Equilibrium & Elasticity

Equilibrium & Elasticity Macroeconomics Unit One Activity 7 & 8 by Advanced Placement Economics Teacher Resource Manual. National Council on Economic Education, New York, N.Y.

Objectives • Define equilibrium price and equilibrium quantity. • Determine the equilibrium price and quantity when given the demand for and supply of a good or commodity. • Explain why, at prices above or below the equilibrium price, market forces operate to move the price back toward equilibrium price. • Predict the equilibrium price and quantity if there are changes in demand or supply. • Given a change in supply or demand, explain which curve shifted and why. • Explain how markets act as rationing devices.

Objectives • Define price elasticity of demand and price elasticity of supply. • Calculate price elasticity using the arc method. • Predict the effect on price and quantity given demand curves with different elasticities. • Explain the difference between slope of a line and the elasticity between two points on a line.

Introduction • This lesson will bring the two sides of the market—demand and supply—together to determine the equilibrium price and quantity. • You should understand that unless there are forces operating to change supply or demand, the price and quantity will remain at the equilibrium.

Introduction • Activity 7 brings the supply and demand sides of the market together and helps the students understand equilibrium price and quantity. • The factors that shift supply and demand are also used to emphasize the impact of supply or demand on the equilibrium price and quantity. • The second part of Activity 7 has you work through changes in supply and demand and the effects in related markets.

Introduction • Activity 8 focuses on the definition of elasticity and the calculation of the coefficient of elasticity. • The activity then has you see the differences between elasticity of a curve and the slope of a curve.

Equilibrium Quantity and Price • What happens if the price is $10? The quantity supplied is 100, and the quantity demanded is 60. Therefore, there is excess supply.

Equilibrium Quantity and Price • What happens if the price is $6? The quantity demanded is 100, and the quantity supplied is 60. Therefore, there is excess demand.

Equilibrium Quantity and Price • What happens if the price is $8? The quantity that producers want to sell is exactly equal to the quantity that buyers want to buy. The market is in equilibrium.

Activity 7 • Find one partner (not your close friend)! • Complete Activity 7. • You will be called upon to come to the board and share your answers.

S1 S E1 E E2 D1 D

S1 S1 D1 D1

S1 D1 D1 D1

D1 D1 D1 D1

Activity 8 • In many economic situations, producers and policy makers want to know more than simply the direction in which price or quantity will move. • The law of demand tells producers that if price increases, the quantity demanded will decrease. • This law of demand tells producers that if price increases, the quantity demanded will decrease. • This law doesn’t tell the producers by how much the quantity demanded will decrease. • The responsiveness of one variable to changes in another variable is important information. • Elasticity is a measurement of how much one variable will change if another variable changes.

ELASTICITY Demand elasticity is always negative and supply elasticity is always positive. For this reason, we look a the absolute value of the coefficient of elasticity and always talk about positive values. Because elasticity measures responsiveness, changes in the variables are measured relative to some base or starting point.

Calculating the Arc Elasticity If Ed > 1, demand is said to be “price elastic”. If Ed < 1, demand is said to be “price inelastic”.

%  of Qd d = %  of P (90 – 80) (0.117) (90 + 80)/2 (0.545) (10 – 8) (0.222) (10 + 8)/2 (110 – 80) (0.015) (110 – 80)/2 (10 – 8) (0.222) (10 + 8)/2

Remember, that elasticity and slope are different concepts! The slope is 1 at both ends of the demand curve

Demand curve “D” is more inelastic. • What happens to the equilibrium price and quantity with an elastic demand curve, if supply increases? • With elastic demand curve, the price effect is smaller and the quantity effect is larger than with an inelastic demand curve. What happens to the equilibrium price and quantity with an inelastic demand curve, if supply increases? With an inelastic demand curve, the price effect is greater and the quantity effect is smaller than with the elastic demand curve.

Problem Involving Extra Credit % change in number of Q’s % change in extra cr. pts.

Activity 8: Elasticity – An Introduction • Part A • Now, suppose that your economics teacher currently allows you to earn extra credit by submitting answers to the end-of-the-chapter questions in your textbook. • The number of questions you’re willing to submit depends on the amount of extra credit for each question. • How responsive you are to a change in the extra-credit points the teacher gives can be represented as an elasticity.

Write the formula for the elasticity of extra-credit submitted: εps = Percentage change in number of questions Percentage change in extra-credit points

Now, consider that your teacher’s goal is to get you to submit twice as many questions: a 100-percent increase. Underline the correct answer in parentheses. (A) If the number of chapter-end questions you submit is very responsive to a change in extra- credit points, then a given increase in extra credit elicits a large increase in questions submitted. In this case, your teacher will need to increase the extra-credit points by (more than / less than / exactly) 100 percent. (B) If the number of chapter-end questions you submit is not very responsive to a change in extra-credit points, then a given increase in extra credit elicits a small increase in questions submitted. In this case, your teacher will need to increase the extra-credit points by (more than / less than / exactly) 100 percent.

Part D – Problem Involving Coffee • Suppose Moonbucks, a national coffee-house franchise, finally moves into the little town of Middle-of-nowhere. Moonbucks is the only supplier of coffee in town and faces the following demand schedule each week. • Write the correct answer on the answer blanks, or underline the correct answer in parentheses.

What is the arc price elasticity of demand when the price changes from $1 to $2? .18 20 (180 – 160) = = 0.117 .12 (180 +160)/2 = 170 (1 – 2) = |-1| = 1 .67 = 0.666 (1 + 2)/2 = 1.5 So, over this range of prices, demand is (elastic / unit elastic / inelastic).

What is the arc price elasticity of demand when the price changes from $5 to $6? 1.22 20 90 .22 1 .18 5.5

So, over this range of prices, demand is (elastic / unit elastic / inelastic). Note: Because the relationship between quantity demanded and price in inverse, price elasticity of demand would always be negative. Economists believe using negative numbers is confusing when referring to “large” or “small” elasticities of demand. Therefore, they use absolute or positive numbers, changing the sign on the negative numbers.

Part E • Now, consider Figure 8.4, which graphs the demand schedule given in Figure 8.3. • Recall the slope of a line is measured by the rise over the run: • Slope = rise / run = ∆P / ∆Q.

Using your calculations of P and Q from Question 3, calculate the slope of the demand curve. 1/20 or 0.05 6. Using your calculations of P and Q from Question 4, calculate the slope of the demand curve. 1/20 or 0.05 Change in Price Hint: Change in Quantity

The law of demand tells us that an increase in price results in a decrease in the quantity demanded. Questions 5 and 6 remind us that the slope of a straight line is constant everywhere along the line. Along this demand curve, a change in price of $1 generates a change in quantity demanded of 20 cups of coffee week.

(#7. continued) You’ve now shown mathematically that while the slope of the demand curve is related to elasticity, the two concepts are not the same thing. Briefly discuss the relationship between where you are along the demand curve and the elasticity of demand. How does this tie into the notion of responsiveness? At a higher price, you are in the price elastic portion of the demand curve. As you move to a lower price along a demand curve, the demand curve becomes more price inelastic. Thus, at a high price, a small percentage change in price leads to a large percentage change in quantity. As the price decreases, the same percentage change in price generates a smaller percentage change in quantity, so the elasticity of demand decreases.

Equilibrium & Elasticity