Elasticity of Supply and Demand

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Elasticity of Supply and Demand

• p140-p160

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Price Ceilings

• Government-imposed maximum price that prevents
  the price of a good from rising above a certain
  level in a market

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Price Floors

• Government imposed minimum amount below which
  price is not permitted to fall
• example minimum wage.
• http//www.youtube.com/watch?vtiyXmkMXkkYmoder
  elatedsearch

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Figure 1 A Price Ceiling in the Market for Gas
S
T
4.00
E
2.67
R
V
0.50
D
60,000
50,000
40,000
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Figure 2 A Price Floor in the Market for Nonfat
Dry Milk
S
J
K
5.15
A
4.00
D
200
180
220
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Elasticity

• Elasticity shows us how responsive the amount we
  want to buy to a change in price level.
• Sensitivity.

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Price Elasticity of Demand

• A measure that indicates the degree of consumer
  response to a price change.
• percentage change in quantity demanded divided by
  percentage change in price

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Percentage change

• So if the initial Quantity demanded is 95, and
  new Quantity demanded is 105, how should we
  calculate the percentage change here?
• If the initial price is 55 and the new price is
  45, how should we calculate the percentage change
  here?

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4.1.2 Elasticity Calculation
Ed is typically negative for goods that follow
the law of demand
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How to interpret the elasticity coefficient

• if ?E? 1, demand is elastic
• if ?E?
• if ?E? 1, demand is unitary elastic

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Figure 4 Elasticity and Straight-Line Demand
Curves
3
2
1
D
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Question Which is more elastic, the demand for
cigarettes or the demand for potato chips?
(b)
D
D
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Elasticity and Slope
From last question, we can see Elasticity and
slope are not same thing but the slope can tell
you something about the elasticity.
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Extreme Cases of Demand
(b)
D
D
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4.2 Determinants of price elasticity

• The availability of substitutes
• Narrowness of Market
• The Time Horizon
• Importance in the Buyers Budget

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Availability of Substitutes

• Demand is more elastic
• If close substitutes are easy to find and buyers
  can cut back on purchases of the good in question
• Coke, pepsi
• Demand is less elastic
• If close substitutes are difficult to find and
  buyers can not cut back on purchases of the good
  in question
• Air, water, tuition

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Question

• Whats more elastic?
• Electricity, chicken, salt, Honda Civic
• Inelastic
• Electricity, Salt
• Elastic
• Chicken, Honda Civic

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Elastic v.s. Inelastic

• plumbers services v.s. beauticians expertise
• business class airfare v.s. coach

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Narrowness of Market

• More narrowly we define a good, easier it is to
  find substitutes
• More elastic is demand for the good
• More broadly we define a good
• Harder it is to find substitutes and the less
  elastic is demand for the good
• Different things are assumed constant when we use
  a narrow definition compared with a broader
  definition

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Necessities vs. Luxuries

• The more necessary we regard an item, the
  harder it is to find a substitute
• Expect it to be less price elastic
• The less necessary (luxurious) we regard an
  item, the easier it is to find a substitute
• Expect it to be more price elastic

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For which of the following items is demand likely
to be the most price elastic? a. Tide laundry
detergent b. laundry detergent in
general c. shoes d. gasoline e. electricity
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Time Horizon

• Short-run elasticity
• Measured a short time after a price change
• Long-run elasticity
• Measured a year or more after a price change
• Usually easier to find substitutes for an item in
  the long run than in the short run
• Therefore, demand tends to be more elastic in the
  long run than in the short run

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Example for time horizon

• In the 1970s the price of gas increased
  significantly.
• In the short run, the demand fell as people began
• Car pool
• Cut vacations
• In the long run, demand fell even more as people
• Move closer to job
• Buy compact cars

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Importance in the Buyers Budget

• The more of their total budgets that households
  spend on an item
• The more elastic is demand for that item
• The less of their total budgets that households
  spend on an item
• The less elastic is demand for that item

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Examples for buyers budget

• Gasoline
• You buy 1,000 gallons per year 2.98 per gallon.
• Salt
• You buy 1 box a year, price 50 cents.

