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1、1,Elasticity of Demand and Supply,Chapter 5,2006 Thomson/South-Western,2,Price Elasticity of Demand,Price elasticity of demand measures how responsive consumers are to price change;elasticity is another word for responsivenessPrice elasticity of demand=Percentage change in quantity demanded/Percenta
2、ge change in price,3,Exhibit 1:Demand Curve for Tacos,For the price elasticity to be a useful measure,we should come up with the same result between points a and b as we get between b and a.To do this we must take the average of the initial price and the new price and use that as the base in computi
3、ng the percent change in price,Price elasticity between a and b=10%/-20%=-0.5,0.90,0,b,Thousands per day,D,$1.10,a,95,105,Price,4,Price Elasticity of Demand,Generalize the price elasticity formula,5,Price Elasticity of Demand,Because the average quantity and average price are used as a base for comp
4、uting percent change,the same elasticity results whether going from the higher price to the lower price or the other way aroundSince the focus is on the percent change,we need not be concerned with how output or price is measured,6,Price Elasticity of Demand,Because price and quantity demanded are i
5、nversely related,the price elasticity of demand has a negative signThis tends to be cumbersome,thus it is commonplace to discuss the price elasticity of demand as an absolute value positive numberFor example,absolute value of the elasticity for tacos computed earlier will be referred to as 0.5 rathe
6、r than 0.5,7,Categories of Price Elasticity,Three general categories Percent change in quantity demanded is smaller than the percent change in price,the price elasticity has an absolute value between 0 and 1.0 demand is inelastic quantity demanded is relatively unresponsive to a change in price Perc
7、ent change in quantity demanded just equals the percent change in price a price elasticity with an absolute value of 1.0 unit-elastic demandPercent change in quantity demanded exceeds the percent change in price,the price elasticity has an absolute value exceeding 1.0 demand is said to be elastic qu
8、antity is responsive to changes in price,8,Elasticity and Total Revenue,Total revenue(TR)is the price(p)multiplied by the quantity demanded(q)at that price TR=p x qWhat happens to total revenue when price decreases?Lower price producers get less for each unit sold total revenue declinesLower price i
9、ncreases quantity demanded total revenue increasesOverall impact of lower price on total revenue depends on the net result of these opposite effects,9,Elasticity and Total Revenue,When demand is elastic,the percent increase in quantity demanded exceeds the percent decrease in price total revenue inc
10、reasesWhen demand is unit elastic,the two are equal total revenue remains unchangedWhen demand is inelastic,the percent increase in quantity demanded is more than offset by the percent decrease in price total revenue decreases,10,Exhibit 2:Demand,Price Elasticity and Total Revenue,11,Exhibit 2:Deman
11、d,Price Elasticity and Total Revenue,Panel(a)shows the linear demand curve and panel(b)shows the total revenue generated by each price-quantity combination along the demand curveBecause the demand curve is linear,its slope is constant:a given decrease in price always causes the same unit increase in
12、 priceHowever,the price elasticity of demand is larger on the high end of the demand curve than it is on the low price end,$100,90,80,70,60,50,40,30,20,10,D,0,Quantity per period,100,200,500,800,900,1,000,$25,000,0,Total,revenue,(b)Total Revenue,TR=p x q,Price per unit,Quantity per period,1,000,500,
13、12,(a)Demand and Price Elasticity,$100,90,80,70,60,50,40,30,20,10,e,d,c,b,a,D,0,Quantity per period,100,200,500,800,900,1,000,Price per unit,Consider a movement from point a to point b on the demand curve.The 100-unit increase in quantity demanded is a percent change of 100/150=0.67%while the$10 dro
14、p in price is a percent change of 10/85=12%the price elasticity of demand here is 5.6 Between points d and e,the 100 quantity increase is a 12%change and the$10 price decrease is a 67%price decrease price elasticity of 0.2,Exhibit 2:Demand,Price Elasticity and Total Revenue,13,$100,90,80,70,60,50,40
15、,30,20,10,e,d,c,b,a,D,Inelastic ED 1,Unit elastic ED=1,Elastic ED 1,0,Quantity per period,100,200,500,800,900,1,000,$25,000,0,Total,revenue,(b)Total Revenue,TR=p x q,Price per unit,Quantity per period,1,000,500,When demand is elastic,a decrease in price(from a to b)will increase total revenue becaus
16、e the gain in revenue from selling more units(blue box)exceeds the loss in revenue from selling all units at a lower price(red box)When demand is elastic,a price decrease(from d to e)reduces total revenue because the gain in revenue from selling more units(blue box)is less than the loss in revenue a
17、t the lower price(red box),Exhibit 2:Demand,Price Elasticity and Total Revenue,14,Exhibit 3:Constant Elasticity Demand Curves,P,r,i,c,e,p,e,r,u,n,i,t,P,r,i,c,e,p,e,r,u,n,i,t,P,r,i,c,e,p,e,r,u,n,i,t,p,0,Quantity,per period,Quantity,per period,Quantity,per period,E=,D,(a)Perfectly elastic demand curve
18、,$10,6,0 60 100,E=,D,1,(c)Unit elastic demand curve,D,0,E=,D,0,(b)Perfectly inelastic demand curve,D,Q,D,a,b,This demand curve indicates consumers will demand all that is offered at the given price,p.If the price rises above p,quantity demanded drops to zero.,This demand curve indicates that quantit
19、y demanded does not vary when the price changes;no matter how high the price,consumers will purchase the same quantity.,This demand curve is unit-elastic everywhere:any percent change in price results in an identical offsetting percent change in quantity demanded.,15,Availability of Substitutes,The
