econ quiz 1
kentucky79
Tucker.Ch05_LECTURE_SLIDES_EFT_9e.ppt*
Chapter 5
Price Elasticity of Demand and Supply
Lecture Slides
Economics for Today
Irvin B. Tucker
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What will I learn in this chapter?
- How to calculate price elasticity of demand and how this relates to total revenue (sales)
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What is price elasticity of demand?
- The responsiveness, or sensitivity, to a change in price
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What is the definition of price
elasticity of demand?
- The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price
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% in Q demanded
% in price
Ed =
Price Elasticity of Demand
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Suppose a university’s enrollment drops by 20% because tuition rises by 10%, what is the price elasticity of demand?
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Ed =
-20%
+10%
=
-.20
+.10
=
2
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Why is elasticity 2 in the previous example and not -2?
- Because we know from the law of demand that quantity demanded and price are inversely related
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Problem - When we move along a demand curve between two points, we get different answers to elasticity depending on whether we are moving up or down the demand curve
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How is the percent increase or decrease of two numbers calculated?
- Percent change is the difference between the two numbers divided by the original number
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A
B
P
D
Q
3
5
11
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If there is a decrease in quantity demanded of 5 units at point B to 3 units at point A on a demand curve, what is the percentage decrease?
(5-3)/5 = 2/5 = 40%
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A
B
P
D
Q
3
5
13
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If there is an increase from a quantity demanded of 3 units at point A on a demand curve to 5 units, what is the percentage increase?
(5-3)/3=2/3 = 66%
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Economists can solve this problem of different base points by using the midpoints as the base points of changes in prices and quantity demanded
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in quantity demanded
sum of quantities/2
divided by
in price
sum of prices/2
Price elasticity equals the
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%Q
%P
Ed =
Using the midpoints formula, how can price elasticity of demand be calculated?
=
Q2 – Q1
Q1 + Q2
P2 – P1
P1 + P2
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What is elastic demand?
- A condition in which the percentage change in quantity demanded is greater than the percentage change in price
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Price increase
Decrease in total revenue
Elastic Demand
Price decrease
Increase in total revenue
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40
30
20
10
10
20
30
40
A
B
Exhibit 1(a) Elastic Demand (Ed > 1)
Demand curve
Quantity of Tickets per Concert (thousands)
Price per Ticket (dollars)
0
20
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Why is the demand curve in the previous slide elastic?
- See the price elasticity of demand calculation in the following slide:
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20
40
=
.50
% change in Q =
% change in P =
10
50
=
.20
Ed =
% change in Q
% change in P
=
.50
.20
Ed = 2.50, which is > 1
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What is inelastic demand?
- The percentage change in the quantity demanded is less than the percentage change in price
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Price increase
Increase in total revenue
Inelastic Demand
Price decrease
Decrease in total revenue
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40
30
20
10
10
20
30
40
C
D
Exhibit 1(b) Inelastic Demand (Ed < 1)
Price per Ticket (dollars)
Quantity of Tickets per Concert (thousands)
Demand curve
0
25
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Why is the demand curve in the previous slide inelastic?
- See the price elasticity of demand calculation in the next slide:
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5
45
=
.11
% change in Q =
% change in P =
10
50
=
.20
Ed =
% change in Q
% change in P
=
.11
.20
= 0.55, which is < 1
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What is a unitary elastic demand curve?
- The percentage change in the quantity demanded is equal to the percentage change in price
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Price decrease
No change in total revenue
Unitary Elastic Demand
Price increase
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40
30
20
10
10
20
30
40
E
F
Exhibit 1(c) Unitary Elastic Demand (Ed = 1)
Demand curve
Price per Ticket (dollars)
Quantity of Tickets per Concert (thousands)
0
30
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Why is the demand curve in the previous slide unitary elastic?
- See the price elasticity of demand calculation in the next slide:
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10
50
=
.20
% change in Q =
% change in P =
10
50
=
.20
Ed =
% change in Q
% change in P
=
.20
.20
Ed = 1
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What is a perfectly elastic demand curve?
- An extreme condition in which a small percentage change in price brings about an infinite percentage change in the quantity demanded
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Price change
Infinite change in quantity demanded
Perfectly Elastic Demand
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40
30
20
10
10
20
30
40
Exhibit 2(a) Perfectly Elastic Demand (Ed=∞)
Demand
Price per Ticket (dollars)
Quantity of Tickets per Concert (thousands)
0
35
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Why is the demand curve in the previous slide perfectly elastic ?
- At a price of $20, buyers will purchase an infinite quantity. But at any other price, they will purchase zero. Therefore, the change in quantity demanded is infinite and Ed =∞.
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What is a perfectly inelastic demand curve?
- Another extreme condition in which the quantity demanded does not change as the price changes.
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Price change
Zero change in quantity demanded
Perfectly Inelastic Demand
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40
30
20
10
10
20
30
40
Exhibit 2(b) Perfectly Inelastic Demand (Ed = 0)
Demand
Price per Ticket (dollars)
Quantity of Tickets per Concert (thousands)
0
39
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Why is the demand curve in the previous slide perfectly inelastic ?
