ECO 182 (Micro) CH 05 Elasticity of Demand and Supply

ECO 182 Chapter 5 Elasticity of Demand and Supply
PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5
Price Elasticity of Demand

Elasticity
Responsiveness
Price elasticity of demand

How responsive quantity demanded is to a price change Formula: percentage change in quantity demanded divided by percentage change in price

%q ED = %p q p ED = (q + q' ) / 2 ( p + p' ) / 2
%q = percentage change in quantity
q = change in quantity p = change in price

3
%p = percentage change in price

Price elasticity of demand, ED
Law of demand
o Price and quantity demanded are inversely related
ED negative Absolute value of ED positive
Exhibit 1
Demand Curve for Tacos

a b
$1.10
Price per taco
0.90
D 0 95 105 Thousands per day
If the price of tacos drops from $1.10 to $0.90, the quantity demanded increases from 95,000 to 105,000.
If %q < %p
Categories of ED Inelastic, Unit Elastic, Elastic
A change in price has relatively little effect on quantity demanded ED between 0 and 1 Inelastic demand
If %q = %p
ED = 1 Unit elastic demand
Categories of ED
If %q > %p
A change in price has a relatively large effect on quantity demanded ED greater than 1 Elastic demand
Elasticity and Total Revenue

Total revenue = price * quantity demanded at this price TR= p q As price decreases
If demand is elastic, TR increases If demand is inelastic, TR decreases If demand is unit elastic, TR constant
Price Elasticity and Linear D Curve

Linear demand curve
Straight line demand curve Constant slope Varying elasticity
Demand becomes less elastic as we move downward
Upper half: elastic Lower half: inelastic Midpoint: unit elastic

Exhibit 2
$100 90 80 70 60 50 40 30 20 10
Demand, Price Elasticity, and Total Revenue

(a) Demand and price elasticity a b
Unit elastic, ED =1 Elastic, ED >1
c d
100 200 500
Inelastic, ED <1
Where the demand curve is elastic, a lower price increases total revenue. Total revenue reaches a maximum at the rate of output where the demand curve is unit elastic.
Price per unit
D
Quantity per period
800 900 1,000
(b) Total revenue

Total revenue
25,000
Total revenue
Where the demand curve is inelastic, further decreases in price reduce total revenue.
500
1,000
Quantity per period

10
Constant Elasticity Demand Curves

Perfectly elastic demand curve
Horizontal line
Any price increase would reduce quantity demanded to zero
ED = Consumers dont tolerate price increases
11

Perfectly inelastic demand curve
Vertical line
Any price change has no effect on the quantity demanded
ED = 0 Price is no object
12

Unit-elastic demand curve
Everywhere along the demand curve
% p causes an equal but offsetting %q Total revenue remains the same
ED = 1
Constant-elasticity demand curve

Price elasticity is the same everywhere along the curve Elasticity value is unchanged
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Exhibit 3
Price per unit
Constant-Elasticity Demand Curves

Price per unit
D
Price per unit
(a) Perfectly elastic
(b) Perfectly inelastic
(c) Unit elastic
ED = 1 a b D 60 100 Quantity per period
ED = 0 $10 6
ED =
0 Quantity per period
The three panels show constant-elasticity demand curves, so named because the elasticity value does not change along the demand curve. Along the perfectly elastic, or horizontal, demand curve of panel (a), consumers demand all that is offered for sale at price p, but demand nothing at a price above p. Along the perfectly inelastic, or vertical, demand curve of panel (b), consumers demand amount Q regardless of price. Along the unit-elastic demand curve of panel (c), total revenue is the same for each price-quantity combination.
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Exhibit 4
Summary of Price Elasticity of Demand
15
Determinants of Price Elasticity of D

