Post on 03-Jan-2016
Chapter 20
Elasticity Supply and Demand
How do demand and supply change in response to changes in price and quantity?=Elasticity
Elasticity of Demand and Elasticity of Supply
Bottom Line on Elasticity of Supply
If producers are relatively responsive to price changes supply is elastic
If producers are relatively insensitive to price changes supply is inelastic
If producers are responsive to price changes, supply is elastic.
If they are relatively insensitive to price changes, supply is inelastic
When a large percentage change in price brings about a small percentage change in quantity supplied = inelastic….
(examples: Rise in costs of computers… takes time to shift resources)
Over Time… more plants built, more engineers trained, and more computers supplied
Elasticity and Inelasticity Supply
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60
50
40
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200 10 20 30 40 50 60 70 80 90 100 120 140 160
Supply Elasticity (small percentage increase in price = large percentage increase in quantity
A
B
A
B
Antiques…. Supply elastic or inelastic?
Inelastic…. Only a few authentic pieces, reproductions would be elastic
Gold………Supply elastic or inelasticGold is perfectly inelastic…
(supply fixed)…
When a small percentage change in price brings about a large percentage change in quantity supplied = elastic
Example: Cowboys beat Philadelphia Eagles for wildcard playoff… T-shirt producer can raise his price just a “tad” and sell a ton more shirts…
MAIN DETERMINATION OF ELASTICY OF SUPPLY?
TIME
Many times this only has to do with the producers ability to shift resources…
If resources are not shiftable, then new mix of inputs has to be determined.
Ability to Respond to Price varies
Often the ability of an individual firm to respond to an increase in price is limited or constrained by its existing scale of operations, or capacity, or ability to obtain resources….. IN IN SHORT RUNSHORT RUN
Examples:
IN LONG RUNIN LONG RUN… can adjust. The greater the amount of time producers have to adjust, the greater their output response.
TIME AND ELASTICITY OF SUPPLY
Sm
D1
D2
Ss
D1
D2
SL
D1
D2
Note: perfectly inelastic. (price)(quantity)
Inelastic (price) (quantity)
Elastic (price) (quantity)
See relationship between small percentage increase in P and Q that follows.
Terms to remember Market Period = period that occurs
when the quantity output is fixed. Producer will not produce more until some is sold. No change in quantity supplied.
SR in Micro = period of time too short to change plant capacity, but long enough to use current capacity more or less intensively.
Examples of adjusting to the market period.
truck farmer (farmer’s market)*limited growing season*accepts price as it is brought to
market*can’t hold back on what is sold
because of spoilage.*has to take price even if cost of
production not met.
Perfectly elastic supply curve
Relatively elastic supply curve
Perfectly inelastic supply curve
Relatively inelastic supply curve
Supply tends to be inelastic in SR
Example:After WWII… cars impossible to get at
any price.Resources needed to be converted back from tanks, jeeps and plane production.Even if you had the $1,000 it took to buy a car… had to put name on year waiting list.
1946 Billboard Ad by Ford
Remember
Supplier is looking at revenueRevenue Test = P x Q = TR
What is profit?TR-TC
Question is: If I decrease the price of steak $1 what will happen to my revenue?
Math for Measuring Price Elasticity
Problem: Sirloin steak drops $4.00 to $3.00
Butcher sales increase from 500 lbs to 1,000 lbs
e Formula: Pe = % Change in Q % Change in P
500 lbs to 1000 lbs = 500 / 500 = 1 (Q change = 100%)
$4.00 to $3.00 = 1/ 4 = .251 / .25 = 4The steak at this price is very elastic.Anything over 1 is elastic.Anything .01 to .99 is inelastic
Helpful HintsTo find coefficient of price
elasticity supply or demand simply:
Find % change in quantity and % change in price, then divide Q/P
Hint: former-current/formerPrice increase $1 to $2, quantity decrease 10 to 81/1 x 100 = 100% = P2/10 x 100 = 20% = Q20/100 = .2 = inelastic
Another Helpful Hint!What is the first movement for variables?i.e.. When a producer wants to check if
he can get more $$ for increasing or decreasing, what is the first thing he does?
Price OR Price Then the quantity adjusts accordinglyP = triggerQ = response
Elasticity of Demand
Logic Dictates that:
Firms contemplating a price hike want to know how consumers will respondGM advertises 0% financing for 60 months… huge reductions on Suburban's, Tahoes,Trucks) What do they expect consumers to do?
What do the dealers expect to receive?
Bottom Line for Elasticity of Demand
The responsiveness or (sensitivity) of consumers to a price change is measured by a product’s price elasticity of demand
Inelastic demand perfectly inelastic totally elastic
Explanation of Perfectly Inelastic Demand
Unit Elasticity (Percentage change in price and resulting change in quantity demanded are the same.
