are completely responsive toa price change. This extreme situation, inwhich a small reduction in price would causebuyers to increase their purchases to allthat is possible to obtain, is perfectlyelastic, and the demand curve would behorizontal. 13
  13. 13.  14
  14. 14. Get your calculator out!On page 359, look at table 20.1. In yournotebook, compute the elasticity betweeneach two prices, using the midpoint formula.Did you get the same numbers from thetable? Awesome! You’re ready to move on tothe next problem… 15
  15. 15. 2. Complete the following table: QUANTITY ELASTICITY CHARACTER OF PRICE DEMANDED COEFFICIENT DEMAND $1.00 300 - - .90 400 .80 500 .70 600 .60 700 .50 800 .40 900 16
  16. 16. a) Graph the demand schedule shown below.b) Determine the Ed between the prices.c) Where is elastic demand found?d) Where is the demand schedule inelastic? PRICE QUANTITY DEMANDED $5 1 4 2 3 3 2 4 1 5 17
  17. 17. e) What can you conclude about the relationship between the slope of the demand curve and its elasticity? How are they different?f) Explain in a nontechnical way why demand is elastic in the northwest segment and inelastic in the southeast segment. 18
  18. 18. A. Elasticity varies over a range of prices: 1. Demand is more elastic in the upper left portion of the curve because when the initial price is high and initial quantity is low, a unit change in price is a low percentage while the unit change in quantity is a high percentage change. The percent change in quantity exceeds the percent change in price, making demand elastic. 19
  19. 19. 2. Demand is more inelastic in the lower right portion of the curve because the initial price is low and the initial quantity is high, a unit change in price is a high percentage change while a unit change in quantity is a low percentage change. The percentage change in quantity is less than the percentage change in price, making demand inelastic. 20
  20. 20. It is impossible to judge the elasticity of asingle demand curve by its steepness orflatness, since demand elasticity canmeasure both elastic and inelastic atdifferent points on the same demand curve. 21
  21. 21. It is impossible to judge the elasticity of asingle demand curve by its steepness orflatness, since demand elasticity canmeasure both elastic and inelastic atdifferent points on the same demand curve. 22
  23. 23. The total-revenue test is the easiest way tojudge whether demand is inelastic or elastic.This test can be used in place of theelasticity formula, unless there is a need todetermine the elasticity coefficient.1. Elastic demand and the total-revenue test:Demand is elastic if a decrease in price resultsin a rise in total revenue, or if an increase inprice results in a decline in total revenue (priceand revenue move in different directions-indirectly related). 24
  24. 24. 2. Inelastic demand and the total-revenue test: Demand is inelastic if a decrease in price results in a fall in total revenue, or if an increase in price results in a rise in total revenue (price and revenue move in the same direction-directly related).3. Unit elasticity and the total revenue test: Demand has unit elasticity if total revenue does not change when the price changes. 25
  25. 25. 4. See the graphical representation of the relationship between the relationship between total revenue and price elasticity shown in the data from the table on page 359 and the Figure 20.2 on page 360.5. Table 20.2 on page 362 shows the summary of the rules and concepts related to elasticity of demand. 26
  26. 26. There are several determinants of the priceelasticity of demand.1. Substitutes for the product: Generally, the more substitutes for the products, the more elastic the demand.2. The proportion of price relative to income: Generally, the larger the expenditure is relative to one’s budget, the more elastic the demand, because buyers notice the change in price more. 27
  27. 27. 3. Whether the product is a necessity or a luxury: Generally, the less necessary the item, the more elastic the demand.4. The amount of time involved: Generally, the longer the time period involved, the more elastic the demand becomes. 28
  28. 28. See the table 20.3 from page 363, whichpresents some real-world elasticities. Usethe determinants and to see if the actualelasticities are equivalent to what you wouldpredict, based on the characteristics of thegood. Discuss your thoughts with yourneighbors. 29
  29. 29. There are many practical applications ofelasticity:1. Inelastic demand for agricultural products help explain why bumper crops depress the prices and total revenues for farmers. 30
  30. 30. 1. Government looks at elasticity of demand when levying excise taxes. Excise taxes on products with inelastic demand will raise the most revenue (in taxes) and have the least impact on quantity demanded for those products. 31
  31. 31. 3. Demand for cocaine is highly inelastic and presents problems for law enforcement. Stricter enforcement reduces supply, raises prices and revenues for sellers, and provides more incentives for sellers to remain in business. Crime may also increase as buyers have to find more money to buy their drugs. 32
  32. 32. 1. Opponents of legalization think that occasional users or “dabblers” have a more elastic demand and would increase their use at lower, legal prices.2. Removal of the legal prohibitions might make drug use more socially acceptable and shift demand to the right.3. The impact of minimum-wage laws will be less harmful to employment if the demand for minimum-wage workers is inelastic. 33
  34. 34.  35
  35. 35. B. The time period involved is very important in price elasticity of supply because it will determine how much flexibility a product has to adjust his/her resources to a change in the price. The degree of flexibility, and therefore the time period, will be different in different industries. 36
  36. 36. 1. The market period is so short that elasticity of supply is inelastic; it could be almost perfectly inelastic or vertical. In this situation, it is virtually impossible for producers to adjust their resources and change the quantity supplied (for example, think of adjustments on a farm once the crop has been planted). 37
  37. 37. 2. The short-run supply elasticity is more elastic than the market period and will depend on the ability of producers to respond to price change. Industrial producers are able to make some output changes by having workers work overtime or by bringing on an extra shift. 38
  38. 38. 3. The long-run supply elasticity is the most elastic, because more adjustments can be made over time and quantity can be changes more relative to a small change in price. The producer has time to build a new plant. 39
  39. 39.  40
  40. 40.  41