ED is greater:
The greater the availability of substitutes, and the more similar the substitutes The more important the good as a share of the consumers budget The longer the period of adjustment (time)
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Exhibit 5
Demand Becomes More Elastic Over Time
Price per unit
$1.25
1.00
Dw 0 50 75 95 100
Dm
Dy
Quantity per day
Dw is the demand curve one week after a price increase from $1.00 to $1.25. Along this curve, quantity demanded per day falls from 100 to 95. One month after the price increase, quantity demanded has fallen to 75 along Dm. One year after the price increase, quantity demanded has fallen to 50 along Dy. At any given price, Dy is more elastic than Dm, which is more elastic than Dw.
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Elasticity Estimates
Short run
Consumers have little time to adjust
Long run
Consumers can fully adjust to a price change
Demand is more elastic in the long run
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Exhibit 6
Selected Price Elasticities of Demand (Absolute Values)
19
Deterring Young Smokers
Health hazard
Kills 440,000 Americans a year
10 times more than traffic accidents Lung cancer Heart disease Emphysema Stroke
20
Cost to society
More than $7 per pack sold in
Higher health cost Lost worker productivity
Total: more than $150 billion a year

More than $3,400 per smoker per year
21
About 80% of adult smokers

Began before the age of 18
Each day
3,500 U.S. teens under 18 try smoking for the first time One third become regular smokers
22
Discouraging smoking
Prohibit the sale of cigarettes to minors Higher cigarette tax
ED is higher for teens
Big share of budget Less peer pressure Not an addiction yet
Reduces teen smoking
Change consumer tastes

Health warnings
23
Price Elasticity of Supply

Elasticity
Responsiveness
Price elasticity of supply

Responsiveness of quantity supplied to a price change Percentage change in quantity supplied divided by percentage change in price
24

%q ES = %p q p ES = (q + q' ) / 2 ( p + p' ) / 2
Law of supply ES positive
25
Exhibit 7
Price per unit
S p
Quantity per period
If the price increases from p to p, the quantity supplied increases from q to q. Price and quantity supplied move in the same direction, so the price elasticity of supply is a positive number.
26
Categories of ES Inelastic, Unit Elastic, Elastic

If %q < %p
A change in price has relatively little effect on quantity supplied ES between 0 and 1 Inelastic supply
If %q = %p
ES = 1 Unit elastic supply
27
Categories of ES
If %q > %p
A change in price has a relatively large effect on quantity supplied ES greater than 1 Elastic supply
28
Constant Elasticity Supply Curves

Perfectly elastic supply curve
Horizontal line
o Any price decrease drops the quantity supplied to zero
ES =
Unit-elastic supply curve, ES=1

%p causes an identical %q Straight line from the origin
29
Constant Elasticity Supply Curves

Perfectly inelastic supply curve
Vertical line
o A price change has no effect on the quantity supplied
ES = 0 Goods in fixed supply
30
Exhibit 8
Constant-Elasticity Supply Curves
Price per unit Price per unit
S
Price per unit
(a) Perfectly elastic
(b) Perfectly inelastic
(c) Unit elastic S
ES = 1
ES = 0 $10 5
ES =
10 20
Quantity per period
In each of the three panels is a constant-elasticity supply curve, so named because the elasticity value does not change along the curve. Supply curve S in panel (a) is perfectly elastic, or horizontal. Along S, firms supply any amount of output demanded at price p, but supply none at prices below p. Supply curve S is perfectly inelastic, or vertical. S shows that the quantity supplied is independent of the price. In panel (c), S, a straight line from the origin, is a unit-elastic supply curve. Any percentage change in price results in the same percentage change in quantity supplied.
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Determinants of Supply Elasticity

ES is greater:
If the marginal cost rises slowly as output expands The longer the period of adjustment (time)
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Exhibit 9
Supply Becomes More Elastic Over Time
Sw Sm Sy $1.25
Price per unit
1.00
Quantity per day 0 100 110 140 200 The supply curve one week after a price increase, Sw, is less elastic, at a given price, than the supply curve one month later, Sm, which is less elastic than the supply curve one year later, Sy. Given a price increase from $1.00 to $1.25, quantity supplied per day increases to 110 units after one week, to 140 units after one month, and to 200 units after one year.
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Income Elasticity of Demand

Income elasticity of demand
Demand responsiveness to a change in consumer income Percentage change in demand divided by the percentage change in income that caused it
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Income Elasticity of Demand

