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Porterville College California Community College by nikeborome

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									   Economics
    Combined Version
        Edwin G. Dolan
  Best Value Textbooks
             4th edition


         Chapter
Supply, Demand,
   and Elasticity




      Dolan, Microeconomics 4e, Ch. 3
                  Elasticity

 Elasticity: A way to measure responsiveness
   How responsive is a dependant variable to a change in
    the independent variable?
    or
   How much “bounce” do you get in your Quantity
    Demanded for a change in your price?

   Economics uses several
   different types of elasticity
Price Elasticity of Demand
 Definitions of Price Elasticity of Demand:
   The percentage change in the quantity demanded of a
    product divided by the percentage change in the price of
    the product.

   The percentage change in the quantity demanded
    caused by a one percent change in the price.
Price Elasticity of Demand -
- Simplified
 How sensitive is the quantity demanded
 to changes in price? … How responsive are consumers
 to price changes?
  A producer wants to know:
   How many sales will I lose if I increase my price?
   What if I lower my price?
   What effect will that have on my revenue?
Price Elasticity:
Mathematical Definition – the easy one
 The price elasticity of demand, ed, is:




 Example: If the quantity of movie tickets sold falls by
 3% when the price is raised by 1%, then the price
 elasticity of demand is -3/1 = -3.
Calculating Percentage Change
(The simple, standard way)
      Calculating Percentage Change
      (the Midpoint Method)




 Percent Change stays
  constant whether
  moving up or moving
  down.
Elasticity:
The all-out mathematical version
Sign of Price Elasticity
 According to the law of demand, whenever the price
 rises, the quantity demanded falls.
  Thus the price elasticity of demand is always
   negative.

 Because it is always negative, economists usually state
 the value without the sign.
Defining elasticities
 When price elasticity is between zero and -1 we say
 demand is inelastic.
  When demand is inelastic, revenue rises when price rises

 When price elasticity is between -1 and
 - infinity, we say demand is elastic.
  When demand is elastic, revenue falls when price rises

 When price elasticity is -1, we say demand is unit
 elastic.
  When demand is unit elastic, revenue is maximized and will
   decline if price rises or falls
        Demand Curve
        Shapes and Elasticity
 Perfectly Elastic Demand Curve
   The demand curve is horizontal, any change in price can and
    will cause consumers to change their consumption completely.
   An increase of $0.01 leads to a 100% decrease in sales


 Perfectly Inelastic Demand Curve
   The demand curve is vertical, the quantity demanded is totally
    unresponsive to the price. Changes in price have no effect on
    consumer demand.
   Even a large change in price will not effect the sales


 In between the two extreme shapes of demand curves are
 the demand curves for most products.
Demand Curve
Shapes and Elasticity
Price Elasticity Along
a Straight Line Demand Curve
 The price elasticity of demand changes as we move
  up or down a straight-line demand curve. The
  price elasticity becomes more inelastic as we move
  down the curve.

 If an entire demand curve (D2) is more elastic than
  another (D1) it means that at every single price,
  D2 is more elastic than on D1.
Elastic and Inelastic
 All downward-sloping straight-line demand curves are
 divided into three parts:
   Inelastic region: where ed < 1. (bottom half of curve)


   Unit elastic point: where ed = 1. (center of curve)


   Elastic region: where ed > 1. (top half of curve)


 All elasticies are percentages of change.
The Price Elasticity of Demand Along
   a Straight-line Demand Curve
Determinants of the
Price Elasticity of Demand
 The degree to which the price elasticity of demand is
 inelastic or elastic depends on:
   How many substitutes there are
       More substitutes make for greater elasticity
   How well a substitute can replace the good or service
    under consideration
       Closer substitutes make for greater elasticity
   The importance of the product in the consumer’s total
    budget
       Larger parts of the budget create greater price elasticity
   The time period under consideration
       The longer the time, the greater the elasticity
Using the Price Elasticity of Demand

Price Elasticity of Demand is crucially important to any
  firm manager:
 It tells a manager in a firm whether to raise or lower
  prices if they want to increase revenue.

 Total Revenue (TR) equals the price times the quantity
 sold: TR = P x Q.
Total Revenue and
Price Elasticity of Demand
 Total Revenue (TR) equals the price (P) of a
  product multiplied by the quantity sold (Q):

                     TR = P x Q

 Total revenue increases as price is increased if
  demand is inelastic, decreases as price is increased
 if demand is elastic, and does not change as price
 is increased if demand is unit-elastic.
Using the Price Elasticity of Demand

 The law of demand tells us that:

          Q decreases when P rises.
What is the optimal price to maximize total revenue?
 Answer: the price at the unit-elastic point. At any
  higher price – or any lower price – total revenue is
  decreased!
Total Revenue and Price Elasticity

  Price   Quantity   Revenue
  $1000   200        $200,000
  $900    400        $360,000
  $800    600        $480,000
  $700    800        $560,000
  $600    1000       $600,000
  $500    1200       $600,000
  $400    1400       $560,000
  $300    1600       $480,000
  $200    1800       $360,000
  $100    2000       $200,000
Price Discrimination
 Price discrimination is charging different
 customers different prices for the same product.

