Supply%20

1
Supply DemandElasticity Government Set
Prices

• Chapter 7

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Price Elasticity of Demand

• Measured by the responsiveness of consumers to a
  price change.
• Formula
• change in quantity demanded
• change in price

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Elimination of Minus Sign

• Price and quantity have an inverse relationship
• When using the elasticity formula, it will be a
  negative number.
• Ignore the minus sign to avoid any ambiguity

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Elastic Demand

• Demand is elastic if change in price results in
  a larger change in quantity demanded
• Formula results in a number greater than 1

5
Inelastic Demand

• Demand is inelastic if change in price produces
  a smaller change in demand
• Formula results in a number less than 1

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Unit Elastic Demand

• change in price and change in demand are the
  same
• Formula equals 1

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Extreme Cases

• Perfectly inelastic- price change results in no
  change in quantity demanded
• Perfectly elastic- small price reductions cause
  buyers to increase their purchases from zero to
  all they can obtain

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Midpoint Formula

• Change in quantity change in price
• Sum of quantities sum of prices

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Quantity Price Total Revenue (Price X Qty) Elasticity E, I, or U
1 8 --- ---
2 7
3 6
4 5
5 4
6 3
7 2
8 1
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Total-Revenue Test

• Total revenue- total amount sellers receive from
  sale of a product
• Price X Quantity sold
• Total revenue test looks at what happens to total
  revenue when product price changes

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Summary
Absolute Value Demand Is Description Impact on TR of a Price increase Impact on TR of a Price decrease
gt1 Elastic Qd changes by a larger than does price TR decreases TR increases
1 Unit Elastic Qd changes by the same as price TR is unchanged TR is unchanged
lt1 Inelastic Qd changes by a smaller than price TR increases TR decreases
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Price Elasticity Total Revenue Curve

• Comparison of curves D and TR shows relationship
  between elasticity and total revenue

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Determinants of Price Elasticity of Demand

• Substitutability
• Proportion of Income
• Luxuries vs. Necessities
• Time

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Price Elasticity of Supply

• If producers are responsive to a price change,
  supply is elastic vice versa
• Formula
• change in quantity supplied
• change in price

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Cross Elasticity of Demand

• Measures how sensitive consumer purchases of one
  product are to a change in price of some other
  product
• Formula
• change in qty demanded for product x
• change in price of product y

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Income Elasticity of Demand

• Formula
• change in quantity demanded
• change in income
• Measures the responsiveness of consumers to
  changes in income and the impact it has on demand

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Government Set Prices

• Price ceiling- maximum legal price a seller may
  charge
• Rationale enable consumers to obtain an
  essential product that they could not afford at
  equilibrium.

18
Black Markets

• Products are bought and sold at prices above the
  legal limits.
• Buyers are willing to pay more than the ceiling
  price which allows companies to make more
  profits.

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Price Floors Surpluses

• Minimum prices fixed by the government. A price
  at or above the price floor is legal.
• Examples include farm products that are already
  sold at low prices. Government raises the price
  to assist farmers to earn higher incomes.