20、greater the availability of substitutes for a good and the closer the substitutes,the greater the goods price elasticity of demandThe number and similarity of substitutes depend on how we define the good the more broadly we define a good,the fewer the substitutes and the less elastic the demand,16,P
21、roportion of Consumers Budget,Because spending on some goods represents a large share of the consumers budget,a change in the price of such a good has a substantial impact on the amount consumers are able to purchaseGenerally,the more important the item is as a share of the consumers budget,other th
22、ings constant,the greater will be the income effect of a change in price,the more price elastic will be the demand for the item,17,Exhibit 5:Demand Becomes More Elastic over Time,$1.25,Suppose the price increases from the initial price of$1.00 to$1.25.Dw shows that one week after the price increase,
23、the quantity demanded has not changed much,from 100 to 95After one month,Dm,it has declined to 75,and after one year,Dy,to 50 The longer the time period the larger the response to a given price change,Quantity per period,1.00,0,Dw,100,75,50,95,Dm,Dy,Price per unit,18,Price Elasticity of Supply,The p
24、rice elasticity of supply measures how responsive producers are to a price changeEquals the percent change in quantity supplied divided by the percent change in priceSince the higher price usually results in an increased quantity supplied,the percent change in price and the percent change in quantit
25、y supplied move in the same direction the price elasticity of supply is usually a positive number,19,Exhibit 7:Price Elasticity of Supply,20,Exhibit 7:Price Elasticity of Supply,If the price increases from p to p,the quantity supplied increases from q to qThe price elasticity of Es isWhere q is the
26、change in quantity supplied and p is the change in price.,21,Categories of Supply Elasticity,The terminology for supply elasticity is the same as for demand elasticityIf supply elasticity is less than 1.0,supply is inelasticIf it equals 1.0,supply is unit elasticIf it exceeds 1.0,supply is elasticEx
27、hibit 8 illustrates some special cases of supply elasticity to consider,22,Exhibit 8:Constant-Elasticity Supply Curves,P,r,i,c,e,p,e,r,u,n,i,t,P,r,i,c,e,p,e,r,u,n,i,t,P,r,i,c,e,p,e,r,u,n,i,t,p,0,E=,S,(a)Perfectly elastic,$10,5,0,10,20,E=,S,1,(c)Unit elastic,S,0,E=,S,0,(b)Perfectly inelastic,S,Q,S,Qu
28、antity per period,Quantity per period,Quantity per period,At one extreme is the horizontal supply curve.Here producers will supply none of the good at a price below p,but will supply any amount at a price of p,The most unresponsive relationship is where there is no change in the quantity supplied re
29、gardless of the price where the supply curve is perfectly vertical.,Any supply curve that is a straight line from the origin such as shown above is a unit-elastic supply curve.,23,Determinants,The responsiveness of sellers depends on how easy it is to alter output when price changesIf the cost of su
30、pplying additional units rises sharply as output expands,then a higher price will elicit little increase in quantity suppliedBut if the marginal cost rises slowly as output expands,the lure of a higher price will prompt a large increase in output,24,Length of Time,Supply also becomes more elastic ov
31、er time as producers adjust to price changesThe longer the time period under consideration,the more able producers are to adjust to changes in relative prices,25,Exhibit 9:Supply Becomes More Elastic over Time,1.00,Sw is the supply curve when the period of adjustment is a week.Sm is the supply curve
32、 when the adjustment period is one month;supply more elastic and quantity supplied increases to 140After one year the supply curve becomes Sy and the quantity supplied increases to 200,$1.25,Price,26,Income Elasticity of Demand,Measures how responsive demand is to a change in incomeEquals the percen
33、t change in demand divided by the percent change in incomeCategoriesGoods with income elasticities less than zero are called inferior goods demand declines when income increases,27,Income Elasticity of Demand,Normal goods have income elasticities greater than zero demand increases when income increa
34、sesNormal goods with income elasticities greater than zero but less than 1 are called income inelastic goods demand increases but not as much as does incomeGoods with income elasticity greater than 1 are called income elastic demand not only increases when income increases but increases by more than
35、 does income,28,Exhibit 11:The Demand for Grain,29,Exhibit 12:Effect of Increases in Supply and Demand on Farm Revenue,$8,Billions of bushels per year,D,S,0,4,14,D,S,10,Over time,technological advances in farming have sharply increased the supply of grain In addition,increases in household income ov
36、er time have increased the demand for farm productsBut because increases in the supply of grain have exceeded increases in demand,the combined effect has been a drop in the market price and a fall in total farm revenue,Price per bushel,30,Cross-Price Elasticity of Demand,Since firms often produce an
37、 entire line of products,it has a special interest in how a change in the price of one product will affect the demand for anotherThe responsiveness of the demand for one good to changes in the price of another good is called the cross-price elasticity of demand,31,Cross-Price Elasticity of Demand,De
38、fined as the percent change in the demand of one good divided by the percent change in the price of another goodIf an increase in the price of one good leads to an increase in the demand for another good,their cross-price elasticity is positive the two goods are substitutesIf an increase in the price of one good leads to a decrease in the demand for another,their cross-price elasticity is negative the two goods are complements,
