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Transcript of Lecture 4 - Concept of Market Equilibrium, Elasticity and Its Application
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Managerial Economics
PGDM : 2013 15Term 1 (June September, 2013)
(Lecture 4)
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P
Q
Market Equilibrium
D SEquilibrium:
P has reached the level
where quantity supplied
equals quantity
demanded
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D S
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P
Q
Equilibrium Price: The price that equates quantity
supplied with quantity demanded (Max WTP = Min WTA)
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 205 9 25
6 6 30
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D S
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P
Q
Equilibrium quantity: The quantity supplied and quantity
demanded at the equilibrium price
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 205 9 25
6 6 30
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P
Q
D S
Surplus (excess supply):When quantity supplied is
greater than quantity demanded
SurplusExample:
IfP = $5,
thenQD = 9 lattes
and
QS = 25 lattes
resulting in asurplus of 16 lattes
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P
Q
D S Facing a surplus,
sellers try to increase sales
by cutting price.
This causes
QD to rise
Surplus
which reduces the
surplus.
andQS to fall
6
Surplus (excess supply):When quantity supplied is
greater than quantity demanded
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0 5 10 15 20 25 30 35
P
Q
D S Facing a surplus,
sellers try to increase sales
by cutting price.
This causes
QD to rise andQS to fall.
Surplus
Prices continue to fall until
market reachesequilibrium.
7
Surplus (excess supply):When quantity supplied is
greater than quantity demanded
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0 5 10 15 20 25 30 35
P
Q
D S
Shortage (excess demand): when quantity demanded is
greater than quantity supplied
Example:
IfP = $1,
thenQD = 21 lattes
and
QS = 5 lattes
resulting in ashortage of 16 lattes
Shortage
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0 5 10 15 20 25 30 35
P
Q
D S Facing a shortage,
sellers raise the price,
causing QD
to fall
which reduces the
shortage.
andQS to rise,
Shortage
9
Shortage (excess demand): when quantity demanded is
greater than quantity supplied
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0 5 10 15 20 25 30 35
P
Q
D S Facing a shortage,
sellers raise the price,
causing QD
to fallandQS to rise.
Shortage
Prices continue to rise
until market reaches
equilibrium.
10
Shortage (excess demand): when quantity demanded is
greater than quantity supplied
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EXAMPLES
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Demand Curve
A. The price of iPods falls
B. The price of music
downloads falls
C. The price of CDs falls
12
Draw a demand curve for music downloads. What
happens to it in each of the following scenarios?
Why?
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A. Price of iPods falls
13
Q2
Price of
music
down-
loads
Quantity of
music downloads
D1 D2
P1
Q1
Music downloads
and iPods are
complements.
A fall in price of
iPods shifts the
demand curve for
music downloads
to the right.
Music downloads
and iPods are
complements.
A fall in price of
iPods shifts the
demand curve for
music downloads
to the right.
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B. Price of music downloads falls
14
TheD curve
does not shift.
Move down along curveto a point with lowerP,
higherQ.
TheD curve
does not shift.
Move down along curveto a point with lowerP,
higherQ.
Price of
music
down-
loads
Quantity of
music downloads
D1
P1
Q1 Q2
P2
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C. Price of CDs falls
15
P1
Q1
CDs and
music downloads are
substitutes.
A fall in price of CDsshifts demand for
music downloads
to the left.
CDs and
music downloads are
substitutes.
A fall in price of CDsshifts demand for
music downloads
to the left.
Price of
music
down-
loads
Quantity of
music downloads
D1D2
Q2
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Supply Curve
16
Draw a supply curve for tax
return preparation software.
What happens to it in each
of the following scenarios?A. Retailers cut the price of
the software.
B. A technological advance
allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the price of the
services they provide.
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A. Fall in price of tax return software
17
Scurve does
not shift.
Move downalong the curve
to a lowerP
and lowerQ.
Scurve does
not shift.
Move downalong the curve
to a lowerP
and lowerQ.
Price of
tax return
software
Quantity of tax
return software
S1
P1
Q1Q2
P2
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B. Fall in cost of producing the software
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Scurve shifts
to the right:
at each price,Q increases.
Scurve shifts
to the right:
at each price,Q increases.
Price of
tax return
software
Quantity of tax
return software
S1
P1
Q1
S2
Q2
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C. Professional preparers raise their price
19
This shifts the
demand curve for
tax preparationsoftware, not the
supply curve.
