Chapter 20 Elasticity of Supply and Demand.ppt

ElasticityofDemand Supply PriceElasticityofDemandThelawofdemandtellsusthatconsumerswillrespondtoapricedecreasebybuyingmoreofaproduct otherthingsremainingconstant butitdoesnottellushowmuchmore Thedegreeofresponsivenessorsensitivityofconsumerstoachangeinpriceismeasuredbytheconceptofpriceelasticityofdemand Ifconsumersarerelativelyresponsivetopricechanges demandissaidtobeelastic Ifconsumersarerelativelyunresponsivetopricechanges demandissaidtobeinelastic Notethatwithbothelasticandinelasticdemand consumersbehaveaccordingtothelawofdemand thatis theyareresponsivetopricechanges Thetermselasticorinelasticdescribethedegreeofresponsiveness PriceelasticityformulaQuantitativemeasureofelasticity Ed changeinquantity changeinprice Calculatethepercentagechangeinquantitybydividingtheabsolutechangeinquantitybytheoriginalquantity Calculatethepercentagechangeinpricebydividingtheabsolutechangeinpricebytheoriginalprice Thepercentagechangeinprice Thepercentagechangeinquantity 1 2 Elasticityis 5 Q P P1 P2 Q1 Q2 D MeasuresResponsivenesstoPriceChanges PRICEELASTICITYOFDEMAND Thepercentagechangeinprice Thepercentagechangeinquantity Q P P1 P2 Q1 Q2 D CommonlyExpressedas PRICEELASTICITYOFDEMAND Elasticityis 5 PRICEELASTICITYOFDEMAND Percentagesmakesitpossibletocompareelasticitiesofdemandfordifferentproducts Becauseoftheinverserelationshipbetweenpriceandquantitydemanded theactualelasticityofdemandwillbeanegativenumber However weignoretheminussignandusetheabsolutevalueofbothpercentagechanges Ifthecoefficientofelasticityofdemandisanumbergreaterthanone wesaydemandiselastic ifthecoefficientislessthanone wesaydemandisinelastic Inotherwords thequantitydemandedis relativelyresponsive whenEdisgreaterthan1and relativelyunresponsive whenEdislessthan1 Aspecialcaseisifthecoefficientequalsone thisiscalledunitelasticity Note Inelasticdemanddoesnotmeanthatconsumersarecompletelyunresponsive Thisextremesituationcalledperfectlyinelasticdemandwouldbeveryrare andthedemandcurvewouldbevertical Likewise elasticdemanddoesnotmeanconsumersarecompletelyresponsivetoapricechange Thisextremesituation inwhichasmallpricereductionwouldcausebuyerstoincreasetheirpurchasesfromzerotoallthatitispossibletoobtain isperfectlyelasticdemand andthedemandcurvewouldbehorizontal ThemidpointformulaforelasticityisEd changeinQ sumofQs 2 dividedby changeinP sumofPs 2 SummaryofPriceelasticitieofDemandrelativelyelasticEd 1 unitaryelasticEd 1 relativeinelasticEd 1 Extremecases perfectlyelasticEd perfectlyinelasticEd 0 ExtremeCases PRICEELASTICITYOFDEMAND PerfectlyInelasticDemand PerfectlyElasticDemand P 0 P 0 D1 Ed 0 D2 Ed Q Q ElasticityvariesoverrangeofpricesDemandismoreelasticinupperleftportionofcurve becausepriceishigherandquantitysmaller Demandismoreinelasticinlowerrightportionofcurve becausepriceislowerandquantitylarger Itisimpossibletojudgeelasticityofasingledemandcurvebyitsflatnessorsteepness sincedemandelasticitycanmeasurebothaselasticandasinelasticatdifferentpointsonthesamedemandcurve TotalRevenueTestAtotal revenuetestistheeasiestwaytojudgewhetherdemandiselasticorinelastic Thistestcanbeusedinplaceofanelasticityformula unlessthereisaneedtodeterminetheelasticitycoefficient Elasticdemandandthetotal revenuetest Demandiselasticifadecreaseinpriceresultsinariseintotalrevenue orifanincreaseinpriceresultsinadeclineintotalrevenue Priceandrevenuemoveinoppositedirections Inelasticdemandandthetotal revenuetest Demandisinelasticifadecreaseinpriceresultsinafallintotalrevenue oranincreaseinpriceresultsinariseintotalrevenue Priceandrevenuemoveinsamedirection Unitelasticityandthetotal revenuetest Demandhasunitelasticityiftotalrevenuedoesnotchangewhenthepricechanges ThegraphicalrepresentationoftherelationshipbetweentotalrevenueandpriceelasticityisshowninFig 20 2 Q P D Whenpricesarelow TR QuantityDemanded PRICEELASTICITY TOTALREVENUE Soistotalrevenue Q P D Totalrevenueriseswithpricetoapoint TR QuantityDemanded PRICEELASTICITY TOTALREVENUE Q P D Totalrevenueriseswithpricetoapoint thendeclines TR QuantityDemanded PRICEELASTICITY TOTALREVENUE Q P D Totalrevenueriseswithpricetoapoint