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What did you study last time?

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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

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

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

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

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

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

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

4. What are the corresponding demand curves? demands?

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

4. What are the corresponding demand curves? demands?

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

4. What are the corresponding demand curves? demands?

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

4. What are the corresponding demand curves? demands?

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

4. What are the corresponding demand curves? demands?

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

4. What are the corresponding demand curves? demands?

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

Important points demands?

- 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

Important points demands?

- 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

4. How are Ed & total revenue (TR) related? demands?

- Graph of a straight-line demand curve
- Table (using point formula to calculate Ed)
- General case
- Findings & implications

CRC Microeconomics

a. Graph of a straight-line D curve demands?

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

b. Table (using point formula) demands?

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

c. General case--a linear downward-sloping demand curve demands?

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

d. Findings & implications demands?

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

II. What is income elasticity of demand (Ey)? demands?

- 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

II. What is income elasticity of demand (Ey)? demands?

General formula

%DQd

=

Ey

%DY

Midpoint formula

DQd/avgQd

Ey

=

DY/avgY

CRC Microeconomics

III. What is cross-price elasticity of demand (Exz)? demands?

- 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

III. What is cross-price elasticity of demand (Exz)? demands?

General formula

%DQd,x

=

Exz

%DPz

Midpoint formula

DQd/avgQd,x

Exz

=

DP/avgPz

CRC Microeconomics

IV. What is price elasticity of supply (Es)? demands?

- 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

What is Es? demands?

- 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

2. How to calculate Es? demands?

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

2. What determines the values of Es? demands?

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

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

4. What are the corresponding supply curves? supplies?

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

4. What are the corresponding supply curves? supplies?

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

4. What are the corresponding supply curves? supplies?

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

4. What are the corresponding supply curves? supplies?

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

4. What are the corresponding supply curves? supplies?

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

4. What are the corresponding supply curves? supplies?

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

Important points supplies?

- 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

Important points supplies?

- 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

Summary supplies?

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

Now you know … supplies?

- 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

What will you study next time? supplies?

Chapter 5

Elasticity & Its Applications

- Applications of elasticities

CRC Microeconomics

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