This shifts the
demand curve for
tax preparationsoftware, not the
supply curve.
Price of
tax return
software
Quantity of tax
return software
S1
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Three Steps to Analyze Changes in Equilibrium
To determine the effects of any event,
1. Decide whether event shiftsScurve,
D curve, or both.2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see
how the shift changes eqmPandQ.
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Example 1: The Market for Diesel Cars
P
Q
D1
S1
P1
Q1
price of
hybrid cars
quantity of
hybrid cars
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STEP 1:
D curve shifts
because price of gas
affects demand for
hybrids.
Scurve does not shift,
because price of gasdoes not affect cost of
producing hybrids.
STEP 2:
D shifts right
because high gas price
makes hybrids more
attractive relative to
other cars.
Example 1:A Shift in Demand
Event to be analyzed:
Increase in price of Petrol.
P
Q
D1
S1
P1
Q1
D2
P2
Q2
STEP 3:
The shift causes an increasein price and quantity of
hybrid cars.
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P
Q
D1
S1
P1
Q1
D2
P2
Q2
Notice:
WhenPrises,
producers supply
a larger quantity
of hybrids, eventhough theScurve
has not shifted.
Always be carefulAlways be careful
to distinguish b/wto distinguish b/wa shift in a curvea shift in a curve
and a movementand a movement
along the curve.along the curve.
Example 1:A Shift in Demand
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STEP 1:
Scurve shifts
because event affects
cost of production.
D curve does not shift,
because production
technology is not one ofthe factors that affect
demand.
STEP 2:
Sshifts right
because event reduces
cost,
makes production more
profitable at any given
price.
Example 2:A Shift in Supply
P
Q
D1
S1
P1
Q1
S2
P2
Q2
Event: New technology
reduces cost of producing
diesel cars.
STEP 3:
The shift causes priceto fall and quantity to
rise.
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Example3: A Shift in Both Supply and Demand
P
Q
D1
S1
P1
Q1
S2
D2
P2
Q2
Events:
price of fuel rises AND
new technology reduces
production costs
STEP 1:
Both curves shift.
STEP 2:
Both shift to the right.
STEP 3:
Q rises, but effectonPis ambiguous:
If demand increases more than
supply,Prises.
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STEP 3, cont.
P
Q
D1
S1
P1
Q1
S2
D2
P2
Q2
EVENTS:
price of fuel rises AND
new technology reduces
production costs
But if supply
increases more
than demand,
P falls.
Example3: A Shift in Both Supply and Demand
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Shifts in Supply and Demand
Use the three-step method to analyze the effects of each event on the
equilibrium price and quantity of music downloads.
Event A: A fall in the price of CDs
Event B: Sellers of music downloads negotiate a reduction in
the royalties they must pay for each song they sell.
Event C: Events A and B both occur.
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A. Fall in price of CDs
2. D shifts left
P
Q
D1
S1
P1
Q1
D2
The market for
music downloads
P2
Q2
1. D curve shifts
3. PandQboth fall.
STEPS
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B. Fall in cost of royalties
P
Q
D1
S1
P1
Q1
S2
The market for
music downloads
Q2
P2
1. Scurve shifts
2. Sshifts right
3. Pfalls,
Q rises.
STEPS
(Royalties are part ofsellers costs)
a1
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Slide 29
a1 The royalties that sellers must pay the artists are part of sellers costs of production. Typically, this royalty is a fixed amount each
time one of the artists songs is downloaded. Event B, therefore, describes a reduction in sellerscosts of production.
Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. This event causes a fall in
costs of production for sellers of music downloads. Hence, the S curve shifts to the right.
arnab, 7/7/2013
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C. Fall in price of CDs and fall in cost of
royalties
Results
Punambiguously falls.Effect on Q is ambiguous:
The fall in demand reduces Q;
The increase in supply increases Q.
a2
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Slide 30
a2 Verify the result by a graphical analysis as discussed in the class.arnab, 7/7/2013
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A Problem
In Rolling Stone magazine, several fans and rock stars, including Pearl Jam, werebemoaning the high price of concert tickets. One superstar argued, It just isnt worth $75to see me play. No one should have to pay that much to go to a concert. Assume this starsold out arenas around the country at an average ticket price of $75.
