econ 351 elasticity of demand & supply week 4.1 september 17, 2013
TRANSCRIPT
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ECON 351Elasticity of Demand & Supply
Week 4.1
September 17, 2013
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Review
• Markets are the interaction of buyers and sellers.
• Focus on buyers and sellers separately.
• Ceteris paribus: look at one thing at a time; All other things held equal.
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$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10
Demand x
Demand shows the amounts purchased at alternative prices (horizontal distances at each price)
Qtyx /T
Dx
Dx
Demand for X
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Supply Curve$Price
$10
8
6
4
2
2 4 6 8 10 12 14 16 Qty x/ T
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$Price
$ 4
3
2.50
2.00
1.50
1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Demand
Supply
Surplus at this $ Price
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$Price
$ 4
3
2.50
2.00
1.50
1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Demand
Supply
Shortage at this $ Price
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$Price
4
3
2.50
2.00
1.50
PePe 1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T QeQe
Demand Supply
Market EquilibriumMarket Equilibrium
Qty D = Qty S
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$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SupplyDemand
Dx
Pe
Qe
Total Revenue = P X Q
$6x5 = $30
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$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SupplyDo
Do
Sx
Effects of Increase in Demand on Price and Quantity
Increases Price and Quantity
Pe
Qe
D1
D1
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$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
Demand
DxS0
Effects of an Increase in Supply on Price and Quantity
Price decreases and Quantity increases
Pe
Qe
S0
S1
S1
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What causes an increase in price?
Increase in Demand or Decrease in Supply
$ P
S2
$ P
Q/T
D1
Q2Q1 Q1
P2
P1Demand
S1
Q2
P1
P2
D2
Supply
Q/T
(if you know quantity increased) (if you know quantity decreased)
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What causes an decrease in price?
Decrease in Demand or
Increase in Supply
$ P
S2
$ P
Q/T
D1
Q2 Q1Q1
P2
P1
Demand
S1
Q2
P1
P2D2
Supply
Q/T
(if you know quantity decreased) (if you know quantity increased)
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$ P x
109 8 7 6 5 43 2 1
Qtyx /T
Supply
D3
Sx
Market Demand Determines Price
P1
Q2
D2
D1
Q1 Q3
P3
P2
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A B
PxPx
Qx/T Qx/T
P0
Q0
P0
Q0
Slope of Supply Shows responsiveness of quantity to a change
in Price
P1
Q1
P1
Q1
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Slope Shows Responsiveness of Quantity to a Change in Price
A B
Px Px
Qx/T Qx/T
P0 P0
Dx
Dx
Q0Q1 Q0
P1P1
Q1
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A B
PxPx
Qx/T Qx/T
P0
Q0
P0
Q0
Problems using Slope as a measure of responsiveness: Slope depends on the units of measure on the vertical and horizontal axis.
P1
Q1
P1
Q1
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Price Elasticity: a Measure of responsiveness of Quantity to a Change in Price
Ed = % Δ Qd
% Δ Price
Es = % Qs
% Price
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Computing the Point Price Elasticity of demand
Ed = % Δ Qd
% Δ P
% Δ Qd = (Δ Qd/ Q0)
% Δ P = (Δ P/ P0)
Ed = (Δ Qd/ Q0)
(Δ P/ P0)
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Problem with measures of Point Elasticity:
• Evaluate elasticity between two points on the demand curve
• Point A: Price = $4 Quantity = 120
• Point B: Price = $6 Quantity = 80
• From A to B: Ed = (-33% / 50%) = -.66
• From B to A: Ed= (50% / -33%) = -1.5
• Measuring from either endpoint (P0, Q0) gives different estimates
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Arc or midpoint price elasticityInstead of using one end of the price, quantity change as the reference point, use the midpoint.
Ed = (Δ Qd/( (Q1 + Q2)/2 ) / (Δ P/)/ ( (P1 + P2)/2 )
Ed= (- 40/100) / ($2/$5) = - 40% / 40% = -1
By using the midpoint formulation the answer will be the same for a price increase or a price decrease and is therefore an unbiased measure of the responsiveness of quantity to a change in price.
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Measures of Elasticity
• Demand is ElasticElastic : %Δ Qd > %Δ P;
ie |Ed| >1. A decrease in Price an increase in Total Revenue.
• Demand is Unitary ElasticUnitary Elastic: %ΔQd = %ΔP;
ie |Ed| = 1. A Change in price no change in Total Revenue.
• Demand is InelasticInelastic: %ΔQd < %ΔP;i.e. |Ed| < 1. An increase in Price an increase in Total Revenue.
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Elasticity varies on a straight line demand curve
$Price
Qty/T
Demand
Ed > 1
Ed < 1
Ed = 1
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Elasticity, Price Change & Total Revenue
$Px $PxElastic (upper half)
Inelastic(lower half)
Q1Qty/T
P0
P1
Q0
P1
P0
Q0Q1
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Increased Demand with elastic Supply$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
Sx
Dx
Dx
Sx
Pe
Qe
Dx`
Qe`
Pe`
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$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx
Pe
Qe
Dx’
Qe’
Pe’
Increased Demand , Inelastic Supply
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Decrease in Supply, Elastic Demand$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx’
Pe
QeQe`
Pe`
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$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx’
Pe
QeQe’
Pe’
Decrease in Supply, Inelastic Demand
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Determinants of Price Elasticity of Demand
• Number & Closeness of Substitutes.
• Information about price change and availability of substitutes.
• Percentage of Income Spent on good.
• Period of time: Second Law of DemandSecond Law of Demand: Demand is more elastic over a longer period of time.
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Factors creating increased elasticity over time
1. More information about price change and substitutes (Beef & Chicken)
2. More substitutes over time (More Hybrids)
3. Increased opportunity to change the complementary basket of goods (Buy a car with higher MPG. Move closer to work.)
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Other Elasticity's
A Measure of responsiveness of Quantity to a Change in some other factor
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Income Elasticity: Measure of responsiveness of Quantity to a Change in Income
• EdI = % Δ Qd
% Δ income
• Normal Goods: Positive
• Clothing: .95: 10% income → 9.5%
• Stereo: 2.72: 10% income → 27.2%
• Increase may be Quantity or Quality
• Inferior Goods: Negative
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Cross Price Elasticity: Measure of responsiveness of Quantity to a Change Price of other good
• Exy = % Δ Qx
% Δ Py
• Substitutes: Positive
• Complements: Negative
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Uses of Cross Price Elasticity
• Magnitude of cross price elasticity reflects closeness of substitutes or complements
• Able to identify your closest competitors
• Courts use cross-price to measure monopoly power
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Transaction Costs of Exchange
• Information Costs– Search Costs– Quality Identification Cost
• Negotiating Costs: Cost of agreeing on what and how much will be exchanged
• Transportation Costs: Cost of moving goods between parties
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