Where a price change results in no change in quantity demanded, it = “Perfectly Inelastic” or “Unit Elastic”Example: Insulin for Diabetes
What else? (certain medicines.. BP… Heart problems… etc.)
In these cases… price-elasticity coefficient is zero (because no response to change in price)
What is elasticity of demand?
Elasticity of demand measures the percentage change in Quantity demanded in response to a percentage change in price.
Law of demand states that as P increases Q decreases. But how much decrease?
Measure responsiveness of QD to change in P by calculating the coefficient of price elasticity of demand (Ep)
Ep = Percentage change in QD Percentage Change in P
You have already done this!!
What does that mean?
If elasticity is greater than 1, demand is elastic.
Price change causes revenue to change in opposite direction Decrease in price will increase TR
Inelastic demand is defined as an elasticity of less than 1 (anything from 0 to .99)
Price changes causes TR to change in same direction. Decrease in price causes TR to fall
Unit elastic is 1 No change Price elasticity is 0 because an increase in price will not decrease
revenue…nor will it increase revenue… there is no change in revenue with unit elastic.
Elastic Demand = A small percentage change in price brings about a large percentage change in QD
Example: cars, steak, CDs, gold jewelry
Inelastic Demand = Large percentage change in price brings about a small percentage change in QD.
Drugs, gasoline, cigarettes, personal items, deodorant,
All of the inelastic demand concepts depend on available substitutes
Price of steak goes too high… substitute chicken
Price of gasoline too high… no substitute
Income EffectIncome effect simply indicates that at a
lower price one can afford more of the good without giving up alternative goods.
Decline in the price of a product will increase purchasing power of one’s money income
Higher price has opposite effect.Substitution Effect = one has the
incentive to substitute the cheaper good for similar goods which are now relatively more expensive.
Cheap products for dear products
Determinants of Elasticity Necessity vs Luxuries ….examples:
critical medicines, addiction, gas to drive, new car, boat, diamond ring….
Availability of Substitutes…Zirconia, salt substitute, powdered milk, tea vs coffee…
Proportion of Income…the higher the price of a good relative to a consumers’ income, the greater the price elasticity of demand.
Time….As a rule, product demand is more elastic the longer the time period under consideration.
Generally, the larger the number of substitute goods that are available, the greater the price elasticity of demand..(variety of beer options on the market)
Elasticity of Demand depends on how narrowly the product is defined. (Coach Handbag)
Normal or Superior Goods Income goes up… we buy more
expensive items…. (lobster/fish sticks)
Inferior or Poor Man’s Goods Income goes down… take the bus
rather than fly…second-hand clothing stores… garage sales.
How can we calculate coefficient of price elasticities?Let’s re-visit our last example
Let’s say that price is increased from $1.00 to $2.00 for a candy bar…..
The quantity demanded decreases from 10 to 8….
How will this producer know if the price increase brings in more $ relative to decrease in demand or otherwise????
Percent change in P1-2=1/1 x 100 = 100% change in P
Percent change in Q10-8 = 2/10 = 20% change in Q
Response/trigger (Q/P) …..Hence:E = 20/100 =.2 (% change in Q / % change
in P)Trigger was the price…. Response the quantityPrice moves…(trigger)… quantity change
(response)Because % change is less than 1, candy
producer will increase revenue by increasing price.
Meaning of Elasticity
Elasticity is > than 1 … means demand is elastic
(If elasticity is greater than 1, percentage change in quantity must be greater than percentage change in price.)
Inelasticity is anything < than 1 If elasticity is equal to 1 then it is
unitary elastic
Let’s try two more problemsKey chains are reduced from $5 to $4The number of key chains purchased
increases from 80 to 82Was this inelastic or elastic… Revenue went
up or down?Bottled Water increased from $3.00 to $5.00The number of bottles purchased decreased
from 250 to 125.Elastic or inelastic?Key chain- .125 (inelastic)Bottled water 1.25 (elastic)Inelastic –direct revenue relationship
elastic- indirect revenue relationship
Advertising Purpose
1) To sway the consumer. (Bayer and St. Joseph’s aspirin for children) which is better?
2) Producers through advertising want to increase our demand curve and make it more inelastic!
To be Discussed later
Total Revenue and Marginal Revenue….If your company sold 4 computers at
$3,200 each how much total revenue? (PxQ = $12,800)
Marginal Revenue = Increase in TR when output sold goes up by one unit.($12,800 +3,200=$16,000
The additional revenue derived from selling one more unit. (see above)
Kiley Dog Horn- Total Utility
THE END!