Action

Markets
in Action
Price Elasticity of Demand
• Defining price elasticity of demand (Pε D)

– responsiveness of demand to a change in
price
Market supply and demand
S1
Price
a
P1
D
O Q1
Quantity
S2
S1
b
P2
Price
a
P1
D
O Q2 Q1
Quantity
S2
S1
b
P2
Price
a
P1
D'
D
O Q2 Q1
Quantity
S2
S1
b
P2
Price
c
P3
a
P1
D'
D
O Q3 Q2 Q1
Quantity
• Measuring price elasticity of demand

%∆ QD / %∆ P
– use of percentage changes
– the sign: positive or negative?
– the value: greater or less than 1?

Measuring elasticity using the arc method
10
m
8
n
P (£) 6
4
Demand
Q (000s)
10
∆Q ∆P
Pε d = ÷ mid P
mid Q
m
8
7 ∆ P = –2
n
∆ Q = 10
P (£) 6 Mid P
4
Demand
2
15
Mid Q Q (000s)
10
∆Q ∆P
Pε d = ÷ mid P
mid Q
m
10 −2
8
=
15
÷ 7
7 ∆ P = –2
n
∆ Q = 10
P (£) 6 Mid P
4
Demand
2
15
Mid Q Q (000s)
10
∆Q ∆P
Pε d = ÷ mid P
mid Q
m
10 −2
8
=
15
÷ 7
7 ∆ P = –2 = 10/15 x −7/2
n
∆ Q = 10
P (£) 6 Mid P
4
Demand
2
15
Mid Q Q (000s)
10
∆Q ∆P
Pε d = ÷ mid P
mid Q
m
10 −2
8
=
15
÷ 7
7 ∆ P = –2 = 10/15 x −7/2
n
= −70/30
∆ Q = 10
P (£) 6 Mid P
4
Demand
2
15
Mid Q Q (000s)
10
∆Q ∆P
Pε d = ÷ mid P
mid Q
m
10 −2
8
=
15
÷ 7
7 ∆ P = –2 = 10/15 x −7/2
n
= −70/30
∆ Q = 10 = −7/3 = −2.33
P (£) 6 Mid P
4
Demand
2
15
Mid Q Q (000s)
• Determinants of price elasticity of

demand
– number and closeness of substitute goods
– proportion of income spent on the good
– the time period

Price Elasticity of Demand and
Consumer Expenditure
• Defining total consumer expenditure

– TE = P × Q
• Illustrating TE graphically
Total expenditure
4
P(£)
2 Consumers’ total expenditure

=
firms’ total revenue
= D
1 £2 x 3m = £6m
Q (millions of units per period of time)


– TE = P × Q
• Effects of a price change: elastic

demand

– TE = P × Q

demand
– P rises: TE falls
Elastic demand between two points
Expenditure falls
as price rises
P(£)
b
5
a
4
D
0 10 20

– TE = P × Q
demand
– P falls: TE rises
Elastic demand between two points
Expenditure rises
as price falls
P(£)
b
5
a
4
D
0 10 20

– TE = P × Q
demand
• Effects of a price change: inelastic
demand

– TE = P × Q
demand
• Effects of a price change: inelastic
demand
– P rises: TE rises
Inelastic demand between two points
Expenditure rises
as price rises
c
8
P(£)
a
4
0 15 20

– TE = P × Q
• Effects of a price change: elastic demand
• Effects of a price change: inelastic demand
– P rises: TE rises
– P falls: TE falls
Inelastic demand between two points
Expenditure falls
as price falls
c
8
P(£)
a
4
0 15 20
• Special cases
– Pε D =0
Totally inelastic demand (P∈ D = 0)
P
D
P2 b
P1 a
O Q1 Q
• Special cases
– Pε D =0
– Pε D =∞
Infinitely elastic demand (P∈ D = ∞ )
P
a b
P1 D
O Q1 Q2
Q
• Special cases
– Pε D =0
– Pε D =∞
– Pε D = –1
Unit elastic demand (P∈ D = –1)
P
a
20
b
8
D
O 40 100 Q
• Special cases
– Pε D =0
– Pε D =∞
– Pε D = –1
• Applications to pricing decisions
Price Elasticity of Supply
• Meaning of price elasticity of supply
• Elasticity of supply and the supply curve

