micro mceachern 2010-2011 econ 5
TRANSCRIPT
Micro
ECONMcEachern 2010-2011
5CHAPTER Elasticity of Demand and Supply
Designed by
Amy McGuire, B-books, Ltd.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1
Price Elasticity of Demand
Elasticity
– Responsiveness
Price elasticity of demand
– Consumers’
responsiveness to a
change in price
– Percentage change in
quantity demanded
divided by percentage
change in price
LO1
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 2
Price Elasticity of Demand
2/)'(2/)'(
%
%
pp
p
qE
p
qE
D
D
Law of demand
ED negative
LO1 Absolute value of ED positive
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 3
LO1
Demand Curve for Tacos
If the price of tacos drops from
Exhibit 1
P
rice p
er
taco
$1.10
0.90
D
b
a
$1.10 to $0.90, the quantity
demanded increases from
95,000 to 105,000.
0 95 105 Thousands per day
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 4
Categories of ED
If %∆q < %∆p
– ED between 0 and 1
– Inelastic D
If %∆q > %∆p
– ED greater than 1
– Elastic D
If %∆q = %∆p
– ED = 1
– Unit elastic D
LO1
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 5
Elasticity and Total Revenue
Total revenue = price *
quantity demanded at
this price
TR= p * q
As p decreases
If D elastic,
TR increases
If D inelastic,
TR decreases
If D unit elastic,
TR unchanged LO1
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 6
Price Elasticity and the
Linear D Curve
Linear D curve
– Constant slope
– Different elasticity
– D becomes less elastic as we move
downward
D upper half: elastic
D lower half: inelastic
D midpoint: unit elastic
LO1
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 7
LO1 Exhibit 2 P
rice p
er
un
it Demand, Price
Elasticity, and
Total Revenue
Where D is elastic, a
lower P increases TR
Where D is inelastic, a
lower P decreases TR D
90
60
10
70
$100
80
50
40
30
20
b
a
d e
800500200100 Quantity per period 1,0000 900
(a) Demand and price elasticity
Unit elastic, ED =1
Elastic, ED >1
Inelastic, ED <1c
TR reaches a
maximum at the rate
of output where D is
unit elastic
Tota
l re
venu
e $25,000
(b) Total revenue
Total
revenue
500 1,000 Quantity per period Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
0 8
Constant-Elasticity
Demand Curves
Perfectly elastic D curve
– Horizontal; ED = ∞
– Consumers don’t tolerate P increases
Perfectly inelastic D curve
– Vertical; ED = 0
– ‘Price is no object’
Unit-elastic D curve
– %∆p causes an exact opposite %∆q
LO1
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 9
LO1 Exhibit 3
Constant-Elasticity Demand Curves
(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic
aED = ∞ $10 p D
b 6
D’’
Price p
er
unit D’
Price p
er
unit
Price p
er
unit
= 1ED ’’
ED’’ = 0
0 Quantity per period 0 Q Quantity 0 60 100 Quantity
Consumers demand all quantity per period per period
offered for sale at p, but demand Consumers demand Q Total revenue is the same nothing at a price above p regardless of price for each p-q combination
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LO1 Exhibit 4
Summary of Price Elasticity of Demand Effects of a 10 Percent Increase in Price
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 11
Determinants of Price
Elasticity of D
ED is greater:
– The greater the availability of substitutes,
and the more similar the substitutes
– The more important the good as a share of
the consumer’s budget
– The longer the period of adjustment (time)
LO2
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LO2 Exhibit 5
Demand Becomes More Elastic over Time
Price p
er
unit
$1.25
1.00
Dw Dm
Dy
e
Dw: one week after the price increase
Dm: one month after the price increase
Dy: one year after the price increase
0 50 75 95 100 Quantity per day
D is more elastic than D , which is more elastic than Dy m w
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 13
Elasticity Estimates
Short run
– Consumers have little time to adjust
Long run
– Consumers can fully adjust to a price change
Demand is more elastic in the long run
LO2
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LO2 Selected Price Elasticities of
Demand (Absolute Values)
Exhibit 6
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 15
LO2 Deterring Young Smokers Cas
e Stu
dy Health hazard
Kills 440,000 Americans a year
Lung cancer; Heart disease;
Emphysema; Stroke
Cost to society
$7.18 per pack sold
Higher health cost
Lost worker
productivity
Total: $150 billion a year
$3,400 per smoker
per year
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 16
LO2 Deterring Young Smokers Cas
e Stu
dy Discouraging smoking
Prohibit the sale of cigarettes to minors
Higher cigarette tax
ED is higher for teens
Big share of budget
Less peer pressure
Not an addiction yet
Reduces teen smoking
Change consumer tastes
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 17
Price Elasticity of Supply
Elasticity
– Responsiveness
Price elasticity of supply
– Producers’ responsiveness to a change
in price
– Percentage change in quantity supplied divided by percentage change in price
LO3
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 18
Price Elasticity of Supply
2/)'(2/)'(
%
%
pp
p
qE
p
qE
S
S
Law of supply
ES positive
LO3
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 19
LO3 Exhibit 7
Price Elasticity of Supply
If the price increases from p
p’ to p’, the quantity supplied
increases from q to q’.
