Demand and Supply Elasticity -...
Transcript of Demand and Supply Elasticity -...
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Demand and Demand and Supply Elasticity
Professor Charles Fusi
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Economists have estimated that if the price of satellite delivered TV services decreases by a certain percentage, the demand for cable TV falls by about the same percentage, but a given percentage decline in the price of cable TV causes less than half of th t d i th d d f t llit TVthe percentage decrease in the demand for satellite TV.
What does this tell us about how consumers perceive consumption of cable TV versus satellite TV?consumption of cable TV versus satellite TV?
This chapter will help you understand this question through the concept called the cross price elasticity of demandconcept called the cross price elasticity of demand.
6A/ 19-2Lectures by Prof. Fusi
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Price Elasticity Price Elasticity Ranges Elasticity and Total Revenues Determinants of the Price Elasticity of Demand Cross Price Elasticity of Demand Income Elasticity of Demand Price Elasticity of Supply
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Price Elasticity of Demand (Ep)p The responsiveness of quantity demanded of a commodity to changes in its price
Defined as the percentage change in quantity demanded divided by the percentage change in price
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Price Elasticity of Demand (Ep)p
Ep = Percentage change in quantity demanded
Percentage change in pricePercentage change in price
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Example
Price of oil increases 10%
Quantity demanded decreases 1% Quantity demanded decreases 1%
Ep = –1%
+10%= – 0.1
0%
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Question How would you interpret an elasticity of –0.1?
Answer Answer A 10% increase in the price of oil will lead to a 1% decrease in quantity demanded.q y
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Relative quantities only Elasticity is measuring the change in quantity relative to the change in price
Always negative An increase in price decreases the quantity demanded, p q y ,ceteris paribus
By convention, the minus sign is ignored
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Calculating Elasticityg
change in QE =
change in Psum of quantities/2
Ep =sum of prices/2
oror
in QE
in P(Q1 + Q2)/2
Ep =(P1 + P2)/2
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During a recent three‐month period, the price of natural gas decreased from $4.81 per 1,000 cubic feet to $4.44 per 1,000 cubic feet.
During this period the total quantity of natural gas During this period the total quantity of natural gas consumed in the United States increased from 62.21 billion cubic feet per day to 62.64 billion cubic feet per day.
What is the price elasticity of demand?
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Use the elasticity formula:6 6 6 8 62.64 ‐ 62.21 ÷ $4.81 ‐ $4.44
(62.64 + 62.21)/2 ($4.81+$4.44)/2= 0.43 ÷ $0.37 43 37124.85/2 $9.25/2
= 0.09
The price elasticity of 0.09 means that a 1% increase in price generated a 0.09% decrease in the quantity of oranges demanded
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Elastic Demand
Percentage change in quantity demanded is larger than the percentage change in price
Total expenditures and price are inversely related in the elastic region of the demand curve
Ep > 1
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Unit Elasticity of Demand
Percentage change in quantity demanded is equal to the percentage change in price
Total expenditures are invariant to price changes in the unit‐elastic region of the demand curve
Ep = 1
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Inelastic Demand
Percentage change in quantity demanded is smaller than the percentage change in price
Total expenditures and price are directly related in the inelastic region of the demand curve
Ep < 1
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Elastic demand % change in Q > % change in P; Ep > 1
Unit‐elastic Unit‐elastic % change in Q = % change in P; Ep = 1
Inelastic demand % change in Q < % change in P; Ep < 1
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Extreme elasticities
Perfectly Inelastic Demand A demand curve that is a vertical line
It has only one quantity demanded for each price
No matter what the price, quantity demanded does not changechange
A demand that exhibits zero responsiveness to price changes
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6A/ 19-17Lectures by Prof. Fusi
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Extreme elasticities
Perfectly Elastic Demand A demand curve that is a horizontal line
It has only one price for every quantity.
The slightest increase in price leads to zero quantity d d ddemanded.
