EC120 Chapter 5-Elasticity and its Application Week 3 Intro -Elasticity ...
EC120
Chapter 5-Elasticity and its Application
Week 3
Intro -Elasticity is a measure of how much buyers and sellers respond to changes in market conditions The Elasticity of Demand -To measure how much consumers respond to the changes of supply and demand, economists use elasticity. -Elasticity-a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants The Price Elasticity of Demand and its Determinants -Price elasticity of demand-a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. -Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. -Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price. -The elasticity reflects the many economic, social, and psychological forces that shape consider tastes. -General rules about what determines the price elasticity of demand: Availability of Close Substitutes: -Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others Ex. Butter is elastic because a price change will drop sales since margarine is a close substitute Necessities vs. Luxuries -Necessities have inelastic demands -Luxuries have elastic demands Definition of the Market -Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. -Ex. Food, a broad category has a fairly inelastic demand because there are no good substitutes for food. Ice cream, is a more narrow category and has an elastic demand because it has substitutes. Time Horizon -Goods tend to have more elastic demand over longer time horizons. For example as the price of gas starts to rise, people try to have more fuel efficient cars and the demand drops. Computing the Price Elasticity of Demand -Price elasticity of demand=Percentage change in quantity demanded Percentage change in price The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities -Point A: Price $4 Quantity 120 -Point B: Price $6 Quantity 80 -Midpoint price $5 -Midpoint Quantity 100 -Therefore (6-4)/5x100 = 40.
EC120
Chapter 5-Elasticity and its Application
Week 3
The Variety of Demand Curves -Demand is elastic when the elasticity is greater than 1 and inelastic when it is less than 1. -If the elasticity is exactly 1, the demand is said to have unit elasticity. -The flatter the demand curve that passes through a given point, the greater the price elasticity of demand. The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand. -Inelastic curves look like the letter I. Elastic curves look like the letter E.
Total Revenue and the Price Elasticity of Demand -Total revenue (in a market)-the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold -Total revenue is calculated by price x quantity -When demand is inelastic, price and total revenue move in the same direction -When demand is elastic, price and total revenue move in opposite directions -When demand is unit elastic, total revenue remains constant when price changes
EC120
Chapter 5-Elasticity and its Application
Week 3
Elasticity and Total Revenue along a Linear Demand Curve -A linear demand curve has a constant slope -Even though the slope of a demand curve is constant, the elasticity is not.
Other Demand Elasticities The Income Elasticity of Demand -Income elasticity of demand-a measure of how much the quantity demanded of a good responds to a change in consumer’s income, computed as the percentage change in quantity demanded divided by the percentage change in income. -Income Elasticity of Demand=Percentage change in quantity demanded Percentage change in income
EC120
Chapter 5-Elasticity and its Application
Week 3
-Inferior goods (bus rides) have negative income elasticities because quantity demanded and income move in opposite directions -Necessities such as food and clothing have small income elasticies because consumers choose to buy some of these goods regardless of how low their incomes. The Cross-Price Elasticity of Demand -Cross-price elasticity of demand-a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change of the second good -Cross-price elasticity of demand=Percentage change in quantity demanded of good 1 Percentage change in price of good 2 -Whether the cross-price elasticity is a positive or a negative number depends on whether the two goods are substitutes or complements. -Complements cause the cross-price elasticity to be a negative The Elasticity of Supply The Price Elasticity of Supply and its Determinants -Price elasticity of supply-a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price -Supply is said to be elastic if the quantity supplied responds substantially to changes in the price -Supply is said to be inelastic is the quantity supplied responds only slightly to changes in the price -The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce -Supply is usually more elastic in the long run than in the short run Computing the Price Elasticity of Supply -Price Elasticity of Supply=Percentage change in quantity supplied Percentage change in price -Using the mid point method: The price of milk increases from $2.85 to $3.15 and that allows the farmer to move from selling 9 000L to 11 000L. -Percentage change in quantity supplied= (11 000-9 000)/ 10 000 x 100 = 20 % -Percentage change in price=(3.15-2.85)/3.00 x 100 = 10 % -The price elasticity of supply is therefore 20/10=2
EC120
Chapter 5-Elasticity and its Application
Week 3
The Variety of Supply Curves
Three Applications of Supply, Demand, and Elasticity Can Good News for Farming be Bad News for Farmers? -A study comes out and says there is new technology for farmers to raise hybrid of what by 20% the amount farmers can produce from each hectare of land. -This will affect the supply curve -This discovery affects farmers in two conflicting ways: The hybrid allows farmers to produce more wheat (quantity rises) but now each tonne of wheat sells for less (prices fall) -Whether total revenue rises or falls depends on the elasticity of demand. -Wheat is inelastic because it is cheaply produced and there is no replacement. When the demand curve is inelastic a decrease in price causes total revenue to fall
EC120
Chapter 5-Elasticity and its Application
Week 3
-Farmers would adapt this method because they are competing with other farmers -What is good for farmers is not necessarily good for society as a whole. Improvement of farm technology can be bad for farmers who become increasingly unnecessary, but good for consumers who pay less for food.
