Download Elastic Demand

This lesson includes

Basics of Supply and Demand
◦ Movement along curve
◦ Shifts in the curve

Government Interventions
◦ Subsidies, taxes, regulations, price floors and
price ceilings

Market Structures
◦ Monopoly, perfect competition, market,
communism, oligopoly, etcs.

Elasticity of Supply and Demand
◦ Sensitivity to change
Unit Test
When we finish up with this slide
presentation, you will be ready for your
first unit test
 Chapters 1-6 in the textbook
 Vocabulary
 Basic Economic concepts along with
supply, demand, elasticity, etc.
 Will do a basic review
 Your assignment – read the chapters and
find the AP questions on line – study
them

Barter v. Monetary Economy
Barter – goods are traded
directly for other goods
 Problems:

◦ Requires a double coincidence of
wants
◦ Large number of trading ratios
(high information costs)

Monetary Economy has lower
transaction and information
costs
Relative and Nominal
Prices

Relative Price = price of a good in
terms of another good
◦ Example: If milk costs $4 per gallon
and bread costs $2 per loaf, then the
relative price of milk is 2 loaves of
bread


Nominal Price – price expressed
in terms of the monetary unit
Relative price is a more direct
measure of opportunity cost
The market forces of Supply and Demand

Demand: desire, ability and willingness to buy a
good or service
◦ Amount of a product that a consumer (individual) or
group of consumers (market) will purchase at a given
price
◦ Relationship between PRICE and QUANTITY
DEMANDED in a given time period, ceteris paribus


Market – group of buyers and sellers of a good
or service
Competitive Market – a market in which there
are so many buyers and sellers that each has a
negligible impact on the market price
Market structures found in
the world

Perfect Competition
◦ Market where no participants are large
enough to have the market power to set the
price of a homogeneous product
◦ Goods offered for sale are exactly the same
◦ Buyers and sellers are so numerous that no
one has any influence over the price (they are
price takers)
◦ Examples: Wheat, Oranges, Tomatoes, Crude
Oil, Stock Market
Various Market Structures

Monopoly
◦ When one company controls the market of a
good/service and can effectively dictate prices
◦ NFL, Microsoft (until sued), China’s Pandas

Monopolistic Competition
◦ Many companies selling similar products but NOT
identical
◦ Jeans in the United States

Oligopoly
◦ Market structure in which a few large firms dominate
a market; four largest firms produce at least 70% of
the output
◦ Auto industry, the beer industry, the soda industry
The Law of Demand
Prices are lower –
consumers will buy
more (prices are
higher – consumers
will buy less)
 Inverse Negative
relationship between
the price and the
quantity demanded
of a product

Quantity Demanded
– specific amount of
the products buyers
are willing and able
to purchase
 Prices influence the
quantity demanded
of a product

Reasons for the Law of Demand

Income Effect
◦ Change in
consumption resulting
from a change in price
◦ You feel richer when
items are cheaper

Substitution Effect
◦ When consumers
react to an increase in
a good’s price by
consuming less of one
good and more of
other goods
$3.99 to $4.99
$3.99
Change in quantity demanded vs. change in demand
Change in quantity demanded
Movement along the curve
Change in demand
Shift the ENTIRE curve
Shifts in the demand Curve
Changes in Demand
are reflected as a
shift in the curve
 Shifts to the RIGHT
indicate an
INCREASE in
demand
 Shifts to the LEFT
indicate a
DECREASE in
demand

Price
Increase in Demand
Decrease in Demand
Quantity Demanded
Determinants of Demand
Tastes and Preferences
 Prices of related goods and services
 Income
 Number of Consumers
 Expectations of future prices and income

Tastes and preferences

Effect of fads
Consumer tastes and
advertising - changes
in popularity of
products or the
influence of trends
and advertising can
affect demand
 Seasonal Effect
 News Reports
 Popularity

Prices of related goods

Substitute goods
◦ An increase in the
price of one results in
an increase in the
demand for the other

Complementary
goods
◦ An increase in the
price of one results in
a decrease in the
demand for the other
Income

Consumer Income – a consumer’s income
affects their demand for goods and
services
◦ Increase in income will cause an increase in
consumption
◦ Decrease in income will cause a decrease in
consumption
◦ Normal goods – income falls, demand falls
◦ Inferior goods – income falls, demand rises
Number of buyers

Population – an increase in the number of
consumers can cause an
increase/decrease in the demand for
products
◦ Increase – increase
◦ Decrease - decrease
Expectations
A higher expected future price will
INCREASE current demand
 A lower expected future price will
DECREASE current demand
 A higher expected future income will
INCREASE the demand for normal goods
 A lower expected future income will
reduce the demand for all normal goods

