# Chapter 5 Elasticity of Demand and Supply. These slides supplement the textbook, but should not replace reading the textbook

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1 Chapter 5 Elasticity of Demand and Supply These slides supplement the textbook, but should not replace reading the textbook 1

2 What is total revenue? Price multiplied by the quantity sold at that price P X Q 2

3 If you own a business and your raise price, will your total revenue go up or down? That all depends on the price elasticity of demand for your product 3

4 When price increases what two things happen? more money is made per unit fewer units are sold 4

5 What is price elasticity of demand? A measure of the responsiveness of quantity demanded to a price change 5

6 How do I measure responsiveness? You measure the percent change in quantity demanded when price changes 6

7 How do I measure a percent change in quantity? You take the difference between the two quantities and divide by the original number 7

8 For example, if there is an increase from 3 units to 5, what is the percentage increase? The percent increase is 67% 8

9 How do I know this? The difference between the two numbers is 2 and the original number is 3 9

10 So 2/3 = 67% 10

11 If there is a decrease from 5 units to 3, what is the percent decrease? 2/5 = 40% 11

12 How do I calculate price elasticity of demand? Price elasticity of demand = % change in quantity % change in price 12

13 If NRCC raises tuition, what happens to total revenue? If demand is elastic - revenue goes down If demand is inelastic - revenue goes up 13

14 When price increases what two things happen? more money is made per unit fewer units are sold 14

15 If I increase my price from \$1.00 to \$1.10, how will this effect my revenue? The answer depends upon the price elasticity of demand for your product 15

16 When price increases and there is a net loss in revenue, the demand curve is price elastic, > 1 16

17 When price increases demand is elastic when? More money is lost because of the fewer units sold then the money gained because of the higher price 17

18 When price increases and there is a net gain in revenue, the demand curve is price inelastic, < 1 18

19 When price increases demand is inelastic when? More money is gained because of the higher price then the money lost because of the fewer units sold 19

20 What do elastic demand curves look like? Elastic demand curves are more horizontal than inelastic demand curves 20

21 What do inelastic demand curves look like? Inelastic demand curves are more vertical than elastic demand curves 21

22 P A P B oil Ice cream 0 D Q 0 D Q Which of the above demand curves is oil and which ice cream? 22

23 Why is the demand curve for oil more inelastic? oil is a necessity oil has few substitutes 23

24 Why is the demand curve for ice cream more elastic? Ice cream is a luxury ice cream has many substitutes 24

25 If tripling of the price triples the quantity of a good supplied, then price elasticity of supply is? One 25

26 If a \$1 increase in price leads to a 3-unit decrease in quantity demanded, then demand must be elastic? False, the dollar increase is not given as a percent change 26

27 What is unit-elastic demand? The type of demand that exists when a percent change in price causes an equal (but of opposite sign) percent change in quantity demanded 27

28 If total revenue does not change when price increases, the demand curve is unitary elastic, value equals -1 28

29 What determines the price elasticity of demand? substitutes consumers budgets time need 29

30 What do substitutes have to do with elasticity? The more substitutes the more elastic is the demand 30

31 How does the price elasticity of demand for running shoes compare to Nike running shoes? The demand for running shoes is less elastic than the demand for Nike running shoes 31

32 How does my budget effect demand? The smaller the price of something is in relation to your budget, the more inelastic the demand 32

33 What does time have to do with elasticity? The more time to adjust to a price change the more elastic the demand 33

34 Demand Becomes More Elastic Over Time Price per unit \$1.25 \$1.00 W=week M=month Y=year D W D Y D M Quantity per period 34

35 What does need have to do with elasticity? The greater the need the more inelastic the demand 35

36 How do I measure the price elasticity of demand for a good? Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price 36

37 Problem - when you move along a demand curve between two points, you will get different answers to elasticity depending if you are moving up or down the demand curve 37

38 If you go from 3 to 5, the percentage change is 2/3, but if you go from 5 to 3, the percentage change is 2/5, so the elasticities are different! 38

39 6 P 5 A B Q D 39 39

40 The answer to this problem is to use the arc elasticity of demand formula which is... 40

41 change in quantity demanded sum of quantities/2 divided by change in price sum of prices/2 41

42 Price elasticity equals the percentage in quantity demanded divided by the percent change in price (using the arc formula) E = q' q D D D (q' + q )/2 D D p' p (p'+ p)/2 42

43 Mathematically, we invert the denominator and multiply, the 2 s cancel one another out, so formula becomes: E = q' q D D D (q' + q ) D D X (p'+ p) p' p 43