Inferior goods
Negative income elasticity
Normal goods
Positive income elasticity Income inelastic, necessities
o Elasticity between 0 and 1
Income elastic, luxuries

o Elasticity > 1
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Exhibit 10
Selected Income Elasticities of Demand
36
Market for Food & the Farm Problem
1950: 10 millions family farms Today: less than 3 millions Demand

Price inelastic
o Total revenue falls when P falls
Income inelastic: D increases
Supply
Technological improvements: S increases
37
Exhibit 11
The Demand for Grain
Price per bushel
$5 4 3 2 1 D 0 5 10 11 Billions of bushels per year
The demand for grain tends to be price inelastic. As the market price falls, so does total revenue.
38
Exhibit 12
The Effect of Increases in Demand and Supply on Farm Revenue
S Over time, technological advances in farming have sharply increased the supply of grain. In addition, increases in consumer income over time have increased the demand for farm products. But because increases in the supply of grain exceed increases in demand, the combined effect is a drop in the market price and a fall in total farm revenue.
Price per bushel
$8
4 D D 0 5 10 14
Billions of bushels per year
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Cross-Price Elasticity of Demand

Cross-price elasticity of demand
The percentage change in the demand of one good, divided by the percentage change in the price of another good Positive for substitutes Negative for complements Zero for unrelated goods
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Appendix Price Elasticity and Tax Incidence

Tax
Decrease in supply by the amount of tax
Tax incidence
Consumers : high price Producers: lower net-of-tax receipt
41
Appendix Price Elasticity and Tax Incidence

The more price elastic the demand:
The more tax producers pay The less tax consumers pay
The more elastic the supply:

The less tax producers pay The more tax consumers pay
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Exhibit 13
Effects of Price Elasticity of Demand on Tax Incidence
(a) Less elastic demand St $1.15 (b) More elastic demand $0.20 Tax $1.05 1.00 0.85 D St
Price per ounce
$0.20 Tax
D 0 9 10
Price per ounce
1.00 0.95
Millions of ounces per day
10
The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. In panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the more the tax is paid by producers in the form of a lower net-of-tax receipt.
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Exhibit 14
Effects of Price Elasticity of Supply on Tax Incidence
(a) More elastic supply $0.20 Tax St $1.15 (b) Less elastic supply St $1.05 1.00 0.85 D S
Price per ounce
10
Price per ounce
1.00 0.95
$0.20 Tax
9 10
The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. In panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the more the tax is paid by producers in the form of a lower net-of-tax receipt.
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ECO 182 (Micro) CH 05 Elasticity of Demand and Supply

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ECO 182 Chapter 5 Elasticity of Demand and Supply

PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University

Price Elasticity of Demand

Price elasticity of demand

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Price Elasticity of Demand

q = change in quantity p = change in price

%p = percentage change in price

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Price Elasticity of Demand

ED negative Absolute value of ED positive

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Demand Curve for Tacos

Price per taco

D 0 95 105 Thousands per day

Categories of ED Inelastic, Unit Elastic, Elastic

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Elasticity and Total Revenue

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Price Elasticity and Linear D Curve

Upper half: elastic Lower half: inelastic Midpoint: unit elastic

Demand, Price Elasticity, and Total Revenue

Price per unit

800 900 1,000

(b) Total revenue

Quantity per period

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Constant Elasticity Demand Curves

ED = Consumers dont tolerate price increases

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Constant Elasticity Demand Curves

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Constant Elasticity Demand Curves

Constant-elasticity demand curve

Constant-Elasticity Demand Curves

Price per unit

(a) Perfectly elastic

(b) Perfectly inelastic

(c) Unit elastic

ED = 1 a b D 60 100 Quantity per period

0 Quantity per period

0 Quantity per period

Summary of Price Elasticity of Demand

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Determinants of Price Elasticity of D

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Price per unit

Quantity per day

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Demand is more elastic in the long run

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Deterring Young Smokers

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Deterring Young Smokers

Total: more than $150 billion a year

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Deterring Young Smokers

About 80% of adult smokers

Dr. Baban Hasnat, UB/SIM, ECO 182 Microeconomics, Ch. 5

Deterring Young Smokers

Reduces teen smoking