Supply (the other side of the
equation)

Supply:
◦ The relationship that exists between the price
of a good and the quantity supplied in a given
time period, ceteris paribus
◦ Amount of a good or service available in the
market place
◦ The amount of a product that would be
offered for sale at all possible prices that
could prevail in the market
◦ Positive relationship
Reason for the law of supply

The law of supply is the result of the law
of increasing cost
◦ As the quantity of a good produced rises, the
marginal opportunity cost rises.
◦ Sellers will only produce and sell an additional
unit of a good if the price rises above the
marginal opportunity cost of producing the
additional unit
Change in supply vs. change in
quantity supplied
Change in supply
Change in quantity supplied
Determinants of Supply
The price of
resources
 Technology and
productivity
 Expectations of the
producers
 Number of
producers (more
will join if a profit is
being made)and


Price of related
goods and services
◦ Relationship in
production NOT
consumption
Price of resources



As the price of a resource rises, profitability declines, leading to a
reduction in the quantity supplied at any price.
Increase in input prices will cause REDUCTION in production
Decrease in input prices will cause incentive to produce and
INCREASE supply
Technological improvements




Technological improvements (and any changes that raise the
productivity of labor) lower production costs and increase
profitability.
Increases in ability to produce as firms invest in capital goods
Decrease as a result of faulty technology or breakdowns in equipment
Technology – ability to produce based on capital goods and
technological knowledge
Expectations and supply


An increase in the expected future price of a
good or service results in a reduction in
current supply.
Refers to the way suppliers think about the
future, as it relates to production
◦ Negative expectations for the future of a market
can cause suppliers to shut down production in
the short term
◦ Positive speculation for the future of a market
can cause suppliers to increase production and
bring more suppliers to market
Increase in number of sellers
Number of sellers – an increase in the number of sellers
can cause an increase or decrease in the supply of goods
and services.
Increase in sellers, increase in production
Decrease in sellers, decrease in production
Prices of other goods
Firms produce and sell more than one
commodity.
 Firms respond to the relative profitability of the
different items that they sell.
 The supply decision for a particular good is
affected not only by the good’s own price but
also by the prices of other goods and services
the firm may produce.

Government Intervention

Subsidies
◦ Government payment
that supports a
business or market
◦ Increases the ability to
produce as
government protect
some industries
◦ Decrease as a result of
government removing
the subsidies

Taxes
◦ Excise tax – tax on the
production or sale of a
domestically sold good
◦ Increases the ability to
produce as
government removes
the taxes
◦ Decreases the ability
to produce as
government imposes
the taxes
Government Intervention

Regulation
◦ Government intervention in a market that
affects the price, quantity or quality of a good
◦ Increases the ability to produce as
government deregulates
◦ Decreases the ability to produce as the
government increases regulation
Combining Supply and Demand
Price – the monetary value of a product
as established by supply and demand
 A link between the producers and the
consumers
 Determines the WHAT, HOW and FOR
WHOM to produce

Defining Equilibrium
Equilibrium – the point of balance where
demand and supply come together at the
same number
 QD=QS
 Prices are relatively stable

Disequilibrium
Occurs when the quantity supplied is not
equal to the quantity demanded
 If the price exceeds the equilibrium price,
a surplus occurs – force prices down
 If the price is below the equilibrium price,
a shortage occurs – force prices up

Price Controls
Price ceiling - legally
mandated maximum
price
 Purpose: keep price
below the market
equilibrium price
 Examples:

◦ rent controls
◦ price controls during
wartime
◦ gas price rationing in
1970s
Price floor - legally
mandated minimum
price
 designed to maintain
a price above the
equilibrium level
 examples:

◦ agricultural price
supports
◦ minimum wage laws
Elasticity
“Sensitivity to change”
The Elasticity of Demand
Price Elasticity of Demand is a measure of how
much the quantity demanded of a good
responds to a change in the price of that good.
 Price Elasticity of demand is the percentage
change in quantity demanded given a percent
change in the price