44 Quantity Price Bananas Oranges \$20 \$18 \$40 \$70 44

45 What is the Price Elasticity of Demand for bananas? X 19 = =

46 What is the Price Elasticity of Demand for oranges? X 55 = = 6,600 10,200 46

47 What is a linear demand curve? A straight-line demand curve 47

48 Demand, Price Elasticity, and Total Revenue \$ Price per unit a b Elastic c Unit elastic d e ,000 Quantity per period Panel A: Demand and price elasticity Inelastic 48

49 How do price and total revenue relate? In the elastic range of a demand curve, price and total revenue move in opposite directions. In the inelastic range, price and total revenue move in the same direction 49

50 Demand, Price Elasticity, and Total Revenue Total Revenue \$25, Total revenue Quantity per period 0 1,000 Panel B: Total Revenue 50

51 What is a perfectly elastic demand curve? A horizontal line reflecting a situation in which any price increase reduces quantity demanded to zero 51

52 A Perfectly Elastic Demand Curve Price per unit p E D = D 0 Quantity per period 52

53 What is a perfectly inelastic demand curve? A vertical line reflecting a situation in which price change has no effect on the quantity demanded 53

54 A Perfectly Inelastic Demand Curve Price per unit D' Q E D = 0 0 Quantity per period 54

55 What is unit elasticity of demand? The type of demand that exists when price elasticity is the same everywhere along the curve, it has an elasticity of

56 A Unit Elastic Demand Curve Price per unit \$10 \$6 E D = 1 D'' Quantity per period 56

57 What is income elasticity of demand? The percentage change in the quantity demanded resulting from a 1 percent change in total income 57

58 What is a normal good? Something that people will buy more of as their incomes increase 58

59 If a good is normal, then the income elasticity of demand for that good is? Positive 59

60 What is an inferior good? Something that people will by less of as their incomes increase 60

61 If a good is inferior, then the income elasticity of demand for that good is? Negative 61

62 What is cross price elasticity of demand? The percent change in the demand of one good (at a given price) as a result of the percent change in the price of another good 62

63 If negative - complements (steak & steak sauce) If positive - substitutes (butter & margarine) 63

64 If an increase in the price of peanut butter causes a decline in the demand for jelly, then? the goods are complements 64

65 If a decrease in the price of one good causes a decline in the demand for another good, then? The goods are substitutes 65

66 What are some examples of complementary goods? computers and software cars and gasoline CDs and playlists 66

67 What is price elasticity of supply? A measure of the responsiveness of quantity supplied to a price change 67

68 Price elasticity equals the percentage in quantity demanded divided by the percent change in price (using the arc formula) E = q' q S S S (q' + q )/2 S S p' p (p'+ p)/2 68

69 What is a perfectly elastic supply curve? A horizontal line reflecting a situation in which any price decrease reduces the quantity supplied to zero; the elasticity value is infinity 69

70 Price per unit p Perfectly Elastic Supply E S = S 0 Quantity per period 70

71 What is a perfectly inelastic supply curve? A vertical line reflecting a situation in which a price change has no effect on the quantity supplied; the elasticity value is zero 71

72 A Perfectly Inelastic Supply Curve Price per unit S' E S = 0 Q 0 Quantity per period 72

73 What is unit-elastic supply? A percent change in price causes an identical percent change in quantity supplied; the elasticity value is one 73

74 How is unit-elastic supply depicted? A supply curve that is a straight line through the origin 74

75 A Unit Elastic Supply Curve Price per unit \$10 5 S ' Quantity per period 75

76 What are the determinants of supply elasticity? Costs Time 76

77 Market Supply Becomes More Elastic Over Time Price per unit \$12 \$10 S w S m S y W=week M=month Y=year Quantity per period 77

78 Effects of Different Demand Elasticities on Sales Tax Incidence Price per pack \$2.30 S t S \$0.40 tax D Millions of packs per day Panel A: Less elastic demand 78

79 Effects of Different Demand Elasticities on Sales Tax Incidence Price per pack \$ S t S \$0.40 tax D' Millions of packs per day Panel B: More elastic demand 79

80 Effects of Different Supply Elasticities on Sales Tax Incidence Price per pack \$2.30 \$2.00 \$1.90 S t S \$0.40 tax D'' Millions of packs per day Panel A: More elastic supply 80

81 Effects of Different Supply Elasticities on Sales Tax Incidence Price per pack \$ S t S \$0.40 tax Millions of packs per day Panel B: Less elastic supply D'' 81

82 END 82

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