a) How would you evaluate the arguments that ticket prices are too high?
b) Suppose that due to this stars protests, ticket prices were lowered to $50. In whatsense is this price too low? Draw a diagram using supply and demand curves to
support your argument.
c) Suppose Pearl Jam really wanted to bring down ticket prices. Since the bandcontrols the supply of its services, what do you recommend they do? Explainusing a supply and demand diagram.
d) Suppose the band s next CD was a total flop. Do you think they would still have toworry about ticket prices being too high? Why or why not? Draw a supply anddemand diagram to support your argument.
e) Suppose the group announced their next tour was going to be their last. Whateffect would this likely have on the demand for and price of tickets? Illustratewith a supply and demand diagram.
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A Funny Exercise
Explain the story told by this image with the help of DemandSupply Tools..
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Market Equilibrium: Algebraic Approach
Quantity Demanded is function of price
.(1)
An inverse demand function or price function is
.(1.1)
Quantity Supplied is function of
....(2)
An inverse supply function is
..(2.1)
33
dPdQ
( ) ddd bPaPfQ -==\
sQ sP
( )
bband
baawhere
QbaQfP ddd
1,
1
==
-==\ -
( )
ddand
d
ccwhere
QdcQfP sss
1,
1
=-=
+==\ -
( ) sss dPcPfQ +==\
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Market Equilibrium: Algebraic Approach
When the market is in equilibrium, , where, is the
Equilibrium Price
where, is the Equilibrium Quantity
Since, Price cannot be negative
Alternatively, you can obtain the equilibrium price and quantity just byequating equations (1) and (2)
34
esd PPP ==
+
--=
+
-=
+=-\
db
cabaPand
db
caQ
QdcQba
e
e
ee
,
e
eQ
caf
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Example
Demand is given by QD = 620 - 10P and supply is given by QS =
100 + 3P. What is the price and quantity when the market is in
equilibrium?
Answer:In equilibrium,
QD = QS,
620 - 10P = 100 + 3P
So, the equilibrium Price is 40And the equilibrium quantity is 220.
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A note on Equilibrium Price
The objective of Demand supply analysis is to find a price at which the
market is clear. We know it is the equilibrium price.
Other than Market clearing explanation of equilibrium price what else
can you say about this price?
In the simplest manner, equilibrium price can be defined as the market
value of a product or service and at this value the willingness to accept
(WTA) of the sellers matches with willingness to pay (WTP) of the
buyers.
Now the question is why does equilibrium price differ across different
markets?
It was thought by the economists, that intrinsic use value of a commodityis the reason for this difference .
However, the concepts of production cost and scarcity value better
explain this difference. It should be noted that scarcity is also responsible
for increasing the production cost. The following examples help you to
understand this concept: 36
a3
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Slide 36
a3 Comments and Arguments are very much welcome...arnab, 7/11/2013
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A note on Equilibrium Price (contd.)
37
Diamond and Water Paradox
Real Diamond and Cubic Zicronium Diamond
(artificial)
Hand Written Bible and Printed Bible
Whale Oil Lubricant and Lubricant made from
Jojoba Beans
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Suggested Readings
Shuttlecock Production in Uluberia, West Bengal
(http://articles.economictimes.indiatimes.com/2012-12-
28/news/36036532_1_shuttlecocks-duck-feathers-badminton-
players)
Discovery of Jojoba Beans caused a collapse of Whale Oil
Lubricant Price ( MMH, Chapter 2, Page 29)
Depreciation of Rupee and Impact on Product Market (Thearticle sent through e-mail)
Atkins Diet and Demand for Egg (The article sent through e-mail)
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Elasticity
Basic idea:
Elasticity measures how much one variable responds to
changes in another variable.
One type of elasticity measures how much demand for yourwebsites will fall if you raise your price.
Definition:
Elasticity is a numerical measure of the responsiveness of Qd
or Qs to one of its determinants.
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Price elasticity of demand measures how
much Qdresponds to a change inP.
Price elasticity
of demand=
Percentage change in Qd
Percentage change inP
Loosely speaking, it measures the price-sensitivity of
buyers demand.
40
Price Elasticity of Demand
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Price elasticity
of demand
equals
P
Q
D
Q2
P2
P1
Q1
P risesby 10%
Q falls
by 15%
15%10%
= 1.5
Price elasticity
of demand=
Percentage change in Qd
Percentage change inP
Example:
41
Price Elasticity of Demand
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Price Elasticity of Demand
Along aD curve,PandQ move
in opposite directions, whichwould make price elasticity
negative.
