Transcript Chapter 6

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What is something that you won’t “live without”?
What is something that you could “take or leave”?
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Extensions of
Demand and
Supply Analysis
Price Elasticity of Demand
 Measuring Responsiveness to
Price Changes
 Relatively Elastic or Inelastic
 Price-Elasticity Coefficient and
Formula
O 6.1
Ed =
Percentage Change in Quantity
Demanded of Product X
Percentage Change in Price
of Product X
Price Elasticity of Demand
 Formula
Ed =
Restated
Change in Quantity Demanded of X
Original Quantity Demanded of X
÷
Change in Price of X
Original Price of X
• Using Averages
• Midpoint Formula
Ed =
Change in Quantity
Sum of Quantities/2
÷
W 6.1
Change in Price
Sum of Prices/2
Price Elasticity of Demand
• Why Use Percentages?
• Elimination of the Minus
Sign
• Interpretations of Ed
Elastic Demand
Ed =
.04
.02
=2
.01
.02
= .5
.02
.02
=1
Inelastic Demand
Ed =
Unit Elasticity
Ed =
Price Elasticity of Demand
Extreme Cases
Perfectly Inelastic Demand
P
D1
Perfectly
Inelastic
Demand
(Ed = 0)
0
Q
Perfectly Elastic Demand
P
0
Perfectly
Elastic
Demand
(Ed = ∞)
D2
Q
The Total Revenue Test
 Total Revenue (TR)
TR = P x Q
Elastic Demand
W 6.2
P
$3
a
2
b
1
D1
0
10
20
30
40
Q
The Total Revenue Test
 Total Revenue (TR)
TR = P x Q
Inelastic
Demand
P
c
$4
3
2
d
1
D2
0
10
20
Q
W 6.2
The Total Revenue Test
 Total Revenue (TR)
TR = P x Q
Unit-Elastic
W 6.2
P
e
$3
2
f
1
D3
0
10
20
30
Q
Elasticity on a Linear Demand
Curve
Price Elasticity of Demand for Movie G 6.1
Tickets as Measured by the Elasticity
Coefficient and the Total-Revenue Test
(1)
Total Quantity of
Tickets Demanded
Per Week, Thousands
1
2
3
4
5
6
7
8
(2)
Price Per Ticket
8
]
7
]
6
]
5
]
4
]
3
]
2
]
1
(3)
Elasticity
Coefficient (Ed)
5.00
2.60
1.57
1.00
0.64
0.38
0.20
(4)
Total Revenue
(1) X (2)
$8,000
]
14,000
]
18,000
]
20,000
]
20,000
]
18,000
]
14,000
]
8,000
(5)
Total-Revenue
Test
Elastic
Elastic
Elastic
Unit Elastic
Inelastic
Inelastic
Inelastic
Graphically…
Price
Price Elasticity and the TotalRevenue Curve
$8 a
7
b
6
c
5
d
4
e
3
f
2
g
1
Elastic
Ed > 1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
h
D
0 1 2 3 4 5 6 7 8
Total Revenue
(Thousands of Dollars)
Quantity Demanded
$20
18
16
14
12
10
8
6
4
2
Elastic
Ed > 1
Unit Elastic
Ed = 1
TR
0 1 2 3 4 5 6 7 8
Quantity Demanded
Inelastic
Ed < 1
Determinants of Price
Elasticity of Demand
 Substitutability
 Proportion
of Income
 Luxuries versus Necessities
 Time
 Applications:
 Large Crop Yields
 Excise Taxes
 Decriminalization
of Illegal Drugs
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Do you supply more labor/day when the price for that
labor goes up?
Can you increase that amount just within a day? (or
would you have to reshuffle your schedule?)
Can you increase it in a month?
What about over 2 years?
… you become more elastic in your supply over time
See farmer example on page 348
Price Elasticity of Supply
Es =
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
See page 348, example at bottom of page.
Price Elasticity of Supply
O 6.2
Unit Elastic Supply
Es = 1
Market Period:
Not Enough Time to Shift Resources
P
Greatest
Price
Impact
Sm
Pm
P0
D1 D2
Q0
Q
Price Elasticity of Supply
Es =
Percentage Change in Quantity
Supplied of Product X
O 6.2
Percentage Change in Price
of Product X
Inelastic Supply
Es < 1
Short Run:
Resources Not Easily Shifted to Alternative Uses
P
Lower
Price
Impact
Ss
Ps
P0
D1 D2
Q0 Qs
Q
Price Elasticity of Supply
Es =
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
Elastic Supply
Es > 1
Long Run:
Resources Easily Shifted to Alternative Uses
P
Sl
Least
Price
Impact
Pl
P0
D1 D2
Q0 Ql
Q
O 6.2
Price Elasticity of Supply
Applications
 Antiques
and
Reproductions
 Volatile Gold Prices
Cross elasticity
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Will a price decrease on Sprite cannibalize demand from
Coke? (Same company)
Depends on the cross elasticity of demand
Coca-Cola Inc. would need to know what the percentage
change in quantity demanded of coke versus the
percentage change in price of Sprite
Equation looks like …
Cross Elasticity of Demand
Exy =
Percentage Change in Quantity
Demanded of Product X
Percentage Change in Price
of Product Y
 Substitute
Goods – Positive Sign
 Complementary GoodsNegative Sign
 Independent Goods – Zero or
Near-Zero Value
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Do you buy more Gatorade when your income increases?
It does if Gatorade is a normal good.
But how much more? That’s where Income Elasticity of
Demand comes in.
Income Elasticity of Demand
Ei =
 Normal
 Positive
 Inferior
Percentage Change in Quantity
Demanded
Percentage Change in Income
Goods –
Sign
Goods-
Negative Sign
 Insights
into the Economy …
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Income has grown 2 to 3 %
… agriculture has had an Ei = +.2
… housing has had an Ei = +1.4
They’re both normal goods, they both a positive Ei
What might have a negative Ei?
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On your income, what’s the max that you’d pay for a
gallon of gas in any given week?
What do you actually pay?
The difference is your “consumer surplus”
What do you suppose is the lowest price for a gallon that
would cause a station to supply a gallon?
The difference between that and the going price is the
“producer surplus”
Consumer and Producer Surplus
Consumer Surplus
O 6.3
Price (Per Bag)
Consumer
Surplus
Equilibrium
Price = $8
P1
D
Q1
Quantity (Bags)
Consumer and Producer Surplus
Producer Surplus
Price (Per Bag)
S
Equilibrium
Price = $8
P1
Producer
Surplus
Q1
Quantity (Bags)
Consumer and Producer Surplus
Efficiency Revisited
S
Price (Per Bag)
Consumer
Surplus
W 6.3
Equilibrium
Price = $8
P1
Producer
Surplus
D
Q1
Quantity (Bags)
Consumer and Producer Surplus
Efficiency Revisited
Efficiency Losses (Deadweight Losses)
S
Price (Per Bag)
Efficiency
Losses
P1
D
Q2
Q1
Q3
Quantity (Bags)
Elasticity and Pricing Power:
Why Different Consumers
Pay Different Prices
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All Buyers in a Highly Competitive Market Pay
the Same Price Regardless of Their Elasticities
Difficulty in Applying Different Prices
Observe Differences in Group Elasticities
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Business Travelers
Leisure Travelers
Discounting for Children
Different Net Prices for College Tuition