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When demand is elastic, a negative relationship exists between changes in price and changes in total revenues
When demand is unit‐elastic, changes in price do not h t t l change total revenues
When demand is inelastic, a positive relationship exists between changes in price and total revenuesbetween changes in price and total revenues
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6A/ 19-21Lectures by Prof. Fusi
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6A/ 19-22Lectures by Prof. Fusi
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Elasticity‐revenue relationship
Total revenues are the product of price times units sold.
The law of demand states along a given curve price is The law of demand states along a given curve, price is inverse to quantity.
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What happens to the product of price times quantity depends on which of the opposing forces exerts a greater force on total revenues
This is what price elasticity of demand is designed to measure: responsiveness of quantity demanded to a change in pricep
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6A/ 19-26Lectures by Prof. Fusi
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Existence of substitutes The closer the substitutes and the more substitutes there are, the more elastic is demand
Share of the budget The greater the share of the consumer’s total budget spent on a good, the greater is the price elasticity
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The length of time allowed for adjustmentg j
The longer any price change persists, the greater is the elasticity of demand
Price elasticity is greater in the long run than in the short run
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With more time for adjustment the demand curve becomes more elastic and quantity
In the short run, quantity
elastic and quantity demanded falls by a greater amount
demanded falls slightly
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Even if the market demand is inelastic, you have competitors.
If you increase the price of your product, but your competitors do not raise the prices of their products your competitors do not raise the prices of their products, your competitors will pick off your customers.
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How to define the short run and the long rung
The short run is a time period too short for consumers to fully adjust to a price change
The long run is a time period long enough for consumers to fully adjust to a change in price, other things constant
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Economists have found that estimated elasticities of demand are greater in the long run than in the short run.
Remember that even though we are leaving off the negative sign, there is an inverse relationship between price and quantity demanded.
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Cross Price Elasticity of Demand (Exy)y
The percentage change in the demand for one good (holding its price constant) divided by the percentage change in the price of a related good
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Formula for computing cross price elasticity of gdemand between good X and good Y
% change in amount of good X demandedExy =
% change in price of good Yxy
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Substitutes Exy would be positive
An increase in the price of X would increase the quantity of Yd d d t h idemanded at each price.
Complements Exy would be negative
An increase in the price of X would decrease the quantity of Ydemanded at each price.demanded at each price.
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Income Elasticity of Demand (Ei)i The percentage change in demand for any good, holding its price constant, divided by the percentage change in income
The responsiveness of demand to changes in income, holding the good’s relative price constant
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Percentage change in demandEi =
Percentage change in incomeEi
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Calculating the income elasticity of demand
Ei = Change in quantity ÷ Change in incomeAverage quantity Average incomeAverage quantity Average income
The income elasticity of demand can be either negative or positiveor positive.
Remember that in calculating the income elasticity of demand, the price of the good is assumed to y , p gbe constant.
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6A/ 19-40Lectures by Prof. Fusi
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From Table 6A‐3, income elasticity of demand for Blu‐ray discs:
[( ) ]Ei = 2/[(6+8)/2] = 2/7$2000/[($4000+$60000)/2] 2/5
= 0.71
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During a few weeks in the depths of the Great Recession of the late 2000s, U.S. household income declined by 1 percent, while the amount of dental services that people purchased nationwide fell by 5.8 percent. purchased nationwide fell by 5.8 percent.
Thus, the income elasticity of demand for U.S. dental services was equal to 5.8 (‐5.8%/‐1%).
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Price Elasticity of Supply (Es)s The responsiveness of the quantity supplied of a commodity to a change in its price
The percentage change in quantity supplied divided by the percentage change in price
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Formula for computing price elasticity of supplyg
Percentage change in quantity suppliedE
g g q y ppPercentage change in price
ES =
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Classifying supply elasticitiesg
Perfectly Elastic Supply Quantity supplied falls to zero when there is the slightest Q y pp gdecrease in price
The supply curve is horizontal at a given price
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Classifying supply elasticitiesg
Perfectly Inelastic Supply Quantity supplied is constant no matter what happens to Q y pp ppprice
The supply curve is vertical at a given price
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Price elasticity of supply and length of time for gadjustment
1. The longer the time allowed for adjustment, the more g jresources can flow into (out of) an industry through expansion (contraction) of existing firms.
