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What did you study last time?

What did you study last time?. Chapter 4 The Market Forces of Demand & Supply Demand Supply Market equilibrium Effect of changes in demand & supply on markets. Do you know …. what price elasticity of demand is? what income elasticity of demand is?

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What did you study last time?

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  1. CRC Microeconomics

  2. What did you study last time? Chapter 4 The Market Forces of Demand & Supply • Demand • Supply • Market equilibrium • Effect of changes in demand & supply on markets CRC Microeconomics

  3. Do you know … • what price elasticity of demand is? • what income elasticity of demand is? • what cross-price elasticity of demand is? • what price elasticity of supply is? CRC Microeconomics

  4. I. What is price elasticity of demand (Ed)? • What is Ed? • How to calculate Ed? • What determines the value of Ed? • What is the range of values of Ed? • What are the corresponding demand curves? • How are Ed & total revenue related? CRC Microeconomics

  5. What is Ed? • Elasticity is a measure of how much buyers and sellers respond to changes in market conditions. • Price elasticity of demand (Ed) measures how the quantity demanded (Qd) of a good responds to changes in the price (P) of that good. • Ed is always negative, so economists use its absolute value. CRC Microeconomics

  6. 2. How to calculate Ed? General formula %DQd = Ed %DP Midpoint formula Point formula DQd/avgQd 1 P = = Ed Ed DP/avgP Slope (D) Q Used when two values of Qd & P are given. Used when the demand equation is given/known. CRC Microeconomics

  7. 2. What determines the value of Ed? D is more elastic (Ed is larger) if (1) Availability of close substitutes the number of close substitutes is large (2) Luxuries or necessities the good is a luxury (3) Definition of the market the market is narrowly defined (4) Time horizon the time period is longer CRC Microeconomics

  8. 3. What is the range of values of Ed & corresponding demands? Range of values of Ed 0 <1 1 >1 infinity If Ed=0 Ed<1 Ed=1 Ed>1 Ed=inf D is perfectly inelastic inelastic unit elastic elastic perfectly elastic Qd does not change at all when price changes. Qd changes little when price changes. Qd changes as much as price does. Qd changes more than price does. Qd changes a lot more than price does. CRC Microeconomics %DQd = 0 < %DP = %DP > %DP >> %DP

  9. 4. What are the corresponding demand curves? Suppose that at the original point A in the market,the price is $2, and the quantity demanded is 20 units. Now the price rises to $3, an increase of 50%. P 4 3 A 2 Q 10 20 40 CRC Microeconomics

  10. 4. What are the corresponding demand curves? If consumers buy Qd = 20 at P = $3. The new point is point B. With demand curve D1, Qd stays the same, a change of 0%. Ed = 0%/50% = 0, so D1 is perfectly inelastic. P 4 B 3 A 2 D1 Q 10 20 40 CRC Microeconomics

  11. 4. What are the corresponding demand curves? If consumers buy Qd = 15 at P = $3. The new point is point C. With demand curve D2, Qd falls to 15, a decline of 25%. Ed = 25%/50% = 0.5, so D2 is inelastic. P 4 B C 3 A 2 D1 D2 Q 10 20 40 CRC Microeconomics

  12. 4. What are the corresponding demand curves? If consumers buy Qd = 10 at P = $3. The new point is point F. With demand curve D3, Qd falls to 10, a decline of 50%. Ed = 50%/50% = 1, so D3 is unit elastic. P 4 F B C 3 A 2 D3 D1 D2 Q 10 20 40 CRC Microeconomics

  13. 4. What are the corresponding demand curves? If consumers buy Qd = 0 at P = $3. The new point is point G. With demand curve D4, Qd falls to 0, a decline of 100%. Ed = 100%/50% = 2, so D4 is elastic. P 4 G F B C 3 A 2 D3 D1 D2 D4 Q 10 20 40 CRC Microeconomics

  14. 4. What are the corresponding demand curves? If consumers buy Qd = 0 at P = $2.0001. The new point is point H. With demand curve D5, Qd falls to 0, a decline of 100%, while P changes very little. Ed = 100%/0.005% = 20000, so D5 is perfectly elastic. P 4 G F C B 3 D5 A H 2 D3 D1 D2 D4 Q 10 20 40 CRC Microeconomics

  15. Important points • A perfectly inelastic demand curve is vertical. • A perfectly elastic demand curve is horizontal. • A unit-elastic demand curve is part of a hyperbola. CRC Microeconomics

  16. Important points • An inelastic demand curve is steep. • An elastic demand curve is flat. • The flatter a demand curve is, the more elastic it is. CRC Microeconomics

  17. 4. How are Ed & total revenue (TR) related? • Graph of a straight-line demand curve • Table (using point formula to calculate Ed) • General case • Findings & implications CRC Microeconomics

  18. a. Graph of a straight-line D curve Price (P) Along a straight line downward-sloping demand curve, the value of Ed varies from infinity to 1 to zero.(We ignore the negative sign.) Ed = infinity 8 Ed = 3 > 1 6 TR =$6 x 4 = $24 Ed = 1 4 TR = $4 x 8 = $32 Ed = 0.33 < 1 2 D TR = $2 x 12 = $24 Ed = 0 Quantity (Q) O 4 8 12 16 CRC Microeconomics

  19. b. Table (using point formula) P Q TR Slope(D) 1/slope Ed Demand is $8 0 $0 -0.5 -2 infinity perfectly elastic $6 4 $24 -0.5 -2 -3 elastic $4 8 $32 -0.5 -2 -1 unit elastic $2 12 $24 -0.5 -2 -0.33 inelastic $0 16 $0 -0.5 -2 0 perfectly inelastic CRC Microeconomics