- Regardless of the percentage change in ticket price, buyers will purchase a quantity demanded of 20,000. Therefore, Ed =0.
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If demand is elastic - total revenue decreases
If a college raises tuition, what happens to total revenue?
If demand is unitary elastic – total revenue is constant
If demand is inelastic - total revenue increases
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If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic > 1
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If total revenue does not change when price increases, the demand curve is unitary elastic =1
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If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic < 1
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Does price elasticity of demand vary along a demand curve?
- Yes. The price elasticity of demand coefficient of demand applies only to a specific range of prices along the demand curve.
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*
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20
15
10
5
5
10
15
20
25
30
35
25
30
35
40
45
Exhibit 4(a) Price Elasticity of Demand Ranges
Elastic
Inelastic
Unitary elastic
40
Price per Ticket (dollars)
Quantity of Tickets per Concert (thousands)
(Ed
>1)
(Ed
<1)
(Ed
=1)
0
Demand
48
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200
150
100
50
5
10
15
20
250
300
350
400
25
30
35
40
45
Exhibit 4(b) Total Revenue Curve
Elastic
Inelastic
Unitary Elastic
Price per Ticket (thousands of dollars)
Quantity of Tickets per Concert (thousands)
TR
(Ed
=1)
(Ed
<1)
(Ed
>1)
0
49
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What factors influence demand elasticity?
- Availability of substitutes
- Share of budget on the product
- Adjustment to a price change over time
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What do substitutes have to do with a price change?
- The more substitutes a product has, the more sensitive consumers are to a price change, and the more elastic the demand curve
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What conclusion can we make concerning substitutes?
- The price elasticity of demand is directly related to the availability of good substitutes for a product
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A
B
D
D
Which demand curve is for a vital medicine and which is for candy?
54
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P
Q
0
P
Q
0
*
Why does curve A represent the demand curve for medicine?
- Because medicine is a necessity with few substitutes, and the price can change with little effect on the quantity demanded
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Why does curve B represent the demand curve for candy?
- Because candy has many substitutes, a price change can bring about a big change in the quantity demanded
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What does the share of one’s budget have to do with a price change?
- The larger the purchase is to one’s budget, the more sensitive consumers are to a price change, and the more elastic the demand curve
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What does time have to do with sensitivity?
- The longer consumers have to adjust, the more sensitive they are to a price change, and the more elastic the demand curve
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What conclusion can we make?
- In general, the price elasticity coefficient of demand is higher the longer a price change persists
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What are other elasticity measures?
- Income elasticity of demand
- Cross-elasticity of demand
61
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What is income elasticity of demand?
- The ratio of the percentage change in the quantity demanded of a good to a given percentage change in income
62
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% in Q demanded
% in income
Ed =
Income Elasticity of Demand
63
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64
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What is cross-elasticity of demand?
- The ratio of the percentage change in quantity demanded of a good to a given percentage change in price of another good
65
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% Q demanded of good A
% price of good B
Ec =
Cross-elasticity of Demand
66
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% in Q supplied
% in price
Es =
Price Elasticity of Supply
67
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Exhibit 8(a) Perfectly Elastic Supply
8
S
Es =
Quantity supplied
0
Q
P
Price
68
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0
Q
Exhibit 8(b) Perfectly Inelastic Supply
S
Es =
Quantity supplied
0
P
Price
69
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Exhibit 8(c) Unitary Elastic
S
10%
10%
Es = 1
Quantity supplied
Price
P1
P2
Q1
Q2
70
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71
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Who pays the tax levied on sellers of goods such as gasoline, cigarettes, and alcoholic beverages?
- It all depends; the corporation pays all, some, or very little of the tax
72
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What decides who pays what part of the tax increase?
- The more elastic the demand, the more the corporation pays; the less elastic the demand, the more the consumer pays
73
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Increase in gasoline tax
Decrease in supply
Consumers and suppliers share burden of tax
74
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3.00
2.75
2.50
2.25
5
10
15
20
3.25
3.50
3.75
30
35
40
45
s1
s2
Paid by Consumers
D
4.00
E1
E2
Before tax
After tax
Paid by Sellers
T
Exhibit 10(a)Tax Partially Shifted to Buyers
25
Quantity of gasoline (millions of gallons per day)
0
Price per gallon (dollars)
75
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Increase in gasoline tax
Decrease in supply
Consumers bear full burden of tax
76
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3.00
2.75
2.50
2.25
5
10
15
20
3.25
3.50
3.75
25
30
35
40
45
s1
s2
D
Paid by Consumers
Exhibit 10(b) Tax Fully Shifted to Buyers
4.00
E1
E2
Before tax
After tax
Price per gallon (dollars)
0
77
Quantity of Gasoline (millions of gallons per day)
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END
P
Q
0
P
Q
0