 Why do firms want to do this?
   When different groups of customers have different price
    elasticities of demand for the same product, total
    revenue can be increased by charging each of the groups
    a different price.

   The groups must be easily identifiable, and there must
    be little possibility of people from different groups
    trading with each other.
Dumping
 Dumping: A form of price discrimination wherein
 an identical good is sold to foreign buyers for a
 lower price than to domestic buyers.

 Predatory Dumping: dumping intended to drive
 rival firms out of business.

 Usually charges of “dumping” against foreign firms
  really are charges of “predatory dumping”.
Other Demand Elasticities
 Demand may respond to changes in other variables. The
 measures of such responses are also elasticities.
                                          j
                         %ΔQ
                             k
                         %ΔP
 Cross-Price Elasticity of Demand: The
  percentage change in the quantity demand for one
  good, divided by the percentage change in price of
  another good.
   Measures the degree to which goods are substitutes or
    complements.
       If the cross-price elasticity is positive, then the goods are
        substitutes.
       If the cross price elasticity is negative, then the goods are
        complements.
Other Demand Elasticities
 Income Elasticity of Demand: the percentage
 change in the quantity demanded divided by the
 percentage change in income.
                           %ΔQ
                           %ΔY
   Normal goods: goods for which the income elasticity of
    demand is positive.
   Inferior goods: Goods for which the income elasticity
    of demand is negative.
Necessities and Luxuries
 Goods with lower income elasticities are often
  called necessities, since the quantities demanded
  don’t vary much with income.
   Typical income elasticities are 0.4 or 0.5.


 Goods with higher income elasticities are often
  called luxuries, since people give them up readily
 when their incomes fall.
   Typical elasticities are 1.5 to 2.0.
The Price Elasticity of Supply
 The price elasticity of supply is the percentage change
 in the quantity supplied divided by the percentage
 change in price.
Price Elasticity of Supply
and Shape of Supply Curve
 The price elasticity of supply is either zero or a positive
  number.

 A zero price elasticity of supply means that the
  quantity supplied will not vary as the price varies.

 A positive price elasticity of supply means that as the
  price of an item rises, the quantity supplied rises.
Supply Curve
Shapes and Elasticity
Supply Elasticities
in the Long and Short Runs
 The shape of the supply curve depends heavily on
  the length of time being considered.
   In the short run, at least one of the resources used in
    production cannot be changed.
   In the long run, the firm has long enough to change any
    aspect of production, and therefore can more fully
    respond.
Interaction of Price
Elasticities of Demand and Supply
 Together, both the price elasticity of demand and the price
  elasticity of supply determine the full effect of a price
  change.

 If the price elasticity of supply of an item is large and the
  demand for it is price inelastic, then the firm can raise the
  price without losing revenue.

 Conversely, if the price elasticity of supply is small and the
  price elasticity of demand is large, then the firm is unable
  to raise the price because the consumer will switch to
  another firm or product.
Incidence and Taxes
 Incidence is the measure of who actually pays for a
 cost increase or a tax.

 In general, the more elastic the demand and the
  less elastic the supply the more the incidence of a
  tax falls on businesses and the less it falls on
  consumers.
 Tax Incidence and Revenue
 A tax imposed on a good that has an inelastic demand will generate more
  tax revenue than a tax on a good with elastic demand, assuming similar
  supply conditions.
 The diagrams below compare the effects of a $1.00 tax on the markets for
  milk (inelastic demand) and pork (elastic demand).




                     Dolan, Economics Combined Version 4e, Ch. 3
 Effect of Prohibition on Market for Cocaine
 Suppose the demand for
                                                        Supply and Demand for Cocaine
  cocaine is inelastic
 Sale of cocaine is prohibited,
  but the prohibition is not
  completely effective, shifting                          Prohibition
  the supply curve from S1 to S2
 As a result of prohibition, the
  total revenue from cocaine
  increases (PXQ at E2
  compared with PXQ at E1)                                Legal supply
 Some of the revenue is profit
  for drug dealers, some the
  extra cost of selling an illegal
  good.

                   Dolan, Economics Combined Version 4e, Ch. 3

								
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