Price Elasticity of Demand and Supply Key Concepts Key Concepts Summary ©2005 South-Western College...
-
Upload
theresa-lindsey -
Category
Documents
-
view
221 -
download
0
Transcript of Price Elasticity of Demand and Supply Key Concepts Key Concepts Summary ©2005 South-Western College...
2
What will this chapter teach me?
This chapter teaches you to calculate the percentage change in the quantity demanded when the price changes by a given percentage. Then you will see how this relates to total revenue.
3
How is the percent increase or decrease
of two numbers calculated?
Percent change is the difference between the two numbers divided by the original number
4
Suppose the price of a rock concert
increases by 10%, what effect will this
have on sales?That all depends on the price elasticity of demand for this rock concert
5
What is elasticity?A term economists use to describe responsiveness, or sensitivity, to a change in price
6
What is priceelasticity of demand? The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price
8
Supposing a university’s enrollment drops by 20% because tuition rises by 10%, what is the price elasticity of demand?
10
Why is elasticity 2 in the previous example
and not -2? Economists drop the negative sign because we know from the law of demand that quantity demanded and price are inversely related
13
Problem - When we move along a demand curve between two points, we get different answers to elasticity depending on whether we are moving up or down the demand curve
15
Economists can solve this problem of different base points by using the midpoints as the base points of changes in prices and quantity demanded
16
in quantity demanded
sum of quantities/2
divided by
in price
sum of prices/2
Price elasticity equals the
17
What is elastic demand?A condition in which the percentage change in quantity demanded is greater than the percentage change in price
19
Why is the demand curve in the previous
slide elastic?The percentage change in the quantity demanded is greater than the percentage change in price
21
1015
= .66% change in Q =
% change in P = 1025
= .40
Ed = % change in Q% change in P = .66
.40Ed = 1.65
23
Why is the demand curve in the previous
slide inelastic?The percentage change in the quantity demanded is less than the percentage change in price
26
What is a unitary elastic demand curve?The percentage change in the quantity demanded is equal to the percentage change in price
29
What is a perfectly elastic demand curve?
A condition in which a small percentage change in price brings about an infinite percentage change in the quantity demanded
32
What is a perfectly inelastic demand curve?
A condition in which the quantity demanded does not change as the price changes
35
If demand is elastic - total revenue goes down
If demand is inelastic - total revenue goes up
If a college raises tuition, what happens
to revenue?
36
If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1
37
If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1
38
If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1
39
$20$15$10$5
5 10 15 20
$25$30$35$40
25 30 35 40 45
Price Elasticity of Demand RangesElastic
Inelastic
Unitary elastic
40
$200$150$100
$50
5 10 15 20
$250$300$350$400
25 30 35 40 45
Total Revenue Curve
Ela
stic Inelastic
Unitary Elastic
41
What factors influence demand sensitivity?
• Availability of substitutes• Share of budget on the product
• Adjustment to a price change over time
42
What do substitutes have to do with a
price change?The more substitutes a product has, the more sensitive consumers are to a price change, and the more elastic the demand curve
44
Why is A the demand curve for medicine? Because medicine is a necessity with few substitutes, and the price can change with little effect on the quantity demanded
45
Why is B the demand curve for candy?
Because candy has many substitutes, a price change can bring about a big change in the quantity demanded
46
What does the share of one’s budget
have to do with a price change?
The larger the purchase is to one’s budget, the more sensitive consumers are to a price change, and the more elastic the demand curve
47
What does time have to do with sensitivity?The longer consumers have to adjust, the more sensitive they are to a price change, and the more elastic the demand curve
49
What is Income elasticity of demand?
The ratio of the percentage change in the quantity demanded of a good to a given percentage change in income
51
What is cross-elasticity of demand?The ratio of the percentage change in quantity demanded of a good to a given percentage change in price of another good
53
What is the price elasticity of supply?
The ratio of the percentage change in the quantity supplied of a product to the percentage change in its price
58
Who pays the tax levied on sellers of
goods such as gasoline, cigarettes,
and alcoholic beverages?
It all depends; the corporation pays all, some, or very little of the tax
59
What decides who pays what part of the tax increase?
The more elastic the demand, the more the corporation pays; the less elastic the demand, the more the consumer pays
60
$1.00$.75$.50$.25
5 10 15 20
$1.25$1.50$1.75
$2.00
25 30 35 40 45
s1
s2
D
BuyersSellers
Partially shifted tax to buyers
62
$1.00$.75$.50$.25
5 10 15 20
$1.25$1.50$1.75$2.00
25 3035 40 45
s1
s2
D
Buyers
Fully shifted tax to buyers
65
• What is elasticity?• What is price elasticity of demand?• What is elastic demand?• What is a unitary elastic demand curve?• What is a perfectly elastic demand curve?• What is a perfectly inelastic demand curve?• What factors influence demand sensitivity?• What are other elasticity measures?• What is Income elasticity of demand?• What is cross-elasticity of demand?• What is the price elasticity of supply?
67
Price elasticity of demand is a measure of the responsiveness of the quantity demanded to a change in price. Specifically, price elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in price.
70
in quantity demanded
sum of quantities/2
divided by
in price
sum of prices/2
Price elasticity equals the
71
Elastic demand is a change of more than one percent in quantity demanded in response to a one percent change in price. Demand is elastic when the elasticity coefficient is greater than one and total revenue (price time quantity) varies inversely with the direction of the price change.
73
Inelastic demand is a change of less than one percent in quantity demanded in response to a one percent change in price. Demand is inelastic when the elasticity coefficient is less than one and total revenue varies directly with the direction of the price change.
75
Unitary elastic demand is a one percent change in quantity demanded in response to a one percent change in price. Demand is unitary elastic when the elasticity coefficient equals one and total revenue remains constant as the price changes.
77
Perfectly elastic demand is a decline in quantity demanded to zero for even the slightest rise or fall in price. This is an extreme case in which the demand curve is horizontal and the elasticity coefficient equals infinity.
79
Perfectly inelastic demand is no change quantity demanded in response to price changes. This is an extreme case in which the the demand curve is vertical and the elasticity coefficient equals zero.
81
Determinants of price elasticity of demand include (a) the availability of substitutes, (b) the percentage of budget spent on the product, and (c) the length of time allowed for adjustment. Each of these factors is directly related to the elasticity coefficient.
82
Income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in income. For a normal good or service, income elasticity of demand is positive. For an inferior good or service, income elasticity of demand is negative.
83
Cross elasticity of demand is the percentage change in the quantity demanded of one product caused by a change in the price of another product. When the cross-elasticity of demand is negative, the two products are complements.
84
Price elasticity of supply is a measure of the responsiveness of the quantity demanded to a change in price. Price elasticity of supply is the ratio of the percentage change in quantity supplied to the percentage change in price.
85
Tax incidence is the share of a tax ultimately paid by buyers and sellers. Facing a downward-sloping demand curve and an upward-sloping supply curve, sellers cannot raise the price by the full amount of the tax. If the demand curve is vertical, sellers will raise the price by the full amount of a tax.
86
$1.00$.75$.50$.25
5 10 15 20
$1.25$1.50$1.75$2.00
25 3035 40 45
s1
s2
D
Buyers
Fully shifted tax to buyers
87
$1.00$.75$.50$.25
5 10 15 20
$1.25$1.50$1.75$2.00
25 30 35 40 45
s1
s2
D
BuyersSellers
Partially shifted tax to buyers