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23MeierPP06_18e - Chapter 6 Chapter Elasticity LAW OF...

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Unformatted text preview: Chapter 6 Chapter Elasticity LAW OF DEMAND LAW • As Price Falls… …Quantity Demanded Rises • As Price Rises… …Quantity Demanded Falls Question... Question... Would a firm be better off Would raising or lowering product prices in order to increase revenues? revenues? Answer... Answer... It depends on how It consumers react to those price changes. For example... For If price falls and consumers buy a great deal more, total revenue will rise. However... However... If price falls and consumers buy only a tiny bit more, total revenue will fall. Elasticity Elasticity How participants react in markets is known as elasticity. Large responses are elastic, while small ones are inelastic. ELASTICITY ELASTICITY Major types Major • • • • Price elasticity of demand Price elasticity of supply Cross elasticity of demand Income elasticity of demand PRICE ELASTICTY PRICE OF DEMAND How buyers react to a How price change for a particular good or service good % ∆ in Qd of product A % ∆ in P of product A PRICE ELASTICTY PRICE OF SUPPLY How sellers (producers) How react to a price change for a particular good or service particular % ∆ in Qs of product A % ∆ in P of product A CROSS ELASTICTY CROSS OF DEMAND How buyers react to How buying good A when the price of good B changes price % ∆ in Q of product A % ∆ in P of product B INCOME ELASTICTY INCOME OF DEMAND How buyers react to to How buying good A when their income changes income % ∆ in Q of product A % ∆ in income CROSS ELASTICTY CROSS OF DEMAND % ∆ in Q of product A % ∆ in P of product B A and B are related goods Substitutes have a + sign Complements have a - sign INCOME ELASTICTY INCOME OF DEMAND % ∆ in Q of product A % ∆ in income Normal or inferior goods Normal goods have a + sign Inferior goods have a - sign PRICE ELASTICTY PRICE OF DEMAND % ∆ in Qd of product A % ∆ in P of product A Sign is always treated as positive, although technically it should be negative. PRICE ELASTICITY OF DEMAND OF Classifications • • • • • Relatively elastic Relatively inelastic Unitary elastic Perfectly (absolutely) elastic Perfectly (absolutely) inelastic PRICE ELASTICITY PRICE OF DEMAND OF Classifications • • • • • Relatively elastic: Ed > 1 Relatively inelastic: Ed < 1 Unitary elastic: Ed = 1 Perfectly elastic: Ed = ∞ Perfectly inelastic: Ed = 0 Price Elasticity is... Inelastic from 0 to 1 Inelastic Elastic from 1 to ∞ Elastic Unit elastic when exactly = 1 Price Elasticity of Demand P If the percentage If price change was 4... and the percentage quantity change was 2... 2 1 P P 2 1 Elasticity is .5 Elasticity .5 D Q Price Elasticity of Demand P 2 1 If the percentage If price change was 2... and the percentage quantity change was 4... Elasticity is 2 Elasticity 2 1 P P D Q Price Elasticity of Demand P If the percentage If price change was 2... and the percentage quantity change was 2... Elasticity is 1 Elasticity 2 1 2 1 P P D Q PRICE ELASTICTY PRICE OF DEMAND Mid-Point Formula (Q2 - Q1) ÷ (P2 - P1) (Q2 + Q1)/2 (P2 + P1)/2 or (Q2 - Q1) (Q2 + Q1) (Q2 ÷ (P2 - P1) (P2 + P1) APPLICATION P falls from $10 to $8, causing Qd to rise from 20 to 30 rise (30 - 20) ÷ (10 - 8) (30 + 20)/2 (10 + 8)/2 10 ÷ 2 = 1.8 Elastic 10 Elastic 25 9 APPLICATION (30 - 20) (30 + 20) (30 ÷ (10 - 8) (10 + 8) 10 ÷ 2 = 1.8 Elastic Elastic 50 18 50 PRICE ELASTICTY PRICE OF DEMAND Total revenue (TR) test TR = P x Q Marginal revenue (MR) test MR = ∆ TR / ∆ Q MR TR PRICE ELASTICTY PRICE OF DEMAND Total revenue (TR) test TR = P x Q P↓TR↑ or P↑TR↓: elastic P↓TR↓ or P↑TR↑: inelastic P↓or↑, TR same: unitary PRICE ELASTICTY PRICE OF DEMAND Marginal revenue (MR) test MR = ∆ TR / ∆ Q MR TR MR + : elastic MR - : inelastic MR = 0: unitary EXAMPLE EXAMPLE P 7 6 5 4 3 2 Q 2 3 4 5 6 7 TR MR # MR 14 x x 18 +4 2.60 2.60 20 +2 1.57 1.57 20 0 1.00 1.00 18 -2 .64 .64 14 -4 .38 .38 P Demand TR Total Revenue Revenue D Q Quantity Demanded P TR Elastic Demand D Q Elastic Demand Quantity Demanded P TR Inelastic Demand D Q Quantity Demanded Inelastic Demand P TR Unit Elastic D Q Quantity Demanded P TR Elastic Demand Unit Elastic Inelastic Demand D Q Elastic Inelastic Demand Demand Quantity Demanded PRICE ELASTICTY P OF DEMAND Relatively elastic demand D1 Q PRICE ELASTICTY P OF DEMAND Relatively inelastic demand D2 Q PRICE ELASTICTY P OF DEMAND D3 Perfectly inelastic demand Q PRICE ELASTICTY P OF DEMAND D4 Perfectly elastic demand Q DETERMINANTS OF DETERMINANTS PRICE ELASTICTY OF DEMAND • • • • • Substitution Proportion of budget Luxuries / necessities Durables / non-durables Time INELASTIC PRODUCTS INELASTIC • • • • • • • Electricity Bread Medical care Legal services Automobile repair Clothing Gasoline .13 .15 .31 .37 .40 .49 .60 ELASTIC PRODUCTS ELASTIC • • • • • • • Motor vehicles Beef Tableware Residential land Restaurant meals Lamb Fresh peas 1.14 1.27 1.54 1.60 2.27 2.65 2.83 PRICE ELASTICTY PRICE OF SUPPLY % ∆ in Qs of product A % ∆ in P of product A Sign is positive because of a direct relationship. PRICE ELASTICITY OF SUPPLY OF Classifications • • • • • Relatively elastic Relatively inelastic Unitary elastic Perfectly (absolutely) elastic Perfectly (absolutely) inelastic PRICE ELASTICITY PRICE OF SUPPLY OF Classifications • • • • • Relatively elastic: Es > 1 Relatively inelastic: Es < 1 Unitary elastic: Es = 1 Perfectly elastic: Es = ∞ Perfectly inelastic: Es = 0 Price Elasticity of Supply If the percentage If price change was 10... and the percentage quantity change was 5... Elasticity is .5 Elasticity .5 Price Elasticity of Supply If the percentage If price change was 5... and the percentage quantity change was 10... Elasticity is 2 Elasticity Price Elasticity of Supply If the percentage If price change was 10... and the percentage quantity change was 10... Elasticity is 1 Elasticity Price Elasticity is... Inelastic from 0 to 1 Inelastic Elastic from 1 to ∞ Elastic Unit elastic when exactly = 1 Just like demand PRICE ELASTICTY PRICE OF SUPPLY Mid-Point Formula (Q2 - Q1) ÷ (P2 - P1) (Q2 + Q1)/2 (P2 + P1)/2 or (Q2 - Q1) (Q2 + Q1) (Q2 ÷ (P2 - P1) (P2 + P1) APPLICATION P rises from $10 to $12, causing Qs to rise from 20 to 30 to (30 - 20) ÷ (12 - 10) (30 + 20)/2 (12 + 10)/2 10 ÷ 2 = 2.2 Elastic 10 Elastic 25 11 APPLICATION (30 - 20) (30 + 20) (30 ÷ (12 - 10) (12 + 10) 10 ÷ 2 = 2.2 Elastic Elastic 50 22 50 Price Elasticity of Supply Immediate market period m P S Pm o An increase in demand without enough time to change supply causes… an increase in price D2 1 P o D Q Price Elasticity of Supply Short run P s S Ps o With not all With resources variable…a variable… smaller increase in Q increase P More inelastic response D2 1 o Qs D Q Price Elasticity of Supply Long run P With all resources With variable…a greater variable… greater increase in Q increase L PL o P More elastic S response D2 1 o QL D Q PRICE ELASTICTY P OF SUPPLY S1 Perfectly inelastic supply S2 Q Perfectly elastic Supply DETERMINANTS OF DETERMINANTS PRICE ELASTICTY OF SUPPLY • Resource availability • Time APPLICATIONS APPLICATIONS • • • • • • Bumper crops Oil Excise taxes Subsidies Minimum wages Tax burden ...
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