Macroeconomics

Lesson 2

Topics

1. Homework

2. Review Supply and Demand

3. Floors and Ceilings

4. Elasticity

Correct the Homework

Answers:1. P = $7.50 Q = 3502. P = 55¢ Q = 5703. P = $375 Q = 854. P= $1375 Q= 17

Another S & D example

Price Q d Price Q s

60 0 60 500

50 100 50 400

40 200 40 300

30 300 30 200

20 400 20 100

10 500 10 0

Answer:

Price = $35, Quantity = 250

What happens to price and quantity if the price of a substitute good increases?

What happens to price and quantity if the cost of production decreases?

Floors and Ceilings

See the examples on the board.

Price Elasticity of Demand

Measures the sensitivity or (responsiveness) of quantity consumers demand to changes in the price of a product

Equation for Coefficient of Elasticity of Demand

% change in quantity ÷ % change in price

The equation for determining the coefficient elasticity of demand is:

[(Q1-Q2)÷(Q1+Q2)]÷[(P1-P2)÷(P1+P2)]

Examples

1. Q1 = 250 Q2 = 300 P1=50 P2=40

Answer = 0.81 ( <1, inelastic)

2. Q1 = 250 Q2 = 500 P1 = $6 P2=$5

Answer = 3.66 (>1, elastic)

3. Q1 = 250 Q2 = 300 P1 = $6 P2=$5

Answer = 1 (unit elastic)

More examples

4. Q1 = 500 Q2 = 500 P1 = $6 P2=$5

Answer = 0 (perfectly inelastic)

5. Q1 = 500 Q2 = 600 P1 = $5 P2=$5

Answer = undefined (perfectly elastic)

Sesame Street School of Ed

A key to identifying elastic or inelastic demand is the shape of the Demand Curve:

The more the curve looks like a capital I, the more inelastic the demand, and the fewer the substitutes

The more the curve looks like a capital E, the more elastic the demand, and there must be many substitutes

Uses of Elasticity of Demand

We can use Elasticity of Demand to determine the price where we Maximize Total Revenue

Remember the equation for Total Revenue TR = Price x Quantity

Other uses for Ed

Tax incidence: who pays the tax?

Predict the change in quantity from a change in price

Evaluate the effectiveness of social policies

Circular Flow