Why did OPEC Fail to Keep the Price of Oil High? -OPEC continued to raise the prices of oil in order to bring in more profit. They did this several times. -OPEC found it difficult to maintain a high price for oil -In the short run, both the supply and demand for oil are relatively inelastic -Supply is inelastic because the quantity of known oil reserves and the capacity for oil extraction cannot be changed quickly -Demand is inelastic because buying habits do not respond immediately to changes in price -Gas is a necessity in today’s society so people will purchase it no matter the price because there is no alternative
Does Drug Interdiction Increase or Decrease Drug-Related Crime? -Drug has several adverse effects: one is that drug dependence can ruin the lives of drug users and their families. Another is that drug addicts often turn to robbery and other violent crimes to obtain the money needed to support their habit. -What would happen if the government increases the number of officers devoted to the war on drugs? -When the government stops some drugs from entering the country and arrests more smugglers, it raises the cost of selling drugs and therefore reduces the quantity of drugs supplied at any given price -The demand for drugs is inelastic, then an increase in price raises total revenue in the drug market -Drug education can reduce both drug use and drug-related crime
EC120
Chapter 5-Elasticity and its Application
Week 3
Chapter 5-Elasticity and its Application
Week 3
Intro -Elasticity is a measure of how much buyers and sellers respond to changes in market conditions The Elasticity of Demand -To measure how much consumers respond to the changes of supply and demand, economists use elasticity. -Elasticity-a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants The Price Elasticity of Demand and its Determinants -Price elasticity of demand-a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. -Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. -Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price. -The elasticity reflects the many economic, social, and psychological forces that shape consider tastes. -General rules about what determines the price elasticity of demand: Availability of Close Substitutes: -Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others Ex. Butter is elastic because a price change will drop sales since margarine is a close substitute Necessities vs. Luxuries -Necessities have inelastic demands -Luxuries have elastic demands Definition of the Market -Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. -Ex. Food, a broad category has a fairly inelastic demand because there are no good substitutes for food. Ice cream, is a more narrow category and has an elastic demand because it has substitutes. Time Horizon -Goods tend to have more elastic demand over longer time horizons. For example as the price of gas starts to rise, people try to have more fuel efficient cars and the demand drops. Computing the Price Elasticity of Demand -Price elasticity of demand=Percentage change in quantity demanded Percentage change in price The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities -Point A: Price $4 Quantity 120 -Point B: Price $6 Quantity 80 -Midpoint price $5 -Midpoint Quantity 100 -Therefore (6-4)/5x100 = 40.
EC120
Chapter 5-Elasticity and its Application
Week 3
The Variety of Demand Curves -Demand is elastic when the elasticity is greater than 1 and inelastic when it is less than 1. -If the elasticity is exactly 1, the demand is said to have unit elasticity. -The flatter the demand curve that passes through a given point, the greater the price elasticity of demand. The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand. -Inelastic curves look like the letter I. Elastic curves look like the letter E.