thendeclines TR QuantityDemanded PRICEELASTICITY TOTALREVENUE Q P D Totalrevenueriseswithpricetoapoint thendeclines TR QuantityDemanded PRICEELASTICITY TOTALREVENUE TotalRevenueTest Q P D Totalrevenueriseswithpricetoapoint thendeclines InelasticDemand InelasticDemand TR QuantityDemanded PRICEELASTICITY TOTALREVENUE Q P D Totalrevenueriseswithpricetoapoint thendeclines ElasticDemand ElasticDemand InelasticDemand TR QuantityDemanded PRICEELASTICITY TOTALREVENUE InelasticDemand Q P D Totalrevenueriseswithpricetoapoint thendeclines ElasticDemand ElasticDemand InelasticDemand TR QuantityDemanded PRICEELASTICITY TOTALREVENUE InelasticDemand UnitElastic DeterminantsofPriceElasticity Substitutesfortheproduct Generally themoresubstitutes themoreelasticthedemand 2 Theproportionofpricerelativetoincome Generally thelargertheexpenditurerelativetosomeone sbudget themoreelasticthedemand becausebuyersnoticethechangeinpricemore 3 LuxuryversusnecessaryProducts Generally thelessnecessarytheitem themoreelasticthedemand 4 Time Generally thelongerthetimeperiodinvolved themoreelasticthedemandbecomes ThepracticalapplicationsofthepriceelasticityofdemandInelasticdemandforagriculturalproductshelpstoexplainwhygoodcropsdepressthepricesandtotalrevenuesforfarmers Governmentslookatelasticityofdemandwhenlevyingexcisetaxes Excisetaxesonproductswithinelasticdemandwillraisethemostrevenueandhavetheleastimpactonquantitydemandedforthoseproducts Demandfordrugsishighlyinelasticandpresentsproblemsforlawenforcement Stricterenforcementreducessupply raisespricesandrevenuesforsellers andprovidesmoreincentivesforsellerstoremaininbusiness Crimemayalsoincreaseasbuyershavetofindmoremoneytobuytheirdrugs PriceElasticityofSupplyTheconceptofpriceelasticityalsoappliestosupply Theelasticityformulaisthesameasthatfordemand butwemustsubstitutetheword supplied fortheword demanded everywhereintheformula Es percentagechangeinquantitysupplied percentagechangeinpriceAswithpriceelasticityofdemand themidpointsformulaismoreaccurate Now comparetheimmediatemarketperiod theshort run andlongrun PRICEELASTICITYOFSUPPLY Theeaseofshiftingresourcesbetweenalternativeusesisveryimportantinpriceelasticityofsupplybecauseitwilldeterminehowmuchflexibilityaproducerhastoadjusthisorheroutputtoachangeintheprice Thedegreeofflexibility andthereforethetimeperiod willbedifferentindifferentindustries Figure20 3 Themarketperiodissoshortthatelasticityofsupplyisinelastic itcouldbealmostperfectlyinelasticorvertical Inthissituation itisvirtuallyimpossibleforproducerstoadjusttheirresourcesandchangethequantitysupplied Thinkofadjustmentsonafarmoncethecrophasbeenplanted Po P Q D1 Qo Anincreaseindemandwithoutenoughtimetochangesupplycauses Sm ImmediateMarketperiod PRICEELASTICITYOFSUPPLY Po Pm P Q D1 Qo D2 Anincreaseindemandwithoutenoughtimetochangesupplycauses anincreaseinprice Sm ImmediateMarketperiod PRICEELASTICITYOFSUPPLY Po P Q D1 Qo ShortRun PRICEELASTICITYOFSUPPLY Anincreaseindemandwithlessintensitysupplyusecauses Ss Po P Q D1 Qo D2 ShortRun PRICEELASTICITYOFSUPPLY Ps Anincreaseindemandwithlessintensitysupplyusecauses alowerincreaseinprice Ss Qs Po P Q D1 Qo LongRun PRICEELASTICITYOFSUPPLY Anincreaseindemandinthelongrunallowsgreaterchangecausing SL Po P Q D1 Qo D2 LongRun PRICEELASTICITYOFSUPPLY PL Anincreaseindemandinthelongrunallowsgreaterchangecausing SL QL Evenmoreelasticresponse lesspriceincrease Theshort runsupplyelasticityismoreelasticthanthemarketperiodandwilldependontheabilityofproducerstorespondtopricechange Industrialproducersareabletomakesomeoutputchangesbyhavingworkersworkovertimeorbybringingonanextrashift Thelong runsupplyelasticityisthemostelastic becausemoreadjustmentscanbemadeovertimeandquantitycanbechangedmorerelativetoasmallchangeinprice asinFigure20 3c Theproducerhastimetobuildanewplant Applicationsofthepriceelasticityofsupply Antiquesandothernon reproduciblecommoditiesareinelasticinsupply sometimesthesupplyisperfectlyinelastic Thismakestheirpriceshighlysusceptibletofluctuationsindemand 2 Goldpricesarevolatilebecausethesupplyofgoldishighlyinelastic andunstabledemandresultingfromspeculationcausespricestofluctuatesi