Transcript
PART 2: PRICE, QUANTITY,
AND EFFICIENCY
Prepared by Dr. Amy Peng
Ryerson University
© 2013 McGraw-Hill Ryerson Ltd.
Discuss price elasticity of demand and how it can be applied.
Explain the usefulness of the total-revenue test for price elasticity of demand.
Describe price elasticity of supply and how it can be applied.
Apply cross elasticity of demand and income elasticity of demand.
Apply the concept of elasticity to real-world situations.
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4
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The law of demand says:
An increase in price causes a decrease in quantity demanded (and vice-versa)
But how much does quantity demanded change in response to a change in price?
Elasticity gives us a measure of responsiveness
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO1
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When QD responds strongly to a change in P, demand is elastic
When QD responds weakly to a change in P, demand is inelastic
percentage change in quantity demanded of product X
percentage change in price of product X
Ed =
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Chapter 4, LO1
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If the quantity demanded increased from 4 to 5 units the percentage change would be:
%?Qd = ?Qd/Q0 = ¼ x 100 = 25%
If the quantity demanded dropped from 5 to 4, the percentage change would be:
%?Q = ?Qd/Q0 = 1/5 x 100 = 20%
Which percentage change in Qd do we use? 25% or 20%?
To avoid confusion about start and end point we use average change in Qd and the average change in P.
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO1
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If the quantity demanded increased from 4 to 5 units the percentage change would be:
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO1
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Price elasticity of demand:
Use percentages
Unit free measure
Compare responsiveness across products
Eliminate the minus sign
Easier to compare elasticities
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Chapter 4, LO1
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LO1
Ed > 1 demand is elastic
Ed = 1 demand is unit elastic
Ed < 1 demand is inelastic
Extreme cases
Perfectly inelastic
Perfectly elastic
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Chapter 4, LO1
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D1
P
Perfectly inelastic demand
Perfectly inelastic demand
(Ed = 0)
0
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Chapter 4, LO1
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Perfectly elastic demand
P
D2
Perfectly elastic
demand
(Ed = ?)
0
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Chapter 4, LO1
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Total revenue (TR)
TR = P x Q
TR and Ed are related
If TR changes in the opposite direction from price, demand is elastic
If TR changes in the same direction from price, demand is inelastic
If TR does not change when price changes, demand is unit elastic
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO2
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$3
2
1
0 10 20 30 40
Q
P
Loss
Gain
a
b
D1
Lower price and elastic demand
Blue gain exceeds yellow loss
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO2
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$4
3
2
1
0 10 20
Q
P
Loss
Gain
c
d
D2
Lower price and inelastic demand
Yellow loss exceeds blue gain
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO2
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$3
2
1
0 10 20 30
Q
P
Loss
Gain
e
f
D3
Lower price and unit elastic demand
Blue gain equals yellow loss
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO2
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(1)
Total Quantity of Tickets Demanded per Week, Thousands
(2)
Price per Ticket
(3)
Elasticity Coefficient (Ed)
(4)
Total Revenue
(1) X (2)
(5)
Total Revenue Test
1
$8
$8,000
2
7
5.00
14,000
Elastic
3
6
2.60
18,000
Elastic
4
5
1.57
20,000
Elastic
5
4
1.00
20,000
Unit Elastic
6
3
0.64
18,000
Inelastic
7
2
0.38
14,000
Inelastic
8
1
0.20
8,000
Inelastic
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO2
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0
1
2
3
4
5
6
7
8
0
1
2
3
4
5
6
7
8
Quantity Demanded
Quantity Demanded
Price
Total Revenue
(Thousands of Dollars)
$20
18
16
14
12
10
8
6
4
2
$8
7
6
5
4
3
2
1
a
b
c
d
e
f
g
h
Elastic
Ed > 1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
D
TR
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO2
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For all straight-line and most other demand curves
Demand is more elastic toward the upper left
Demand is less elastic toward the lower right
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Chapter 4, LO2
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Absolute value of elasticity coefficient
Impact on total revenue of a
Demand is
Description
Price increase
Price decrease
Greater than 1
(Ed > 1)
Elastic or relatively elastic
Quantity demanded changes by a larger percentage than does price
Total revenue decreases
Total revenue increases
Equal to 1
(Ed = 1)
Unit or unitary elastic
Quantity demanded changes by the same percentage as does price
Total revenue is unchanged
Total revenue is unchanged
Less than 1
(Ed < 1)
Inelastic or relatively inelastic
Quantity demanded changes by a smaller percentage than does price
Total revenue increases
Total revenue decreases
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO2
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Substitutability
Proportion of Income
Luxuries versus Necessities
Time