Elasticity of Demand
Elasticity of Demand
• Elasticity shows how sensitive consumers are
to a change in price.
It helps answer the following questions:
• What if we raise price?
• Will people still buy?
• What if we lower price?
• How much more will they buy?
Who cares about elasticity?
• Used by all firms to help set prices
• Used by the government to decide how to tax
• Used by YOU subconsciously
Inelastic
Inelastic Demand
INelastic = INsensitive to a
change in price.
•If price increases, quantity
demanded will fall a little
20%
•If price decreases, quantity
demanded increases a little.
In other words, people will continue
to buy it.
5%
A INELASTIC demand curve is steep! (looks
like an “I”)
Examples
•Gasoline
•Milk
•Diapers
•Chewing Gum
•Medical Care
•Toilet paper
General Characteristics of INelastic
Goods:
• Few Substitutes
• Necessities
• Small portion of income
• Required now, rather than later
Elastic
Elastic Demand
Elastic = Sensitive to a change
in price.
•If price increases, quantity
demanded will fall a lot
•If price decreases, quantity
demanded increases a lot.
In other words, the amount people
buy is very sensitive to price.
An ELASTIC demand curve is flat!
Examples
•Soda
•Boats
•Beef
•Real Estate
•Pizza
•Gold
General Characteristics of Elastic
Goods
Necessities versus luxuries
Eating at restaurants
Groceries
 Availability of substitutes
Chicken versus beef
 How much of our income a good takes
Salt versus Nike sneakers
 The passage of time

Remember:
P – proportion of income
 A – availability of close substitutes
 I – importance of the good (luxury v. necessity)
 D – Delay purchase possible?

Perfectly Inelastic
What about the demand for insulin for
diabetics?
What about the demand for water for someone
dying of thirst?
Perfectly INELASTIC
Unit Elastic (Unitary)
What if % change in quantity
demanded equals % change in price?
Unit Elastic (45 degrees)
The Total Revenue Test
(AKA Total Expenditures Test)
Important Observations
When demand is elastic, a decrease in price will
result is an increase in the revenue (sales).
When demand is inelastic, a decrease in price will
result is a decrease in the revenue (sales).
When demand is unit-elastic, an increase (or a
decrease) in price will not change the revenue
(sales).
Total Revenue Test
Uses elasticity to show how changes in price will affect total
revenue (TR).
(TR = Price x Quantity)
Elastic Demand• Price increase causes TR to decrease
• Price decrease causes TR to increase
Inelastic Demand• Price increase causes TR to increase
• Price decrease causes TR to decrease
Unit Elastic• Price changes and TR remains unchanged
Ex: If demand for milk is INelastic, what will happen to
expenditures on milk if price increases?
Total Revenue Test
Price and Demand
Elastic
Inelastic
Price Increases
Total Revenue
Decreases
Price Decreases
Total Revenue
Increases
Price Increases
Total Revenue
Increases
Price Decreases
Total Revenue
Decreases
Inverse
Relationship
Direct
relationship
Other Demand Elasticities:
Cross-Price Elasticity
The cross-price elasticity of demand between two goods
measures the effect of the change in one good’s price on
the quantity demanded of the other good. It is equal to
the percent change in the quantity demanded of one
good divided by the percent change in the other good’s
price.
Cross-price elasticity of demand determines
whether two goods are substitutes (positive
number/relationship) or compliments (negative
number/relationship).
The Income Elasticity of Demand
The income elasticity of demand is the percent
change in the quantity of a good demanded when a
consumer’s income changes divided by the percent
change in the consumer’s income.
By calculating the income elasticity of demand for a
product you are able to determine whether it is a
normal good (positive number) or an inferior good
(negative number).
2. Elasticity of
SUPPLY
Price Elasticity of Supply
Elasticity of Supply• Elasticity of supply shows how sensitive producers are
to a change in price.
Which supply is more elastic, electricity or pool cleaning?
Elasticity of supply is based on time limitations.
Some producers need a lot of time to produce more.
INelastic = Insensitive to a change in price (Steep curve)
• Most goods have INelastic supply in the short-run
Elastic = Sensitive to a change in price (Flat curve)
• Most goods have elastic supply in the long-run
Perfectly Inelastic = Q doesn’t change (Vertical line)
• Set quantity supplied (Ex: VanGogh Paintings)
Elasticity and Excise Taxes
Who ends up paying for an excise
tax?
EXCISE TAX ON CIGARETTES
P
$10
Demand- Inelastic
Supply- Unitary
S
8
CS
6
$2 TAX on
Producers
5
4
2
D
8 10
Q
EXCISE TAX ON CIGARETTES
P
$10
S1
S
$6.50 =Pconsumers
$4.50 = Pproducers
8
7
6
5
4
CS
After
Amount Consumers
Pay
$2 TAX on
Producers
Amount Producers Pay
2
D
9 10
Quantity Doesn’t Fall VERY Much!!!
Q
Elasticity on Graphs
Look at the slopes of the lines
Things to Remember






What might impact
demand?
M – market size
E – expected prices
R – related goods
I – income levels
T – tastes






What might impact
supply?
T - technology
R – related goods
I – input prices
C - competition
E – expected prices