2. The longer the time allowed for adjustment, the entry (exit) of firms increases (decreases) production in an industry.industry.
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A study of prices and quantities of salmon supplied by N i l f i fi h h Norwegian salmon‐farming firms shows that a 1 percent rise in the price of salmon induces a percentage increase in quantity supplied that is 28 times greater in the long run h h i h h than that in the short run.
In the long run, these firms have sufficient time to respond to a price increase by changing varieties and amounts of p y g gfeed and capital equipment.
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6A/ 19-50Lectures by Prof. Fusi
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As time passes the supply curve rotates from S1 to S2 and quantity supplied rises to Q1
6A/ 19-51Lectures by Prof. Fusi
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As time passes the supply curve rotates from S1 to S2 and quantity supplied rises to Q1
6A/ 19-52Lectures by Prof. Fusi
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As time passes the supply curve rotates from S1 to S2 and quantity supplied rises to Q1
As more time passes theAs more time passes the supply curve rotates from S2to S3 and quantity supplied rises from Q1 to Q2
6A/ 19-53Lectures by Prof. Fusi
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As time passes the supply curve rotates from S1 to S2 and quantity supplied rises to Q1
As more time passes theAs more time passes the supply curve rotates from S2to S3 and quantity supplied rises from Q1 to Q2
6A/ 19-54Lectures by Prof. Fusi
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While most industry observers anticipated that a basic iP d ld b i d A l i i i i l i iPad would be priced at $1,000, Apple set its initial price at only $499 in 2010.
Apple learned a lesson from its experience with the iPhone pp pin mid‐2007: the estimated price elasticity of demand for smart cellphones like the iPhone was about 1.4.
The company set this lower price in anticipation that the The company set this lower price in anticipation that the demand for the new gadget would also be elastic, so a lower price would ultimately yield higher revenues.
6A/ 19-55Lectures by Prof. Fusi
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Researchers Austan Goolsbee and Amil Petrin estimated that the price elasticity of demand was elastic for cable TV and satellite TV.
They also found that their cross price elasticities were They also found that their cross price elasticities were positive, so they are substitutes.
The cross price elasticities also suggest that consumers of satellite TV perceive cable TV to be less substitutable for satellite TV services than do cable TV consumers.
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Expressing and calculating the price elasticity of g gdemand
Percentage change in quantity demanded divided by the g g q y ypercentage change in price
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The relationship between the price elasticity of demand and total revenues When demand is elastic, price and total revenue are
l l dinversely related
When demand is inelastic, price and total revenue are positively relatedpositively related
When demand is unit‐elastic, total revenue does not change when price changeschange when price changes
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Factors that determine price elasticity of demand
Availability of substitutes
Percentage of a person’s budget spent on the good Percentage of a persons budget spent on the good
The length of time allowed for adjustment to a price changechange
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The cross price elasticity of demand and using it to determine whether two goods are substitutes or complements
h h d d f d d d d Percentage change in the demand for one good divided by the percentage change in the price of a related good
If cross elasticity is positive the goods are substitutes If cross elasticity is positive, the goods are substitutes.
If cross elasticity is negative, the goods are complements.complements.
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Income elasticity of demand
Responsiveness of the demand for the good to a change in income
Percentage change in the demand for a good divided by the percentage change in income.
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Classifying supply elasticities and how the length of time for dj ff i l i i f ladjustment affects price elasticity of supply
Elastic supply: price elasticity of supply is greater than 1
I l i l i l i i f l i l h Inelastic supply: price elasticity of supply is less than 1
Unit‐elastic supply: price elasticity of supply is equal to 1
Th l th ti i d f dj t t th l ti i The longer the time period for adjustment, the more elastic is supply.
6A/ 19-62Lectures by Prof. Fusi