session4usingdemandsupply

session4usingdemandsupply - SESSION 4 SESSION 4 4 Using...

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Unformatted text preview: SESSION 4 SESSION 4 4 Using Demand and Supply SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply Introduction Firms need to know how much demand changes when prices change. Will an increase in price raise a firm's revenue even though the quantity sold falls? If a firm raises its price, it loses customers. How many? SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply The Price Elasticity of Demand The price elasticity of demand ( E d ) measures the responsiveness of consumers to changes in price. It is computed as follows: For example if the quantity of milk demanded falls by 15% when the price is increased by 10% then the elasticity of demand for milk is 1.5: SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply Price Elasticity and the Demand Curve When E d > 1 we say that demand is elastic When E d < 1 we say that demand is inelastic SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply Price Elasticity and the Demand Curve SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply Price Elasticity and the Demand Curve Demand is perfectly inelastic if the quantity demanded is the same at every price. The price elasticity of demand is zero. Demand is perfectly elastic if the quantity demanded is infinitely responsive to changes in price. The price elasticity of demand is infinite. SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply Examples of Price Elasticity of Demand Elastic Demand Inelastic Demand Purchased meals 2.27 Gas, electricity, water 0.92 Metals 1.52 Oil 0.91 Furniture and timber 1.25 Chemicals 0.89 Motor vehicles 1.14 Beverages 0.78 Transportation 1.03 Tobacco 0.61 SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply Price Elasticity of Demand Elasticity of demand is not the same as the slope of the demand curve . Quantity Demanded Price Demand P 1 Q 1 P 2 Q 2 Suppose that price falls from P 1 to P 2 and so quantity demanded increases from Q 1 to Q 2 The price elasticity of demand is: 1 1 2 1 2 1 2 1 1 1 2 1 Q P P P Q Q P P P Q Q Q -- =- - But 2 1 2 1 P P Q Q-- is the inverse of the slope of the demand curve. So we have that slope Q P E d 1 1 1 = SESSION 4: Using Demand and Supply SESSION 4: Using Demand and Supply An Example of Price Elasticity Suppose that the demand curve is P = 100 5 Q The slope of this demand curve is constant at 5 (we ignore the negative sign by convention) So 1/slope = 1/5 = 0.2 What is the elasticity of demand at a price of $80? 80 = 100 5 Q so Q = 20/5 = 4 units So P/Q = 80/4 = 20 E d = 20x0.20 = 4.0 At a price of $50?...
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This note was uploaded on 10/19/2009 for the course ECON 5 taught by Professor Norman during the Fall '08 term at Tufts.

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session4usingdemandsupply - SESSION 4 SESSION 4 4 Using...

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