1 microeconomics – 2008 topic 3 chapter 6 elasticity and its applications
TRANSCRIPT
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Microeconomics – 2008
Topic 3
Chapter 6
Elasticity and its Applications
2
Learning Objectives
Introduce the concept of price elasticity of demand and discuss its determinants.
Relate price elasticity of demand to the changes in total revenue that result from a change in market price.
3
Learning Objectives (cont.)
Introduce the concept of the elasticity of supply and its relationship to time.
Define the cross-price and income elasticities of demand.
Survey some applications of supply and demand analysis.
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Price Elasticity of Demand
The price elasticity of demand is the measure of the responsiveness of the quantity demanded to a change in price of a product
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Price Elasticity is...
Q
P
P1
P2
Q1Q2
D
As price increases fromP1 to P2, quantity decreases
from Q1 to Q2
6
Price Elasticity is... (cont.)
Q
P
P2
P1
Q2Q1
D
As price decreases fromP1 to P2, quantity increases
from Q1 to Q2
7
Price Elasticity is... (cont.)
Q
P
P1
P2
Q1Q2
D
But what percentage did price change and what percentage did quantity
change?
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Formula for Elasticity
Originalquantity
demanded
Ed =
Change inquantity
Change inprice
Originalprice
The percentage change in price
The percentage change in quantityEd =
÷
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Price Elasticity of Demand
Use of percentages choice of units product comparison
Ignore the minus sign the absolute value of the coefficient is what is
important
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Price Elasticity of Demand (cont.)
Elastic Demand a given percentage change in price results in a
larger percentage change in quantity demanded
Ed > 1
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Price Elasticity of Demand (cont.)
Inelastic Demand a given percentage change in price results in a
relatively smaller percentage change in quantity demanded
Ed < 1
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Price Elasticity of Demand (cont.)
Unit elasticity a given percentage change in price results in an
equal percentage change in quantity demanded
Ed = 1
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Perfectly Inelastic Demand
Q
P DD11 Perfectlyinelasticdemand
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Perfectly Elastic Demand
Q
P DD11 Perfectlyinelasticdemand
DD22
Perfectlyelastic
demand
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Midpoints Formula
Ed ==
Change inquantity
Sum ofQuantities/2
Change inprice
Sum ofprices/2
16
4
0 2 4 6 7 8 10 12 14
1
2
3
4
5
Pric
e (p
er u
nit)
0 2 4 6 7 8 10 12 14
Tot
al R
even
ue
Units of X (thousands per week)
Price Elasticity
of Demand
and Revenue
8
12
16
20
TR
Ed > 1
16
17
4
0 2 4 6 7 8 10 12 14
1
2
3
4
5
Pric
e (p
er u
nit)
0 2 4 6 7 8 10 12 14
Tot
al R
even
ue
Units of X (thousands per week)
Price Elasticity
of Demand
and Revenue
8
12
16
20
Ed > 1
Ed = 1
17
18
4
0 2 4 6 7 8 10 12 14
1
2
3
4
5
Pric
e (p
er u
nit)
0 2 4 6 7 8 10 12 14
Tot
al R
even
ue
Units of X (thousands per week)
Price Elasticity
of Demand
and Revenue
8
12
16
20
TR
Ed < 1
Ed > 1
Ed = 1
18
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Total Revenue Test
Elastic demand a change in price will cause total revenue to change in the
opposite direction
Inelastic demand a change in price will cause total revenue to change in the
same direction
Unit elasticity a change in price leaves total revenue unchanged
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Determinants of Price Elasticity of Demand
Substitutability Proportion of income Luxuries versus necessities Time
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Elasticity of Demand: Some Applications
Bumper crops Automation Excise taxes Heroin and crime
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Price Elasticity of Supply
Es=
Percentage change in quantitysupplied of product X
Percentage change in the price of product X
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Price Elasticity of Supply (cont.)
Immediate market period
PPoo
PP
QQDD11
SSmm
PPmm
DD11
DD22
DD22
Qo
24
DD22
Price Elasticity of Supply (cont.)
PPoo
PPss
PP
DD11
Qo
SSss Short run
Qs
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Price Elasticity of Supply (cont.)
PPoo
PPLL
PP
DD11Qo
SSLL
Long run
DD22
SS′′LLSS′′LL
Qo QLQ′L
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Exy =
Percentage change in quantitydemanded of good X
Percentage change in the price of good Y
•Substitute goods—Positive sign
•Complementary goods—Negative sign
•Independent goods—Zero or near-zero value
Cross Elasticity of Demand
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Income Elasticity of Demand
EEi i ==
Percentage change inquantity demanded
Percentage changePercentage changein in income
Normal goods—Positive sign
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Income Elasticity of Demand (cont.)
Ei =
Percentage change inquantity demanded
Percentage changein income
Normal goods—Positive sign
Inferior goods—Negative sign