Micro Economics Elasticity

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Microeconomics Session 1-2

Transcript of Micro Economics Elasticity

Page 1: Micro Economics Elasticity

Microeconomics

Session 1-2

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The demand curve

P

Q

680

5000

Q=q(P)

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The inverse demand curve

Q

P

5000

680

P=p(Q)

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The Demand Curve

The demand curve, labeled D,shows how the quantity of a good demanded by consumers depends on its price. The demand curve is downward sloping; holding other things equal, consumers will want to purchase more of a good as its price goes down. The quantity demanded may also depend on other variables, such as income, the weather, and the prices of other goods. For most products, the quantity demanded increases when income rises. A higher income level shifts the demand curve to the right (from Dto D’).

SUPPLY AND DEMAND

Figure 2.2

The Demand Curve

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IEA sees surge in oil demand from India, emerging nationsPTI May 12, 2016

Surge in oil demand in India and other emerging nations will lead to reduction in global oil surplus in the first half of 2016, the International Energy Agency (IEA) said today.

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Monsoon to wash away diesel demand surgeReuters Jun 16, 2016

The monsoon is expected to dump above-average rainfall on the South Asian nation after two years of drought, cutting its use of diesel for irrigation pumps and generators over the third quarter and potentially rejuvenating exports of the oil product.

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Class Participation Games 1

• Show that the term Supply can be used in two different senses implying either quantity supplied or supply curve using some newspaper articles.

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Shifts in Demand

• Substitutes - Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other.

• Complements - Two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the other.

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SUPPLY AND DEMANDThe Supply Curve

● supply curve Relationship between the quantity of a good that producers are willing to sell and the price of the good.

The Supply Curve

The supply curve, labeled S in the figure, shows how the quantity of a good offered for sale changes as the price of the good changes. The supply curve is upward sloping: The higher the price, the more firms are able and willing to produce and sell.

If production costs fall, firms can produce the same quantity at a lower price or a larger quantity at the same price. The supply curve then shifts to the right (from S to S’).

Figure 2.1

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THE MARKET MECHANISM

Supply and Demand

The market clears at price P0and quantity Q0.

At the higher price P1, a surplus develops, so price falls.

At the lower price P2, there is a shortage, so price is bid up.

Figure 2.3

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• How Parsees are coping up with the problem of extinction?

• Why everybody in China are purchasing increasingly

bigger house over time?

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CHANGES IN MARKET EQUILIBRIUM

New Equilibrium Following Shifts in Supply and Demand

Supply and demand curves shift over time as market conditions change. In this example, rightward shifts of the supply and demand curves lead to a slightly higher price and a much larger quantity. In general, changes in price and quantity depend on the amount by which each curve shifts and the shape of each curve.

Figure 2.6

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A change in quantity

Q

P

5000

680

P=p(Q)

700

4990

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ELASTICITIES

● elasticity Percentage change in one variable resulting from a 1-percent increase in another.

● price elasticity of demand Percentage change in quantity demanded of a good resulting from a 1-percent increase in its price.

Price Elasticity of Demand

(2.1)

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ELASTICITIES

● linear demand curve Demand curve that is a straight line.Linear Demand Curve

Linear Demand Curve

Figure 2.11

The price elasticity of demand depends not only on the slope of the demand curve but also on the price and quantity.

The elasticity, therefore, varies along the curve as price and quantity change. Slope is constant for this linear demand curve.

Near the top, because price is high and quantity is small, the elasticity is large in magnitude.

The elasticity becomes smaller as we move down the curve.

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ELASTICITIES

● infinitely elastic demand Principle that consumers will buy as much of a good as they can get at a single price, but for any higher price the quantity demanded drops to zero, while for any lower price the quantity demanded increases without limit.

Linear Demand Curve

(a) Infinitely Elastic Demand

Figure 2.12

(a) For a horizontal demand curve, ΔQ/ΔP is infinite. Because a tiny change in price leads to an enormous change in demand, the elasticity of demand is infinite.

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ELASTICITIES

● completely inelastic demand Principle that consumers will buy a fixed quantity of a good regardless of its price.

Linear Demand Curve

(b) Completely Inelastic Demand

Figure 2.12

(b) For a vertical demand curve, ΔQ/ΔP is zero. Because the quantity demanded is the same no matter what the price, the elasticity of demand is zero.

