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CHAPTER 20 ELASTICITY of DEMAND & SUPPLY

CHAPTER 20 ELASTICITY of DEMAND & SUPPLY. By: Amanda Reina & Sandra Avila. Three types of Elasticity. Price Elasticity Cross Elasticity Income Elasticity. Price Elasticity . Response of consumers and producers to price change Price Elasticity of Demand Price Elasticity of Supply.

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CHAPTER 20 ELASTICITY of DEMAND & SUPPLY

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  1. CHAPTER 20ELASTICITY of DEMAND & SUPPLY By: Amanda Reina & Sandra Avila

  2. Three types of Elasticity • Price Elasticity • Cross Elasticity • Income Elasticity

  3. Price Elasticity • Response of consumers and producers to price change • Price Elasticity of Demand • Price Elasticity of Supply

  4. Price Elasticity of Demand (Formulas) • Ed= % change in quantity demanded of product X ____________________________ % change in price of product X

  5. Price Elasticity of Demand (Formulas) • Ed= [change in quantity demanded of X / original quantity demanded of X] __________________________________ [change in price of X / original price of X]

  6. Price Elasticity of DemandElimination of Minus Sign • Price and Quantitydemanded are inversely related because of the down-sloping of the demand curve. • Coefficient (first number) of demand Ed will ALWAYS be negative (-). • Take the absolute value. P Down-Sloping 0 D1 Q

  7. Price Elasticity of DemandExample Ed= % change in quantity demanded of product X __________________________ % change in price of product • P↓ Qd ↑ • This means that the numerator in the • formula will be positive and the denominator negative.

  8. Price Elasticity of Demand Interpretations of Ed Ed= % change in quantity demanded of product X __________________________ % change in price of product • Elastic Demand: Ed > 1 • Inelastic Demand: Ed < 1 • Unit Elasticity: Ed = 1 • Perfectly Inelastic: Ed = 0 • Consumers have NO response to price change (Vertical Line) • Perfectly Elastic: Ed =∞ • A slight price fall causes consumers to increase their purchases from 0 to all they can get (Horizontal Line)

  9. Mid-Point Formula Ed = [Change in quantity /(sum of quantities/2)] [Change in price /(sum of prices/2)]

  10. Graphical Analysis • Demand is : • Elastic with high prices (lower quantity) • Inelastic with low prices (higher quantity)

  11. Total Revenue Test • TR = P X Q • P= Price • Q= Quantity

  12. Total Revenue Test • Elastic • ↓P = TR↑ • Inelastic • ↓P = TR ↓

  13. Example Price ($) Elastic Ed > 1 5 4 Unit Elastic Ed = 1 Inelastic Ed < 1 4 5 Quantity Demanded

  14. Determinants of Price Elasticity of Demand • Substitutability: • Higher# of Substitute goods = greater Ed • Proportion of Income: • Higher price of good relative to consumer’s income = greater Ed • Luxuries v. Necessities: • The more the good is luxury = the greater Ed is • Time: • Longer time period = greater Ed

  15. Price Elasticity of Supply • Response of consumers and producers to price change • Es = % change in quantity supplied of product X ____________________________ % change in price of product X

  16. Degree of Price Elasticity of Supply • How quickly and easily producers can shift resources b/w alternative uses • “The longer the time, the greater the resource “shiftability.”

  17. Impact of time on Elasticity of Supply • Immediate market period • Period that occurs immediately after a change in market price, where it is too soon for producers to respond with a change in quantity supplied • Perfectly inelastic supply P Sm Pm P0 D2 D1 Q 0 Qo

  18. Impact of time on Elasticity of Supply • Short run • Period too short to change plant capacity but long enough to use a fixed plant more or less intensively P Ss **Supply more elastic than market period Ps P0 D2 D1 Q 0 Qo Qs

  19. Impact of time on Elasticity of Supply • Long run • Period long enough for all desired adjustments to be made P SL **Supply is even more elastic Pl P0 D2 D1 Q Qo Ql

  20. Cross Elasticity of Demand • Measures how sensitive consumer purchases of product X are to a change in the price of product Y. • Related products • Change in income

  21. Cross Elasticity of DemandFormula • Exy = % change in quantity demanded of product X __________________________ % change in price of product Y

  22. Cross Elasticity of Demand • Substitute goods have a positive Exy • Sales of X is related to price changes of Y • Beef and Chicken • Complementary goods have a negative Exy • Increase in price X = Decrease demand in Y • Milk and Chocolate powder • Independent goods have zero Exy • X and Y are unrelated • Candy and Books

  23. Income Elasticity of Demand • Measurement of the consumers’ response to a change in their incomes by buying more/less goods Ei = % change in quantity demanded % change in income

  24. Income Elasticity of Demand • Positive Ei = Normal/ Superior Goods • Qd & I move in the same direction • Negative Ei = Inferior Goods • Qd & I move in opposite direction

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