Price and quantity supplied p move in the same direction,
so the price elasticity of
supply is a positive number.
Price p
er
unit S
0 q q’ Quantity per period
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 20
Categories of ES
If %∆q < %∆p
– ES between 0 and 1
– Inelastic S
If %∆q > %∆p
– ES greater than 1
– Elastic S
If %∆q = %∆p
– ES = 1
– Unit elastic S LO3
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 21
Constant-Elasticity Supply Curves
Perfectly elastic S curve
– Horizontal; ES = ∞
– Producers supply 0 at a price below P
Perfectly inelastic S curve
– Vertical; ES = 0
– Goods in fixed supply
Unit-elastic S curve
– %∆p causes an exact opposite %∆q
LO3 – S curve is a ray from the origin
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 22
LO3 Exhibit 8
Constant-Elasticity Supply Curves
(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic
S’’ = 1ES’’
Price p
er
unit
S’
Price p
er
unit
Price p
er
unit
p S
5
ES’ = 0 ES = ∞ $10
0 Quantity 0 Q Quantity 0 10 20 Quantity
per period per period per period
Firms supply any amount of
output demanded at p, but
supply 0 at prices below p.
Quantity supplied is
independent of the price
Any %∆p results in the
same %∆q supplied.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 23
Determinants of Supply Elasticity
ES is greater:
– If the marginal cost
rises slowly as
output expands
– The longer the
period of
adjustment (time)
LO3
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 24
LO3 Exhibit 9
Supply Becomes More Elastic over Time
Price p
er
unit
Sw: one week after the
price increase $1.25
Sm: one month after the
price increase 1.00
Sy: one year after the
price increase
Sw
Quantity per day 110 2000 100
Sm
140
Sy
Sw is less elastic than Sm, which is less elastic than Sy
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 25
Income Elasticity
of Demand
Demand responsiveness to a change in
consumer income
Percentage change in demand divided by
the percentage change in income that
caused it
Inferior goods
– Negative income elasticity
Normal goods
– Positive income elasticity
LO4
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 26
Income Elasticity
of Demand
LO4
Normal goods
– Income inelastic
• Elasticity between 0 and 1
• Necessities
– Income elastic
• Elasticity > 1
• Luxuries
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 27
LO4 Exhibit 10
Selected Income Elasticities of Demand
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 28
LO4 The Market for Food and ‘The Farm Problem’Cas
e Stu
dy 1950: 10 million family farms
Today: less than 3 million
Demand
Price inelastic
Total revenue falls
when P falls
Income inelastic
D increases
Technological improvements
S increases
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 29
The Demand for Grain P
rice p
er
bushel
D
$5
4
3
2
1
The D for grain tends to be inelastic.
As the market P falls, so does TR.
0 5 10 11 Billions of bushels per year LO4
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 30
The Effect on Increases in Demand and LO4
Supply on Farm Revenue
$8
Technological advance
- sharp increase in S
Increase in consumer income
- small increase in D4
Drop in P
Drop in total revenue
Exhibit 11
P
rice
per
bushel
S’
D’
D
S
0 5 10 14
Billions of bushels per year
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 31
Cross-Price Elasticity
of Demand
Responsiveness of D for one good to
changes in P of another good
%∆ in demand for one good divided by
%∆ in price of another good
– If positive: substitutes
– If negative: complements
– If zero: unrelated
LO4
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 32
Appendix
Price Elasticity and Tax
Incidence
Tax
– Decrease in S by the amount of tax
Tax incidence
– Consumers: high P
– Producers: net-of-tax receipt
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 33
Appendix
Price Elasticity and Tax
Incidence
The more price elastic the D:
– The more tax producers pay
– The less tax consumers pay
The more elastic the S:
– The less tax producers pay
– The more tax consumers pay
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 34
Exhibit A
Effects of Price Elasticity of D on Tax Incidence
(a) Less elastic demand (b) More elastic demand
St
S
D
$0.20 Tax
Price p
er
ounce
$1.05 1.00
0.85
$1.15
Price p
er
ounce
1.00 0.95
0 9 10 Millions of ounces per day
St
S
D’
$0.20 Tax
107
The more elastic the D curve, the more tax is paid by producers (lower net-of-tax receipt)
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 35
Exhibit B
Effects of Price Elasticity of Supply on Tax Incidence
(a) More elastic supply (b) Less elastic supply
St ’
S’
D’’
$0.20 Tax St ” S”
$1.15 $1.05
$0.20 Tax 1.00
Price p
er
ounce
Price p
er
ounce
1.00 0.95 0.85
D’’
0 8 10 Millions of ounces per day 9 10
The more elastic the S curve, the more tax is paid by consumers as a higher price.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 36