Supply curves with different price elasticity of supply
P
S1
P0
O Q0 Q
P
S1
S2
P0
O Q0 Q
P
S1
S2
P1
P0
O Q0 Q1 Q
P
S1
S2
P1
P0
O Q0 Q1 Q2 Q
Price Elasticity of Supply
• Measuring price elasticity of supply

%∆ QS / %∆ P
– elastic and inelastic supply
• Determinants of price elasticity of

supply
– amount that costs rise as output increases
– time period
Other Elasticities
• Income elasticity of demand

– measurement
– determinants
• degree of necessity
• rate at which people are satisfied
• level of income
– applications
• Cross-price elasticity of demand
– measurement
– determinants
– applications
Markets and Adjustment over Time
• Short-run and long-run adjustment

– short- and long-run supply curves
Response of supply to an increase in demand
P
P1
a
D1
O Q1 Q
P
P1
a
D2
D1
O Q1 Q
P
S short-run
b
P2
P1
a
D2
D1
O Q1 Q2 Q
P
S short-run
b S long-run
P2 c
P3
P1
a
D2
D1
O Q1 Q2 Q3 Q
• Short-run and long-run adjustment

– short- and long-run supply curves
– short- and long-run demand curves

Response of demand to an increase in supply
P
S1
a
P1
O Q1 Q
P
S1
S2
a
P1
O Q1 Q
P
S1
S2
a
P1
P2 b
D short-run
O Q1 Q2 Q
P
S1
S2
a
P1 c
P3
P2 b
D long-run
D short-run
O Q1 Q2 Q3 Q
• Price expectations and speculation

– stabilising speculation
Stabilising speculation: initial price fall
P
S1
P1 a
D1
O Q
P
S1
P1 a
D1
P2 b
D2
O Q
P
S2
S1
P1 a
P3 c
D1
P2 b
D2 D3
O Q
Stabilising speculation: initial price rise
P
S1
P1 a
D1
O Q
P
S1
P2 b
P1 a
D2
D1
O Q
P
S1
S2
P2 b
P3 c
P1 a
D2
D3
D1
O Q
• Price expectations and speculation

– stabilising speculation
– destabilising speculation
Destabilising speculation: initial price fall
P
S1
P1 a
D1
O Q
P
S1
P1 a
P2 b
D1
D2
O Q
P
S1
S2
P1 a
P2 b
P3 c
D1
D2
D3
O Q
Destabilising speculation: initial price rise
P
S1
P1 a
D1
O Q
P
S1
P2 b
P1 a
D2
D1
O Q
P
S2
S1
P3 c
P2 b
P1 a
D3
D2
D1
O Q
• Uncertainty and risk
– defining risk and uncertainty
– reducing risks by holding stocks
– a market in information
Markets where Prices are Controlled
• Minimum prices
– justification
– effects
Minimum price: price floor
P
S
Pe
O Q
Minimum price: price floor
P
S
minimum
surplus
price
Pe
O Qd Qs Q
• Minimum prices
– justification
– effects
– dealing with resulting surpluses
• Minimum prices
– justification
– effects
• Maximum prices
• Minimum prices
– justification
– effects
• Maximum prices
– justification
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
Maximum price: price ceiling
P
S
Pe
O Q
Maximum price: price ceiling
P
S
Pe
maximum
price
shortage
O Qs Qd Q
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
– dealing with resulting shortages
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
– rationing
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
– rationing
– black markets

Action

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Markets

• Defining price elasticity of demand (Pε D)

• Measuring price elasticity of demand

– use of percentage changes

– the sign: positive or negative?

– the value: greater or less than 1?

• Determinants of price elasticity of

– number and closeness of substitute goods

– proportion of income spent on the good

– the time period

• Defining total consumer expenditure

2 Consumers’ total expenditure

Q (millions of units per period of time)

• Defining total consumer expenditure

• Effects of a price change: elastic

• Defining total consumer expenditure

• Effects of a price change: elastic

• Defining total consumer expenditure

• Defining total consumer expenditure

• Defining total consumer expenditure

• Defining total consumer expenditure

• Meaning of price elasticity of supply

• Elasticity of supply and the supply curve

• Measuring price elasticity of supply

– elastic and inelastic supply

• Determinants of price elasticity of

– amount that costs rise as output increases

• Income elasticity of demand

• Short-run and long-run adjustment

• Short-run and long-run adjustment

– short- and long-run demand curves

• Price expectations and speculation

• Price expectations and speculation

• Uncertainty and risk

– defining risk and uncertainty

– reducing risks by holding stocks

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