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4.3 Elasticity and total revenue

• Total revenue (TR) of all firms in the market is
  defined as
• TR P x QD
• As P and QD change, TR changes
• Change in TR Change in Price Change in
  Quantity Demanded

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Elasticity and total revenue

• if ?ED? 1, demand is elastic
• ??Q? ??P?
• Change in TR Change in Price Change in
  Quantity Demanded
• as P increases TR decreases, as P falls, TR
  increases.
• e.g. When JC-Penny has a sale, they hope that
  demand is elastic

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Elasticity and total revenue

• if ?ED?
• ??Q?
• Change in TR Change in Price Change in
  Quantity Demanded
• as P increases TR increases, as P falls, TR
  decreases.
• e.g. Industry of laptop, drugs

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Figure 6 Elasticity and Total Revenue
C
D
D
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example Calculating Price Elasticity of Demand
Calculate elasticity as we move from A to B
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Elasticity and total revenue

• if ?ED? 1, demand is unitary elastic
• ??Q? ??P?
• Change in TR Change in Price Change in
  Quantity Demanded
• So the change in price is offset by the
• change in quantity.

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How Total Revenue Changes Along a Demand Curve
Elastic range ED 1
ED 1
Inelastic range ED Q0
Q0
(b)
(a)
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4.4 Price Elasticity of Supply

• Percentage change in quantity of a good supplied
  that is caused by a 1 change in the price of the
  good
• With all other influences on supply held constant

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Price Elasticity of Supply

• Similarly, we say
• if ?ES? 1, supply is elastic
• if ?ES?
• if ?ES? 1, supply is unitary elastic

Be careful, ES is always be positive. That is,
as P increases, quantity supplied increases
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Income Elasticity of Demand

• Percentage change in quantity demanded divided by
  the percentage change in income
• With all other influences on demandincluding the
  price of the goodremaining constant

Interpret this number as percentage increase
in quantity demanded for each 1 rise in income
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Normal v.s. inferior

• EY 0 As Y increases, Q increases (NORMAL
  GOOD)
• EY GOOD)

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Income Elasticity of Demand

• Economic necessity
• Good with an income elasticity of demand between
  0 and 1
• Economic luxury
• Good with an income elasticity of demand greater
  than 1

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MATCHING packet p111

• Tobacco Products 2.6
• New Furniture -.6
• Macaroni Noodles 3.4
• Mink Coats .21

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Economics in action

• Where have all the farmers gone?
• Marty Stuart Farmers blues
• http//www.youtube.com/watch?vgRnafiAOWQY
• Fact Income elasticity of demand or food is much
  less than 1
• Foreign travel tourism to Canada
• http//www.youtube.com/watch?vVLMlV6ez3Wo

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• An implication follows from these definitions
• As income rises, proportion of income spent on
  economic necessities will fall
• While proportion of income spent on economic
  luxuries will rise
• But, it is important to remember that economic
  necessities and luxuries are categorized by
  actual consumer behavior
• Not by our judgment of a goods importance to
  human survival

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Cross-Price Elasticity of Demand

• Cross-price elasticity of demand
• Percentage change in quantity demanded of one
  good caused by a 1 change in price of another
  good
• While all other influences on demand remain
  unchanged

• the sign of the cross-price elasticity helps us
  distinguish substitutes and complements among
  related goods

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Cross-Price Elasticity of Demand

• If EXZ0, as the price of the related good
  increases, the demand of X increases
• Substitutes in consumption
• If EXZ increases, the demand of X decreases
• Complements in consumption
• Its size tells us how closely the two goods are
  related
• A large absolute value for EXZ suggests that the
  two goods are close substitutes or complements
• While a small value suggests a weaker
  relationship

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Positive or Negative

• EXZ between hot dogs and hamburger
• (EXZ 0 substitutes)
• EXZ between hot dogs and hot dog buns
• (EXZ

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Guess it!

• EXZ between heroin and cocaine
• (EXZ 0 substitutes)
• EXZ between heroin and marijuana
• (almost 0 no relationship)
• EXZ between cigarettes and marijuana
• (EXZ
• EXZ between cigarettes and alcohol
• (EXZ

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Example for cross-price elasticity of supply p112

• The price of apple juice increases from 2.50
  to 5.00 and the demand of apple Sauce rises from
  500 to 600 units. What is EXZ?

• Since EXZ0, the goods are substitutes in
• consumption. Since EXZ
• inelastic

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Comparison of Elasticity
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• Elasticity Song
• http//www.youtube.com/watch?vx5EKPX_atQo