We will drop the minus sign
and report all price elasticitiesas
positive numbers.
Along aD curve,PandQ move
in opposite directions, whichwould make price elasticity
negative.
We will drop the minus sign
and report all price elasticitiesas
positive numbers.
P
Q
D
Q2
P2
P1
Q1
Price elasticityof demand
= Percentage change in Qd
Percentage change inP
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Calculating Percentage Changes
P
Q
D
$250
8
B
$200
12
A
Demand for
your websites
Standard methodof computing the
percentage (%) change:
end value start value
start value x 100%
Going from A to B,
the % change inPequals
($250$200)/$200 = 25%
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P
QD
$250
8
B
$200
12
A
Demand for
your websites
Problem:The standard method gives
different answers depending on
where you start.
From A to B,Prises 25%, Q falls 33%,
elasticity = 33/25 = 1.33
From B to A,
Pfalls 20%, Q rises 50%,
elasticity = 50/20 = 2.50
44
Calculating Percentage Changes
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So, we instead use the midpoint method:
end value start value
midpointx 100%
The midpoint is the number halfway between thestart & end values, the average of those values.
It doesnt matter which value you use as the start
and which as the endyou get the same answer
either way!
45
Calculating Percentage Changes
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Using the midpoint method, the % change
inPequals
$250 $200
$225x 100% = 22.2%
The % change in Q equals
12 8
10x 100% = 40.0%
The price elasticity of demand equals
40/22.2 = 1.8
46
Calculating Percentage Changes
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What determines price elasticity?
To learn the determinants of price elasticity, we look at a series ofexamples.
Each compares two common goods.
In each example: Suppose the prices of both goods rise by 20%.
The good for which Qd falls the most (in percent) has the
highest price elasticity of demand.
Which good is it? Why? What lesson does the example teach us about the determinants
of the price elasticity of demand?
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The Determinants of Price Elasticity
The price elasticity of demand depends on:
the extent to which close substitutes are available
whether the good is a necessity or a luxury how broadly or narrowly the good is defined
the time horizon elasticity is higher in the long
run than the short run
The price elasticity of demand depends on:
the extent to which close substitutes are available
whether the good is a necessity or a luxury how broadly or narrowly the good is defined
the time horizon elasticity is higher in the long
run than the short run
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EXAMPLE 1: Insulin vs. Caribbean Cruises
The prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why?
To millions of diabetics, insulin is a necessity.
A rise in its price would cause little or no decreasein demand.
A cruise is a luxury. If the price rises,
some people will forego it.
Lesson: Price elasticity is higher for luxuries than fornecessities.
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EXAMPLE 2: Breakfast cereal vs. Sunscreen
The prices of both of these goods rise by 20%. For which
good does Qd drop the most? Why?
Breakfast cereal has close substitutes (e.g., pancakes, Eggo
waffles, leftover pizza), so buyers can easily switch if the
price rises.
Sunscreen has no close substitutes, so consumers would
probably not buy much less if its price rises.
Lesson: Price elasticity is higher when close substitutes are
available.
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EXAMPLE 3: Blue Jeans vs. Clothing
The prices of both goods rise by 20%. For which good does Qd
drop the most? Why?
For a narrowly defined good such as blue jeans, there are
many substitutes (black jeans, khakis, Grey Jeans).
There are fewer substitutes available for broadly defined
goods. Actually, there is no substitutes for clothing.
Lesson: Price elasticity is higher for narrowly defined goods
than broadly defined ones.
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EXAMPLE 4: Car Fuel in the Short Run vs. Car Fuel
in the Long Run
The price of petrol rises 20%. Does Qd drop more in the short
run or the long run? Why?
Theres not much people can do in the short run, other than
ride the bus or carpool.
In the long run, people can buy smaller cars or live closer to
where they work.
Lesson: Price elasticity is higher in the long run than the
short run.
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53
The Variety of Demand Curves
The price elasticity of demand is closely related to the
slope of the demand curve.
Rule of thumb:
The flatter the curve, the bigger the elasticity.The steeper the curve, the smaller the elasticity.
Five different classifications ofD curves.