Total Revenue and the Price Elasticity of Demand -Total revenue (in a market)-the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold -Total revenue is calculated by price x quantity -When demand is inelastic, price and total revenue move in the same direction -When demand is elastic, price and total revenue move in opposite directions -When demand is unit elastic, total revenue remains constant when price changes
EC120
Chapter 5-Elasticity and its Application
Week 3
Elasticity and Total Revenue along a Linear Demand Curve -A linear demand curve has a constant slope -Even though the slope of a demand curve is constant, the elasticity is not.
Other Demand Elasticities The Income Elasticity of Demand -Income elasticity of demand-a measure of how much the quantity demanded of a good responds to a change in consumer’s income, computed as the percentage change in quantity demanded divided by the percentage change in income. -Income Elasticity of Demand=Percentage change in quantity demanded Percentage change in income
EC120
Chapter 5-Elasticity and its Application
Week 3
-Inferior goods (bus rides) have negative income elasticities because quantity demanded and income move in opposite directions -Necessities such as food and clothing have small income elasticies because consumers choose to buy some of these goods regardless of how low their incomes. The Cross-Price Elasticity of Demand -Cross-price elasticity of demand-a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change of the second good -Cross-price elasticity of demand=Percentage change in quantity demanded of good 1 Percentage change in price of good 2 -Whether the cross-price elasticity is a positive or a negative number depends on whether the two goods are substitutes or complements. -Complements cause the cross-price elasticity to be a negative The Elasticity of Supply The Price Elasticity of Supply and its Determinants -Price elasticity of supply-a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price -Supply is said to be elastic if the quantity supplied responds substantially to changes in the price -Supply is said to be inelastic is the quantity supplied responds only slightly to changes in the price -The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce -Supply is usually more elastic in the long run than in the short run Computing the Price Elasticity of Supply -Price Elasticity of Supply=Percentage change in quantity supplied Percentage change in price -Using the mid point method: The price of milk increases from $2.85 to $3.15 and that allows the farmer to move from selling 9 000L to 11 000L. -Percentage change in quantity supplied= (11 000-9 000)/ 10 000 x 100 = 20 % -Percentage change in price=(3.15-2.85)/3.00 x 100 = 10 % -The price elasticity of supply is therefore 20/10=2
EC120
Chapter 5-Elasticity and its Application
Week 3
The Variety of Supply Curves
Three Applications of Supply, Demand, and Elasticity Can Good News for Farming be Bad News for Farmers? -A study comes out and says there is new technology for farmers to raise hybrid of what by 20% the amount farmers can produce from each hectare of land. -This will affect the supply curve -This discovery affects farmers in two conflicting ways: The hybrid allows farmers to produce more wheat (quantity rises) but now each tonne of wheat sells for less (prices fall) -Whether total revenue rises or falls depends on the elasticity of demand. -Wheat is inelastic because it is cheaply produced and there is no replacement. When the demand curve is inelastic a decrease in price causes total revenue to fall
EC120
Chapter 5-Elasticity and its Application
Week 3
-Farmers would adapt this method because they are competing with other farmers -What is good for farmers is not necessarily good for society as a whole. Improvement of farm technology can be bad for farmers who become increasingly unnecessary, but good for consumers who pay less for food.
Why did OPEC Fail to Keep the Price of Oil High? -OPEC continued to raise the prices of oil in order to bring in more profit. They did this several times. -OPEC found it difficult to maintain a high price for oil -In the short run, both the supply and demand for oil are relatively inelastic -Supply is inelastic because the quantity of known oil reserves and the capacity for oil extraction cannot be changed quickly -Demand is inelastic because buying habits do not respond immediately to changes in price -Gas is a necessity in today’s society so people will purchase it no matter the price because there is no alternative
Does Drug Interdiction Increase or Decrease Drug-Related Crime? -Drug has several adverse effects: one is that drug dependence can ruin the lives of drug users and their families. Another is that drug addicts often turn to robbery and other violent crimes to obtain the money needed to support their habit. -What would happen if the government increases the number of officers devoted to the war on drugs? -When the government stops some drugs from entering the country and arrests more smugglers, it raises the cost of selling drugs and therefore reduces the quantity of drugs supplied at any given price -The demand for drugs is inelastic, then an increase in price raises total revenue in the drug market -Drug education can reduce both drug use and drug-related crime
EC120
Chapter 5-Elasticity and its Application
Week 3
