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Chapter 4
Working with
Supply and Demand
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western
Government Intervention in Markets
• Excess demand
– Quantity demanded exceeds quantity
supplied
– Sellers - short side of the market
• Excess supply
– Quantity supplied exceeds quantity
demanded
– Buyers - short side of the market
2
Government Intervention in Markets
• Shortage
– Excess demand not eliminated by a rise
in price
• Surplus
– Excess supply not eliminated by a fall in
price
• When quantity supplied and quantity
demanded differ, the short side of the
market will prevail
3
Price Ceilings
• A government imposed maximum price
– Prevents the price from rising above a
certain level
• Creates a shortage
• Unintended consequences
– Black market
• illegal
• price above the ceiling
– Long lines, higher prices
4
Price Ceilings
• Figure 1 A Price Ceiling in the Market for Maple Syrup
5. With a black market,
the lower quantity sells
for a higher price than initially.
Price per
Bottle
3. and decreases the
quantity supplied
S
T
$4.00
3.00
2.00
R
4. The result is a shortage
– the distance between
R and V
E
V
2. increases the
quantity demanded
D
1. A price ceiling lower than
the equilibrium price…
40,000 50,000 60,000
Number of Bottles of
Maple Syrup per Period
5
Price Floors
• A government imposed minimum price
– prevents the price from falling below a
certain level
• Creates a surplus
– that no one wants at the imposed price
• the government buys the excess supply
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Price Floors
• Figure 2 A Price Floor in the Market for Nonfat Dry Milk
Price
per
Pound
1.A price floor higher
than the equilibrium
price . . .
2. decreases quantity
demanded…
3.and increases
quantity supplied
S
J
K
$0.81
A
0.65
4. the result is a surplus
(distance between K and J)
D
180
200
220
Millions of Pounds
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Problems with the Rate of Change
• Price elasticity of demand
– Measures the sensitivity of quantity
demanded to a change in price
• Problems with the rate of change (slope)
– Not a good measure of elasticity
• Depends on the units of measurement
• Significance of a change in price or quantity
8
The Elasticity Approach
• Price elasticity of demand (ED)
– percentage change in quantity
demanded divided by percentage change
in price
% Q D
ED 
% P
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Price Elasticity of Demand
• Negative
• Percentage change in quantity
demanded for each 1% change in price
• The greater the ED the more sensitive
quantity demanded is to price
• Percentage Change
– Use the midpoint formula
• Change in variable divided by the average
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Calculating Price Elasticity of Demand
• %Change in Price
( P1  P0 )
%P 
 P1  P0 
 2 
• %Change in Quantity demanded
(Q1  Q0 )
% Q D 
 Q1  Q0 
 2 
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Calculating Price Elasticity of Demand
• Figure 3 Using the Midpoint Formula for Elasticity
Price
Per
Avocado
$1.50
3. Elasticity of demand for the
move from A to B is
20% / 40% = 0.5
A
B
1.00
1. Using the midpoint
formula, the percentage drop
in price is $0.50/$1.25
= 0.40 or 40% …
4,500
5,500
2. and the percentage rise
in quantity is 1,000 / 5,000
= 0.2 or 20%.
Quantity of
Avocados per week
12
Types of Demand Curves
• Perfectly inelastic demand: ED=0
• Inelastic demand: ED between 0 and 1
• 1% rise in price will cause quantity
demanded to fall by less than 1%
• Perfectly elastic demand:
– ED approaching infinity
• Elastic demand: ED >1
• a 1% rise in price will cause quantity
demanded to fall by more than 1%
• Unit elastic demand: ED=1
13
Types of Demand Curves
• Figure 4 Categories of Demand Curves
b) Inelastic Demand
a) Perfectly Inelastic Demand
P
P
D
$11
$11
9
9
D
Price
rises
by 20%
Price
rises
100
Quantity doesn’t change
Q
95 105
Q
Quantity falls by less than 20%
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Types of Demand Curves
• Figure 4 Categories of Demand Curves
c) Elastic Demand
d) Perfectly Elastic Demand
P
P
Consumers will buy
any quantity at $9,
none at a higher price
D
$11
D
9
$9
Price
rises
by 20%
85
115
Q
100
Q
Quantity falls by more than 20%
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Elasticity and Straight-Line Demand Curves
• Figure 5 How Elasticity Changes along a Straight-Line Demand
Price
$2,000
Each time P
drops by
$500, the
%ΔP is larger
A
B
1,500
Elasticity falls as we
move rightward along
a straight-line demand
curve
C
1,000
D
15,000
25,000 35,000
Each time Q rises by another 10,000, the
%ΔQ is smaller.
Quantity
of Laptops
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Elasticity and Straight-Line Demand Curves
• Demand becomes less elastic (ED gets
smaller) as we move downward and
rightward.
• Demand becomes more elastic (ED
increases) as we move upward and
leftward
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Elasticity and Total Revenue
• Total Revenue TR=PxQ
• Inelastic Demand (ED < 1)
• total revenue moves in same direction as
price
• Elastic Demand (ED > 1)
• total revenue moves in opposite direction
from price
• Unitary elastic demand
• total revenue remains the same as price
changes
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Elasticity and Total Revenue
• Figure 6 Elasticity and Total Revenue
a) Inelastic Demand
b) Elastic Demand
P
$11
P
B
$11
B
A
9
A
9
D
D
95 105
Q
85
115
Q
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