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54
Q1
P1
D
Perfectly inelastic demand (one extreme case)
P
Q
P2
P fallsby 10%
Q changes
by 0%
0%
10% = 0Price elasticity
of demand =
% change in Q
% change inP =
Consumers
price sensitivity:
D curve:
Elasticity:
vertical
none
0
a4
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Slide 54
a4 If Q doesnt change, then the percentage change in Q equals zero, and thus elasticity equals zero.
It is hard to think of a good for which the price elasticity of demand is literally zero. Take insulin, for example. A sufficiently largeprice increase would probably reduce demand for insulin a little, particularly among people with very low incomes and no health
insurance.
However, if elasticity is very close to zero, then the demand curve is almost vertical. In such cases, the convenience of modeling
demand as perfectly inelastic probably outweighs the cost of being slightly inaccurate.arnab, 7/12/2013
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55
Inelastic demand
P
QQ1
P1
Q2
P2
Q rises less
than 10%
< 10%
10% < 1Price elasticity
of demand =
% change in Q
% change inP =
P fallsby 10%
Consumers
price sensitivity:
D curve:
Elasticity:
relatively steep
relatively low
< 1
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Slide 55
a5 An example: Student demand for textbooks that their professors have required for their courses.
Here, its a little more clear that elasticity would be small, but not zero. At a high enough price, some students will not buy theirbooks, but instead will share with a friend, or try to find them in the library, or just take copious notes in class.
Another example: Gasoline in the short run.arnab, 7/12/2013
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56
Unit elastic demand
P
QQ1
P1
Q2
P2
Q rises by 10%
10%
10% = 1
Price elasticity
of demand =
% change in Q
% change inP =
P fallsby 10%
Consumers
price sensitivity:
Elasticity:
intermediate
1
D curve:
intermediate slope
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57
Elastic demand
P
QQ1
P1
Q2
P2
Q rises more
than 10%
> 10%
10% > 1
Price elasticity
of demand =
% change in Q
% change inP =
P fallsby 10%
Consumers
price sensitivity:
D curve:
Elasticity:
relatively flat
relatively high
> 1
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Slide 57
a6 A good example here would be breakfast cereal, or nearly anything with readily available substitutes.
An elastic demand curve is flatter than a unit elastic demand curve (which itself is flatter than an inelastic demand curve).arnab, 7/12/2013
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58
D
Perfectly elastic demand (the other extreme)
P
Q
P1
Q1Pchanges
by 0%
Q changes
by any %
Very Large
Very Low(almost 0%)= infinity
Q2
P2 =Consumers
price sensitivity:
D curve:
Elasticity:
infinity
horizontal
extreme
Price elasticity
of demand =
% change in Q
% change inP =
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Slide 58
a7 Heres a good real-world example of a perfectly elastic demand curve, which foreshadows an upcoming chapter on firms in competitive
markets. Suppose you run a small family farm in Jodhpur. Your main crop is Bazra. The demand curve in this market is
downward-sloping, and the market demand and supply curves determine the price of Bazra. Suppose that price is Rs. 50/Kg.
Now consider the demand curve facing you, the individual Bazra farmer. If you charge a price of Rs.50, you can sell as much or as
little as you want. If you charge a price even just a little higher than Rs. 50, demand for YOUR Bazra will fall to zero: Buyers wouldnot be willing to pay you more than Rs.50 when they could get the same Bazra elsewhere for Rs. 50. Similarly, if you drop your price
below Rs. 50, then demand for YOUR Bazra will become enormous (not literally infinite, but almost infinite): if other Bazra farmers
are charging Rs.50 and you charge less, then EVERY buyer will want to buy Bazra from you.
Why is the demand curve facing an individual producer perfectly elastic? Recall that elasticity is greater when lots of close substitutes
are available. In this case, you are selling a product that has many perfect substitutes: the wheat sold by every other farmer is a
perfect substitute for the wheat you sell.arnab, 7/12/2013
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Problem
59
Use the following
information to
calculate the
price elasticityof demand
for hotel rooms:
ifP= $70, Qd = 5000
ifP= $90, Qd = 3000
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Answers
60
Use midpoint method to calculate
% change in Qd
(5000 3000)/4000 = 50%
% change inP
($90 $70)/$80 = 25%
The price elasticity of demand equals50%
25%= 2.0
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You design websites for local businesses.