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A change in quantity (algebra) Total Revenue ≡ TR(Q) = p(Q) · Q Marginal Revenue ≡ MR(Q) = TR’(Q) TR’(Q) = p(Q) + p’(Q) · Q

= p(Q) [ 1 + p’(Q) · Q / p(Q)]= p(Q) [ 1 + 1/e]

where

e = p / (p’(Q) · Q)

AVIJEET
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Price elasticity of demand e = p · Q’(p) / Q(p) TR’(Q) = MR(Q) = p(Q) [ 1 + 1/e]

Abs(e) > 1 ; demand is elastic; TR’(Q) > 0 Abs(e) < 1 ; demand is inelastic; TR’(Q) < 0

AVIJEET
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ELASTICITIES

● income elasticity of demand Percentage change in the quantity demanded resulting from a 1-percent increase in income.

Other Demand Elasticities

● cross-price elasticity of demand Percentage change in the quantity demanded of one good resulting from a 1-percent increase in the price of another.

● price elasticity of supply Percentage change in quantity supplied resulting from a 1-percent increase in price.

Elasticities of Supply

(2.2)

(2.3)

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DemandSHORT-RUN VERSUS LONG-RUN ELASTICITIES

(a) Gasoline: Short-Run and Long-Run Demand Curves

Figure 2.13

(a) In the short run, an increase in price has only a small effect on the quantity of gasoline demanded. Motorists may drive less, but they will not change the kinds of cars they are driving overnight.

In the longer run, however, because they will shift to smaller and more fuel-efficient cars, the effect of the price increase will be larger. Demand, therefore, is more elastic in the long run than in the short run.

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DemandSHORT-RUN VERSUS LONG-RUN ELASTICITIES

(b) Automobiles: Short-Run and Long-Run Demand Curves

Figure 2.13

(b) The opposite is true for automobile demand. If price increases, consumers initially defer buying new cars; thus annual quantity demanded falls sharply.

In the longer run, however, old cars wear out and must be replaced; thus annual quantity demanded picks up. Demand, therefore, is less elastic in the long run than in the short run.

Demand and Durability

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DemandSHORT-RUN VERSUS LONG-RUN ELASTICITIES

Income Elasticities

Income elasticities also differ from the short run to the long run.

For most goods and services—foods, beverages, fuel, entertainment, etc.— the income elasticity of demand is larger in the long run than in the short run.

For a durable good, the opposite is true. The short-run income elasticity of demand will be much larger than the long-run elasticity.

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MARKET DEMAND● market demand curve Curve relating

the quantity of a good that all consumers in a market will buy to its price.

From Individual to Market DemandTABLE 4.2 Determining the Market Demand Curve

(1) (2) (3) (4) (5)Price Individual A Individual B Individual C Market

($) (Units) (Units) (Units) (Units)

1 6 10 16 322 4 8 13 253 2 6 10 184 0 4 7 115 0 2 4 6

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MARKET DEMANDFrom Individual to Market Demand

Summing to Obtain a Market Demand Curve

The market demand curve is obtained by summing our three consumers’ demand curves DA, DB, and DC. At each price, the quantity of coffee demanded by the market is the sum of the quantities demanded by each consumer. At a price of $4, for example, the quantity demanded by the market (11 units) is the sum of the quantity demanded by A (no units), B (4 units), and C (7 units).

Figure 4.10

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CONSUMER SURPLUS

● consumer surplus Difference between what a consumer is willing to pay for a good and the amount actually paid.

Consumer Surplus and Demand

Consumer Surplus

Consumer surplus is the total benefit from the consumption of a product, less the total cost of purchasing it.

Here, the consumer surplus associated with six concert tickets (purchased at $14 per ticket) is given by the yellow-shaded area.

Figure 4.13

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CONSUMER SURPLUS

Consumer Surplus and Demand

Consumer Surplus Generalized

For the market as a whole, consumer surplus is measured by the area under the demand curve and above the line representing the purchase price of the good.

Here, the consumer surplus is given by the yellow-shaded triangle and is equal to 1/2 × ($20 − $14) × 6500 = $19,500.

Figure 14.4

Applying Consumer SurplusWhen added over many individuals, it measures the aggregate benefit that consumers obtain from buying goods in a market.

When we combine consumer surplus with the aggregate profits that producers obtain, we can evaluate both the costs and benefits not only of alternative market structures, but of public policies that alter the behavior of consumers and firms in those markets.

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Consumer and Producer Surplus

Individual consumer surplus is the difference between the maximum amount that a consumer is willing to pay for a good and the amount that the consumer actually pays. Producer surplus for a particular unit of output is the difference between the price at which it is sold and the marginal cost of producing it. Total producer surplus is the sum of producer surplus over all units sold. It equals the difference between revenue and variable costs.