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Chapter 4, LO2
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Product or service
Coefficient of price elasticity of demand, Ed
Product or service
Coefficient of price elasticity of demand, Ed
Newspapers
0.10
Household appliances
0.63
Electricity (household)
0.13
Movies
0.87
Bread
0.15
Beer
0.90
Major league baseball tickets
0.23
Shoes
0.91
Telephone service
0.26
Motor vehicles
1.14
Sugar
0.30
Beef
1.27
Eggs
0.32
China, glassware, tableware
1.54
Legal services
0.37
Residential land
1.60
Automobile repair
0.40
Restaurant meals
2.27
Clothing
0.49
Lamb and mutton
2.65
Gasoline
0.60
Fresh peas
2.83
Milk
0.63
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Chapter 4, LO2
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Large Crop Yields
Sales Taxes
Decriminalization of Illegal Drugs
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Chapter 4, LO2
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Es=
Percentage change in quantity
supplied of product X
Percentage change in
the price of product X
The main determinant of Es is the amount of time producers have for responding to a change in product price
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO3
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Perfectly inelastic supply
D1
D2
Sm
Q0
Pm
P0
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Chapter 4, LO3
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Supply is more elastic than in market period
D1
D2
Ss
Q0
Ps
P0
Qs
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Chapter 4, LO3
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Supply is even more elastic than in the short run
D1
D2
Sl
Q0
Pl
P0
Ql
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Chapter 4, LO3
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Antiques and Reproductions
Volatile Gold Prices
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Chapter 4, LO3
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Percentage change in quantity
demanded of product X
Percentage change in
the price of product Y
Exy =
Substitute Goods -positive sign
Complementary Goods -negative sign
Independent Goods - near zero
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Chapter 4, LO4
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Applications
Coca-Cola vs. Sprite
Assessing competition
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Chapter 4, LO4
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Ei =
Percentage change in
quantity demanded
Percentage change
in income
Normal Goods - positive sign
Inferior Goods - negative sign
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Chapter 4, LO4
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High income elasticities
Most affected by a recession
Low or negative income
Least affected by a recession
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Chapter 4, LO4
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Value of Coefficient
Description
Type of Good(s)
Cross elasticity:
Positive (Ewz > 0)
Negative (Exy < 0)
Quantity demanded of W changes in same direction as change in price of Z
Quantity demanded of X changes in opposite direction from change in price of Y
Substitutes
Complements
Income elasticity:
Positive (Ei >0)
Negative (Ei<0)
Quantity demanded of the product changes in same direction as change in income
Quantity demanded of the product changes in opposite direction from change in income
Normal or superior
Inferior
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO4
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Harmonized sales tax
Ontario, New Brunswick, Nova Scotia, and Newfoundland and Labrador
The HST varies across provinces
The HST extends provincial taxes on services
Elasticity and Tax Incidence
Division of Burden
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO5
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D
St
Quantity (millions of bottles per month)
S
Tax = $2
P
10
8
6
0 5 10 15 20 Q
Price (per bottle)
Consumers and producers share the burden of the tax in some proportion (here, equally at $2 per unit).
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO5
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De
St
Tax incidence and elastic demand
Pe
Q1
S
Q0
P1
Pa
TAX
Producer bears most of the tax burden
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO5
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DI
St
Tax incidence and inelastic demand
PI
Q1
S
Q2
P1
Pb
TAX
Consumer bears most of the tax burden
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO5
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D
St
Tax incidence and elastic supply
Pe
Q1
S
Q0
P1
Pa
TAX
Consumer bears most of the tax burden
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO5
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D
St
Tax incidence and inelastic supply
PI
Q1
S
Q0
P1
Pa
TAX
Producer bears most of the tax burden
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4, LO5
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Differences in price elasticities of demand are often exploited by suppliers, consider…
Price airlines charge business versus leisure travellers
Charges for children versus adults at hair stylists or ski resorts, etc.
Colleges and universities that offer financial aid to low-income students
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4
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4.1 Price Elasticity of Demand
4.2 The Total-Revenue Test
4.3 Price Elasticity of Supply
4.4 Cross Elasticity and Income Elasticity of Demand
4.5 Elasticity and Real-World Applications
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 4
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