You charge $200 per website, and currently sell 12 websites per
month.
Your costs are rising (including the opportunity cost of your
time), so you consider raising the price to $250.
The law of demand says that you wont sell as many websites if
you raise your price.
How many fewer websites? How much will your revenue fall,
or might it increase?
You design websites for local businesses.
You charge $200 per website, and currently sell 12 websites per
month.
Your costs are rising (including the opportunity cost of your
time), so you consider raising the price to $250.
The law of demand says that you wont sell as many websites if
you raise your price.
How many fewer websites? How much will your revenue fall,
or might it increase?
A scenario
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62
Price Elasticity and Total Revenue
Continuing our scenario, if you raise your price
from $200 to $250, would your revenue rise or fall?
Revenue =Px Q
A price increase has two effects on revenue:
HigherPmeans more revenue on each unit
you sell.
But you sell fewer units (lowerQ),
due to Law of Demand.
Which of these two effects is bigger?
It depends on the price elasticity of demand.
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Slide 62
a8 It should be clear that making the best possible decision would require information about the likely effects of the price increase on
revenue. That is why elasticity is so helpful, as we will now see.arnab, 7/12/2013
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63
If demand is elastic, then
price elast. of demand > 1
% change in Q > % change inP
The fall in revenue from lowerQ is greaterthan the increase in revenue from higherP,so revenue falls.
Revenue =Px Q
Price elasticity
of demand=
Percentage change in Q
Percentage change inP
Price Elasticity and Total Revenue
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64
Price Elasticity and Total Revenue
Elastic demand
(elasticity = 1.8) P
Q
D
$200
12
IfP= $200,
Q = 12 and revenue
= $2400.
WhenD is elastic,
a price increase
causes revenue to fall.
$250
8
IfP= $250,
Q = 8 and
revenue = $2000.
lost
revenue
due to
lowerQ
increased revenue
due to higherP
Demand foryour websites
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65
Price Elasticity and Total Revenue
If demand is inelastic, then
price elast. of demand < 1% change in Q < % change inP
The fall in revenue from lowerQ is smaller
than the increase in revenue from higherP,
so revenue rises.
In our example, suppose that Q only falls to 10 (instead
of 8) when you raise your price to $250.
Revenue =Px Q
Price elasticityof demand =Percentage change in Q
Percentage change inP
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66
Price Elasticity and Total Revenue
Now, demand is
inelastic:elasticity = 0.82 P
Q
D
$200
12
IfP= $200,
Q = 12 and revenue
= $2400. $250
10
IfP= $250,
Q = 10 and
revenue = $2500.
WhenD is inelastic,
a price increase
causes revenue to rise.
lost
reven
ue
due
to
lowerQ
Demand for your websites
increased revenue due tohigherP
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A. Pharmacies raise the price of insulin by 10%. Does total
expenditure on insulin rise or fall?
B. As a result of a fare war, the price of a luxury cruise falls
20%. Does luxury cruise companies total revenue rise or
fall?
Problem
67
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Answers
68
A. Pharmacies raise the price of insulin by 10%. Does
total expenditure on insulin rise or fall?
Expenditure =Px Q
Since demand is inelastic, Q will fall less
than 10%, so expenditure rises.
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Answers
69
B. As a result of a fare war, the price of a luxury cruise
falls 20%.
Does luxury cruise companies total revenue
rise or fall?
Revenue =Px Q
The fall inPreduces revenue,
but Q increases, which increases revenue. Which
effect is bigger?
Since demand is elastic, Q will increase more than
20%, so revenue rises.
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Other Types of Elasticity of Demand
Income elasticity of demand: measures the response ofQd toa change in consumer income
Income elasticity of
demand=
Percent change in Qd
Percent change in income
Recall : An increase in income causes an increase in demand
for a normalgood.
Hence, for normal goods, income elasticity > 0. Forinferiorgoods, income elasticity < 0.
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Cross-price elasticity of demand:measures the response of demand for one good to changes in
the price of another good
Cross-price elast.
of demand
=% change in Qd for good 1
% change in price of good 2
For substitutes, cross-price elasticity > 0
(e.g., an increase in price of mutton causes an increase in
demand for chicken)
For complements, cross-price elasticity < 0
(e.g., an increase in price of computers causes decrease in
demand for software)
71
Other Types of Elasticity of Demand