Equilibrium & Elasticity

1
Equilibrium Elasticity

• Macroeconomics
• Unit One
• Activity 7 8

by Advanced Placement Economics Teacher Resource
Manual. National Council on Economic Education,
New York, N.Y.
2
Objectives

• Define equilibrium price and equilibrium
  quantity.
• Determine the equilibrium price and quantity when
  given the demand for and supply of a good or
  commodity.
• Explain why, at prices above or below the
  equilibrium price, market forces operate to move
  the price back toward equilibrium price.
• Predict the equilibrium price and quantity if
  there are changes in demand or supply.
• Given a change in supply or demand, explain which
  curve shifted and why.
• Explain how markets act as rationing devices.

3
Objectives

• Define price elasticity of demand and price
  elasticity of supply.
• Calculate price elasticity using the arc method.
• Predict the effect on price and quantity given
  demand curves with different elasticities.
• Explain the difference between slope of a line
  and the elasticity between two points on a line.

4
Introduction

• This lesson will bring the two sides of the
  marketdemand and supplytogether to determine
  the equilibrium price and quantity.
• You should understand that unless there are
  forces operating to change supply or demand, the
  price and quantity will remain at the equilibrium.

5
Introduction

• Activity 7 brings the supply and demand sides of
  the market together and helps the students
  understand equilibrium price and quantity.
• The factors that shift supply and demand are also
  used to emphasize the impact of supply or demand
  on the equilibrium price and quantity.
• The second part of Activity 7 has you work
  through changes in supply and demand and the
  effects in related markets.

6
Introduction

• Activity 8 focuses on the definition of
  elasticity and the calculation of the coefficient
  of elasticity.
• The activity then has you see the differences
  between elasticity of a curve and the slope of a
  curve.

7
Equilibrium Quantity and Price

• What happens if the price is 10?
• The quantity supplied is 100,

and the quantity demanded is 60.
Therefore, there is excess supply.
8
Equilibrium Quantity and Price

• What happens if the price is 6?
• The quantity demanded is 100, and the quantity
  supplied is 60. Therefore, there is excess
  demand.

9
Equilibrium Quantity and Price

• What happens if the price is 8?
• The quantity that producers want to sell is
  exactly equal to the quantity that buyers want to
  buy. The market is in equilibrium.

10
Activity 7

• Find one partner (not your close friend)!
• Complete Activity 7.
• You will be called upon to come to the board and
  share your answers.

11
S
S1
E1
E
E2
D
D1
12
S1
S1
D1
D1
13
S1
D1
D1
D1
14
D1
D1
D1
D1
15
Activity 8

• In many economic situations, producers and policy
  makers want to know more than simply the
  direction in which price or quantity will move.
• The law of demand tells producers that if price
  increases, the quantity demanded will decrease.
• This law of demand tells producers that if price
  increases, the quantity demanded will decrease.
• This law doesnt tell the producers by how much
  the quantity demanded will decrease.
• The responsiveness of one variable to changes in
  another variable is important information.
• Elasticity is a measurement of how much one
  variable will change if another variable changes.

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ELASTICITY
Demand elasticity is always negative and supply
elasticity is always positive. For this reason,
we look a the absolute value of the coefficient
of elasticity and always talk about positive
values. Because elasticity measures
responsiveness, changes in the variables are
measured relative to some base or starting point.
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Calculating the Arc Elasticity
If Ed gt 1, demand is said to be price elastic.
If Ed lt 1, demand is said to be price
inelastic.
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? of Qd
?d
? of P
(90 80)
(0.117)
(90 80)/2
(0.545)
(10 8)
(0.222)
(10 8)/2
(110 80)
(0.015)
(110 80)/2
(10 8)
(0.222)
(10 8)/2
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• Remember, that elasticity and slope are different
  concepts!
• The slope is 1 at both ends of the demand curve

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• Demand curve D is more inelastic.