  20. c. General case--a linear downward-sloping demand curve Price (P) Ed = infinity  Perfectly elastic demand Ed > 1  Elastic demand Ed = 1  Unit elastic demand At Ed = 1, TR = maximum Ed < 1  Inelastic demand D Ed = 0  Pid Quantity (Q) O CRC Microeconomics

  21. d. Findings & implications If D is and P then TR inelastic, rises, rises. elastic, rises, falls. So to increase TR, a firm should - raise P if demand is inelastic, - lower P if demand is elastic. CRC Microeconomics

  22. II. What is income elasticity of demand (Ey)? • Ey measures how quantity demanded (Qd) responds to changes in income (Y). Ey > 0 Ey < 0 If The good is a(n) inferior good normal good 0<Ey<=1 Ey>1 a necessity a luxury good Fur coats, diamond rings, etc. Used, second-hand stuff Food, gasoline, etc. e.g. CRC Microeconomics

  23. II. What is income elasticity of demand (Ey)? General formula %DQd = Ey %DY Midpoint formula DQd/avgQd Ey = DY/avgY CRC Microeconomics

  24. III. What is cross-price elasticity of demand (Exz)? • Exz measures of how quantity demanded (Qd) of good x responds to changes in the price of good z (Pz) Exz < 0 Exz > 0 If Goods x & z are complements substitutes Shell gasoline or Arco gasoline, etc. Cars & gasoline; coffee & sugar, etc. e.g. CRC Microeconomics

  25. III. What is cross-price elasticity of demand (Exz)? General formula %DQd,x = Exz %DPz Midpoint formula DQd/avgQd,x Exz = DP/avgPz CRC Microeconomics

  26. IV. What is price elasticity of supply (Es)? • What is Es? • How to calculate Es? • What determines the values of Es? • What is the range of values of Es? • What are the corresponding supply curves? CRC Microeconomics

  27. What is Es? • Price elasticity of supply (Es) measures how the quantity supplied (Qs) of a good responds to changes in the price (P) of that good. • Es is always positive. CRC Microeconomics

  28. 2. How to calculate Es? General formula %DQs = Es %DP Midpoint formula Point formula DQs/avgQs 1 P Es = = Es DP/avgP Slope (S) Q Used when two values of Qs & P are given. Used when the supply equation is given/known. CRC Microeconomics

  29. 2. What determines the values of Es? S is more elastic (Es is larger) if sellers can easily change the amount of the good they produce (1) Flexibility in production (2) Time horizon the time period is longer CRC Microeconomics

  30. 3. What is the range of values of Es & corresponding supplies? Range of values of Es 0 <1 1 >1 infinity If Es=0 Es<1 Es=1 Es>1 Es=inf S is perfectly inelastic inelastic unit elastic elastic perfectly elastic Qs does not change at all when price changes. Qs changes little when price changes. Qs changes as much as price does. Qs changes more than price does. Qs changes a lot more than price does. CRC Microeconomics %DQs = 0 < %DP = %DP > %DP >> %DP

  31. 4. What are the corresponding supply curves? Suppose that at the original point A in the market,the price is $2, and the quantity supplied is 20 units. Now the price rises to $3, an increase of 50%. P 4 3 2 A Q 20 30 40 CRC Microeconomics

  32. 4. What are the corresponding supply curves? If sellers sell Qs = 20 at P = $3. The new point is point B. With supply curve S1, Qs stays the same, a change of 0%. Es = 0%/50% = 0, so S1 is perfectly inelastic. P 4 B 3 2 A S1 Q 20 30 40 CRC Microeconomics

  33. 4. What are the corresponding supply curves? If sellers sell Qs = 25 at P = $3. The new point is point C. With supply curve S2, Qs rises to 25, an increase of 25%. Es = 25%/50% = 0.5, so S2 is inelastic. P 4 S2 B 3 C 2 A S1 Q 20 30 40 CRC Microeconomics

  34. 4. What are the corresponding supply curves? If sellers sell Qs = 30 at P = $3. The new point is point F. With supply curve S3, Qs rises to 30, an increase of 50%. Es = 50%/50% = 1, so S3 is unit elastic. P 4 S2 S3 B 3 C F 2 A S1 Q 20 30 40 CRC Microeconomics

  35. 4. What are the corresponding supply curves? If sellers sell Qs = 40 at P = $3. The new point is point G. With supply curve S4, Qs rises to 40, an increase of 100%. Es = 100%/50% = 2, so S4 is elastic. P 4 S2 S3 B S4 3 C F G 2 A S1 Q 20 30 40 CRC Microeconomics

  36. 4. What are the corresponding supply curves? If sellers sell Qs = 50 at P = $2.0001. The new point is point H. With supply curve S5, Qs rises to 50, an increase of 150%, while P changes very little. Es = 150%/0.005% = 30000, so S5 is perfectly elastic. P 4 S3 B S2 S4 3 C F G S5 2 H A S1 Q 20 30 40 CRC Microeconomics

  37. Important points • A perfectly inelastic supply curve is vertical. • A perfectly elastic supply curve is horizontal. • A unit-elastic supply curve starts from the point of origin. CRC Microeconomics

  38. Important points • An inelastic supply curve starts from the horizontal axis. • An elastic supply curve starts from the vertical axis. • The flatter a supply curve is, the more elastic it is. CRC Microeconomics

  39. Summary Price Income Cross-price Price elasticity of demand supply measures how quantity demanded (Qd) Qs responds to changes in price. income. the price price. of another good. CRC Microeconomics

  40. Now you know … • what price elasticity of demand is. • what income elasticity of demand is. • what cross-price elasticity of demand is. • what price elasticity of supply is. CRC Microeconomics

  41. What will you study next time? Chapter 5 Elasticity & Its Applications • Applications of elasticities CRC Microeconomics

  42. See You! Take Care! CRC Microeconomics

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