Chapter 5 Elasticities of Dmand and Supply revised

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```					CHAPTER CHECKLIST
When you have completed your study of this
chapter, you will be able to
1   Define, explain the factors that influence, and
calculate the price elasticity of demand.
2   Define, explain the factors that influence, and
calculate the price elasticity of supply.
3   Define and explain the factors that influence the
cross elasticity of demand and the income elasticity
of demand.
Understanding Elasticity
Star Bucks Example
Bob: An increase in price for a
cup of latte is a great idea. We’ll
collect more money from our
customers.
Ann: Wait a minute, Bob.
Haven’t you heard about the law
of demand? An increase in price
will decrease the quantity of lattes
our customers will be willing to
purchase. We may not collect more
money.
Who is correct?
What is Elasticity?
How sensitive is the consumer
with respect to price changes in
the market place.

Elasticity describes
responsiveness (increase/decrease) in
the quantity demanded by
consumers to changes in prices.
How is the Price Elasticity of
Demand computed?

The ratio of the
percentage change in the
quantity demanded of a
product to a percentage
change in its price
(A)Price=\$2.0     Units = 50
(B)Price=\$3.0     Units = 10
Decrease in the number of units purchased is 40
P            B               Sales = TR = P x Q
\$3.0                         \$2.0 x 50 = \$100
\$3.0 x 10 = \$30
\$2.0                         A
Sales = TR =
decrease =
\$1.0                                  \$70 it seems
that Ann is
correct

Q         10      30      50
Price Elasticity of Demand
Formula on Page 112 & 113
THE PRICE ELASTICITY OF DEMAND
FORMULA ON PAGE 112 AND 113
Percentage Change in Quantity demanded
At \$2 quantity demanded is 50 cup of latte.
At \$3 quantity demanded is 10 cup of latte
What is the percentage change in quantity?

New Q – Initial Q
Percent change in Q =                                 x 100
Initial Q

10 – 50
Percent change in Q =                      x 100 = -80.00 percent
50
THE PRICE ELASTICITY OF DEMAND
FORMULA ON PAGE 112 AND 113

Percentage Change in Price
Suppose Starbucks raises the price of a latte from \$2
to \$3 a cup. What is the percentage change in price?

New price – Initial price
Percent change in price =                                x 100
Initial Price

\$3 – \$2
Percent change in price =                    x 100 = 50.00 percent
\$2
Price Elasticity of Demand
Formula on Page 112 & 113

Ignore the negative sign. Why?
Ed = 1.66         Ed > 1  elastic
Why is Elasticity +1.66 in the previous
example and not –1.66?

Economists drop the
negative sign because we
know from the law of demand
that quantity demanded and
price are inversely related.
The negative sign is
consistent with the theory.
(A)Price=\$2           Units = 30
(B)Price=\$3           Units = 25
Decrease in the number of units purchased is 5
P                                    \$3.0 x 25 = \$75
\$3.0                        B
\$2.0 x 30 = \$60
\$2.0                             A

\$1.0
C

Q         10 20 25 30 Sales = increase =
\$15 Bob is correct
THE PRICE ELASTICITY OF DEMAND
FORMULA ON PAGE 112 AND 113
Percentage Change in Quantity demanded
At \$2 quantity demanded is 30 cup of latte.
At \$3 quantity demanded is 25 cup of latte
What is the percentage change in quantity?

New Q – Initial Q
Percent change in Q =                                 x 100
Initial Q

25 – 30
Percent change in Q =                      x 100 = -16.66 percent
30
THE PRICE ELASTICITY OF DEMAND
FORMULA ON PAGE 112 AND 113

Percentage Change in Price
Suppose Starbucks raises the price of a latte from \$2
to \$3 a cup. What is the percentage change in price?