What happens to the equilibrium price and
quantity with an elastic demand curve, if supply
increases? With elastic demand curve, the
price effect is smaller and the quantity effect
is larger than with an inelastic demand curve.
What happens to the equilibrium price and
quantity with an inelastic demand curve, if
supply increases? With an inelastic demand
curve, the price effect is greater and the
quantity effect is smaller than with the elastic
demand curve.
21
Problem Involving Extra Credit
change in number of Qs
change in extra cr. pts.
22
Activity 8 Elasticity An Introduction

• Part A
• Now, suppose that your economics teacher
  currently allows you to earn extra credit by
  submitting answers to the end-of-the-chapter
  questions in your textbook.
• The number of questions youre willing to submit
  depends on the amount of extra credit for each
  question.
• How responsive you are to a change in the
  extra-credit points the teacher gives can be
  represented as an elasticity.

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• Write the formula for the elasticity of
  extra-credit submitted
• eps

Percentage change in number of questions
Percentage change in extra-credit points
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• Now, consider that your teachers goal is to get
  you to submit twice as many questions a
  100-percent increase. Underline the correct
  answer in parentheses.
• (A) If the number of chapter-end questions you
  submit is very responsive to a change in
  extra- credit points, then a given increase in
  extra credit elicits a large increase in
  questions submitted. In this case, your
  teacher will need to increase the extra-credit
  points by (more than / less than / exactly)
  100 percent.
• (B) If the number of chapter-end questions you
  submit is not very responsive to a change in
  extra-credit points, then a given increase in
  extra credit elicits a small increase in
  questions submitted. In this case, your
  teacher will need to increase the extra-credit
  points by (more than / less than / exactly)
  100 percent.

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• Part D Problem Involving Coffee
• Suppose Moonbucks, a national coffee-house
  franchise, finally moves into the little town of
  Middle-of-nowhere. Moonbucks is the only supplier
  of coffee in town and faces the following demand
  schedule each week.
• Write the correct answer on the answer blanks, or
  underline the correct answer in parentheses.

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What is the arc price elasticity of demand when
the price changes from 1 to 2?
.18
20
(180 160)
0.117
.12
170
(180 160)/2
(1 2) -1
1
.67
0.666
1.5
(1 2)/2
So, over this range of prices, demand is (elastic
/ unit elastic / inelastic).
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• What is the arc price elasticity of demand when
  the price changes from 5 to 6?

1.22
20
90
.22
1
.18
5.5
28

• So, over this range of prices, demand is (elastic
  / unit elastic / inelastic).
• Note Because the relationship between quantity
  demanded and price in inverse, price elasticity
  of demand would always be negative.
• Economists believe using negative numbers is
  confusing when referring to large or small
  elasticities of demand. Therefore, they use
  absolute or positive numbers, changing the sign
  on the negative numbers.

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• Part E
• Now, consider Figure 8.4, which graphs the demand
  schedule given in Figure 8.3.
• Recall the slope of a line is measured by the
  rise over the run
• Slope rise / run ?P / ?Q.

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Using your calculations of ?P and ?Q from
Question 3, calculate the slope of the demand
curve.
1/20 or 0.05
6. Using your calculations of ?P and ?Q
from Question 4, calculate the slope of the
demand curve.
1/20 or 0.05
Change in Price
Hint
Change in Quantity
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• The law of demand tells us that an increase in
  price results in a decrease in the quantity
  demanded.
• Questions 5 and 6 remind us that the slope of a
  straight line is constant everywhere along the
  line. Along this demand curve, a change in
  price of 1 generates a change in quantity
  demanded of 20 cups of coffee week.

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• (7. continued)
• Youve now shown mathematically that while the
  slope of the demand curve is related to
  elasticity, the two concepts are not the same
  thing. Briefly discuss the relationship between
  where you are along the demand curve and the
  elasticity of demand. How does this tie into the
  notion of responsiveness?

At a higher price, you are in the price elastic
portion of the demand curve. As you move to a
lower price along a demand curve, the demand
curve becomes more price inelastic. Thus, at a
high price, a small percentage change in price
leads to a large percentage change in quantity.
As the price decreases, the same percentage
change in price generates a smaller percentage
change in quantity, so the elasticity of demand
decreases.