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18. Extensions of Demand and Supply Analysis. Chapter Objectives. Price Elasticity of Demand and How It Can Be Applied The Usefulness of the Total Revenue Test for Price Elasticity of Demand Price Elasticity of Supply and How It Can Be Applied
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18 Extensions of Demand and Supply Analysis
Chapter Objectives • Price Elasticity of Demand and How It Can Be Applied • The Usefulness of the Total Revenue Test for Price Elasticity of Demand • Price Elasticity of Supply and How It Can Be Applied • Cross Elasticity of Demand and Income Elasticity of Demand • Consumer Surplus, Producer Surplus, and Efficiency Losses
O 18.1 Price Elasticity of Demand • Measuring Responsiveness to Price Changes • Relatively Elastic or Inelastic • Price-Elasticity Coefficient and Formula Percentage Change in Quantity Demanded of Product X Ed = Percentage Change in Price of Product X
W 18.1 Change in Quantity Change in Price Ed = ÷ Sum of Quantities/2 Sum of Prices/2 Price Elasticity of Demand • Formula Restated Change in Quantity Demanded of X Ed = Original Quantity Demanded of X Change in Price of X ÷ Original Price of X • Using Averages • Midpoint Formula
.04 Ed = = 2 .02 .01 Ed = = .5 .02 .02 Ed = = 1 .02 Price Elasticity of Demand • Why Use Percentages? • Elimination of the Minus Sign • Interpretations of Ed Elastic Demand Inelastic Demand Unit Elasticity
P 0 Q P 0 Q Price Elasticity of Demand Extreme Cases Perfectly Inelastic Demand D1 Perfectly Inelastic Demand (Ed = 0) Perfectly Elastic Demand D2 Perfectly Elastic Demand (Ed = ∞)
W 18.2 P $3 2 1 Q 0 10 20 30 40 The Total Revenue Test • Total Revenue (TR) TR = P x Q Elastic Demand a b D1
W 18.2 P $4 3 2 1 Q 0 10 20 The Total Revenue Test • Total Revenue (TR) TR = P x Q Inelastic Demand c d D2
W 18.2 P $3 2 1 Q 0 10 20 30 The Total Revenue Test • Total Revenue (TR) TR = P x Q Unit-Elastic e f D3
G 18.1 ] ] ] ] ] ] ] ] ] ] ] ] ] ] Elasticity on a Linear Demand Curve Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test (1) Total Quantity of Tickets Demanded Per Week, Thousands (3) Elasticity Coefficient (Ed) (4) Total Revenue (1) X (2) (5) Total-Revenue Test (2) Price Per Ticket 1 2 3 4 5 6 7 8 8 7 6 5 4 3 2 1 $8,000 14,000 18,000 20,000 20,000 18,000 14,000 8,000 5.00 2.60 1.57 1.00 0.64 0.38 0.20 Elastic Elastic Elastic Unit Elastic Inelastic Inelastic Inelastic Graphically…
$8 7 6 5 4 3 2 1 a b c Price d e f g h 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 Quantity Demanded $20 18 16 14 12 10 8 6 4 2 Total Revenue (Thousands of Dollars) Quantity Demanded Price Elasticity and the Total-Revenue Curve Elastic Ed > 1 Unit Elastic Ed = 1 Inelastic Ed < 1 D Elastic Ed > 1 Unit Elastic Ed = 1 TR Inelastic Ed < 1
Determinants of Price Elasticity of Demand • Substitutability • Proportion of Income • Luxuries versus Necessities • Time • Applications: • Large Crop Yields • Excise Taxes • Decriminalization of Illegal Drugs
O 18.2 P Q Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Unit Elastic Supply Es = 1 Market Period: Not Enough Time to Shift Resources Sm Pm Greatest Price Impact P0 D1 D2 Q0
O 18.2 P Q Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Inelastic Supply Es < 1 Short Run: Resources Not Easily Shifted to Alternative Uses Ss Lower Price Impact Ps P0 D1 D2 Q0 Qs
O 18.2 P Q Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Elastic Supply Es > 1 Long Run: Resources Easily Shifted to Alternative Uses Sl Least Price Impact Pl P0 D1 D2 Q0 Ql
Price Elasticity of Supply • Applications • Antiques and Reproductions • Volatile Gold Prices
Cross Elasticity of Demand Percentage Change in Quantity Demanded of Product X • Substitute Goods – Positive Sign • Complementary Goods- Negative Sign • Independent Goods – Zero or Near-Zero Value Exy = Percentage Change in Price of Product Y
Income Elasticity of Demand • Normal Goods – Positive Sign • Inferior Goods- Negative Sign • Insights into the Economy Percentage Change in Quantity Demanded Ei = Percentage Change in Income
O 18.3 Consumer and Producer Surplus Consumer Surplus Consumer Surplus Equilibrium Price = $8 P1 Price (Per Bag) D Q1 Quantity (Bags)
Consumer and Producer Surplus Producer Surplus S Equilibrium Price = $8 P1 Price (Per Bag) Producer Surplus Q1 Quantity (Bags)
W 18.3 Consumer and Producer Surplus Efficiency Revisited S Consumer Surplus Equilibrium Price = $8 P1 Price (Per Bag) Producer Surplus D Q1 Quantity (Bags)
Consumer and Producer Surplus Efficiency Revisited Efficiency Losses (Deadweight Losses) S Efficiency Losses P1 Price (Per Bag) D Q3 Q2 Q1 Quantity (Bags)
Elasticity and Pricing Power: Last Word Why Different Consumers Pay Different Prices • All Buyers in a Highly Competitive Market Pay the Same Price Regardless of Their Elasticities • Difficulty in Applying Different Prices • Observe Differences in Group Elasticities • Business Travelers • Leisure Travelers • Discounting for Children • Different Net Prices for College Tuition
price elasticity of demand midpoint formula elastic demand inelastic demand unit elasticity perfectly inelastic demand perfectly elastic demand total revenue test (TR) total-revenue test price elasticity of supply market period short run long run cross-elasticity of demand income elasticity of demand consumer surplus producer surplus efficiency losses (deadweight losses) Key Terms
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