New price – Initial price
Percent change in price =                                x 100
Initial Price

\$3 – \$2
Percent change in price =                    x 100 = 50.00 percent
\$2
Price Elasticity of Demand
Formula on Page 112 & 113

Ignore the negative sign. Why?
Ed = 0.33         Ed < 1  inelastic
THE PRICE ELASTICITY OF DEMAND
Inelastic demand
If the percentage change in the quantity demanded is
less than the percentage change in price.
Perfectly elastic demand
When the quantity demanded changes by a very large
percentage in response to an almost zero percentage
change in price.
Perfectly inelastic demand
When the quantity demanded remains constant as the
price changes.
Practice Questions
Practice Questions
Practice Question
PRACTICE QUESTIONS
PRACTICE QUESTIONS
Applications practice questions
Applications practice questions
Reasons for different
elasticity.
 # of substitutes
 #of uses (single verses many)
 Passage of time
 Luxury vs. necessary goods
Price Elasticity of
\$40              Demand Ranges
\$35
\$30
\$25
\$20
\$15
\$10
\$5
5 10 15 20 25 30 35 40 45
A
CHAPTER CHECKLIST        B

D                  D

Which demand curve is for a vital
medicine and which is for candy?
THE PRICE ELASTICITY OF SUPPLY

Computing the Price Elasticity of Supply

Price elasticity        Percentage change in quantity supplied
of supply        =
Percentage change in quantity price

• If the price elasticity of supply is greater than 1,
supply is elastic.
• If the price elasticity of supply equals 1, supply is
unit elastic.
• If the price elasticity of supply is less than 1, supply
is inelastic.
THE PRICE ELASTICITY OF SUPPLY

 Figure shows an elastic supply: 10% increase in price
 More than 10% increase in supply.

1. A 10% rise in the price
of a book,
2. Increases the quantity
supplied by 20%.

3. The supply of books
is elastic.
INELASTIC SUPPLY SUPPLY CURV
Figure shows an inelastic supply: 20% increase in price leads less than
10% increase in supply.

1. A 20% rise in the price of
a hotel room,

2. Increases the quantity
supplied of hotel rooms by
10%.
3. The supply of hotel
rooms is inelastic.
PERFECTLY ELASTIC SUPPLY

Figure shows a perfectly elastic supply: small increase in price leads to
a large increase quantity in supply.

1. A small rise in the the price,

2. increases the quantity
supplied by a very large
amount,

3. Supply is perfectly elastic. Example, silicon is perfectly
elastic because silicon is extracted from sand at a tiny and
almost constant cost. Production possibilities are infinite.
PERFECTLY INELASTICITY OF SUPPLY

Figure shows a perfectly inelastic supply: Large increase in
price leads to no change quantity in supply.

1. A small rise in the price of
a beachfront lot,

2. Increases the quantity
supplied by 0%.

3. The supply of beachfront
lots is perfectly inelastic.
How does quantity supplied responds to
changes in price?

Influences on the Price Elasticity of Supply
The two main influences are:
• Production possibilities
• Storage possibilities
Production Possibilities
Goods that can be produced at a constant (or very
gently rising) opportunity cost have an elastic supply.

Goods that can be produced in only a fixed quantity
have a perfectly inelastic supply.
THE PRICE ELASTICITY OF SUPPLY

Time Elapsed Since Price Change
As time passes after a price change, producers find it
easier to change their production plans, so supply
becomes more elastic.
Storage Possibilities
The supply of a storable good is highly elastic.

The cost of storage is the main influence on the
elasticity of supply of a storable good.
CROSS ELASTICITIES

–The cross elasticity of demand for a substitute is
positive.

–The cross elasticity of demand for a complement is
negative.

cross price          % change in Q demanded for good A
elasticity of   =
demand                    % change in price of good B
Income Elasticity of Demand
Income elasticity of demand
A measure of the extent to which the demand for a good
changes when income changes, other things remaining
the same
Greater 1 the good is normal
Less than zero the good is inferior

Income              Percentage change in quantity demanded
elasticity of   =
demand                   Percentage change in income

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