Download Powerpoint Chapter 18 - McGraw Hill Higher Education

Chapter 18
The Elasticities of Demand and
Supply
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Chapter Objectives
•
•
•
•
•
The elasticity of demand
The determinants of elasticity
Elasticity and total revenue
The elasticity of supply
Tax incidence
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-2
The Elasticity of Demand
• The elasticity of demand for a good or service
measures the change in quantity demanded in
response to a change in price
– In other words, elasticity measures the sensitivity
(measured in percentage change) of quantity
demanded because of a change (percentage) in price
– When price goes up, we know that quantity
demanded declines.
• But we don’t know by how much?
– Elasticity provides us a way of measuring this
response
• Elasticity answers the “how much” question
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-3
Measuring Elasticity
Calculate the coefficient of price elasticity (Ep)
Percentage change in quantity demanded
Ep =
Percentage change in price
Q2 - Q1 P2 + P1
X
Ep =
Q2 + Q1 P2 - P1
P1 is the initial price; P2 is the new price
Q1 is the initial quantity sold; Q2 is the new quantity sold
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-4
A firm has been selling 100 chairs a week.
It runs a sale, charging $8 instead of the
usual $10. Sales go up to 140 chairs.
Ep =
Q2
- Q1
Q2 + Q1
X
P2 + P1
P2 - P1
140 -100
8 + 10
Ep =
X
8 - 10
140 + 100
40
18
Ep = 240 X -2
= - 1.4999994
Ep = 1.5
Note: the answer is always negative
So the negative sign is ignored
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-5
Price is raised from $40 to $41, and
quantity sold declines from 15 to 12
Ep =
Q2
- Q1
Q2 + Q1
X
P2 + P1
P2 - P1
15 - 12
41 + 40
Ep =
X
41 - 40
12 + 15
-3
Ep = 27 X 81
1 = -8.9999991
Ep = 9.0
Note: the answer is always negative
So the negative sign is ignored
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-6
The Meaning of Elasticity
• Elasticity is many things
– First, elasticity is a number
• An Ep greater than 1 is elastic
• This means that demand is relatively sensitive to price
changes
• The larger the number, the greater will be the sensitivity to
price changes
– This number represents the percent change in
quantity demanded resulting from each 1% change
in a goods price
• An Ep of 10 means that for every 1% change in price there
will be a 10% change in QD
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-7
The Meaning of Elasticity
• An Ep less than 1 is inelastic
• This means that demand is relatively less
sensitive to price changes
• The smaller the number, the greater the
insensitivity to price changes
• An Ep of .1 means that for every 1% change in
price there will be a .1% change in quantity
demanded
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-8
The Meaning of Elasticity
– An Ep that is exactly 1 is unit elastic
• This means that demand is neither elastic nor
inelastic
• An Ep of 1 means that for every 1% change in
price there will be a 1% change in QD
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-9
Perfectly Elastic Demand Curve
14
12
10
8
D
6
4
2
5
10
15
20 25
Quantity
30
The elasticity of a perfectly elastic demand curve is infinity
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-10
Perfectly Inelastic Demand Curve
D
30
25
20
15
10
5
5
10
15
20
25
Quantity
The elasticity of a perfectly inelastic demand curve is 0
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-11
Relativity Elasticity of Demand Curves
D1
D2
Quantity
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-12
Straight Line Demand Curve
11
10
9
8
7
6
5
4
3
2
1
D
0
0
1
2
3
4
5
6
7
8
9
10
11
Quantity
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-13
Elasticity of Straight Line Demand Curve
11
Very elastic
10
e = 6.33
9
8
Slightly elastic
7
Unit elastic
e = 1.0
Slightly inelastic
6
5
4
e = .29
3
Very
inelastic
2
1
D
0
0
1
2
3
4
5
6
7
8
9
10
11
Quantity
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-14
Relatively Inelastic Demand Curve
D
Quantity
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18-15
Relatively Elastic Demand Curve
5
4
3
2
1
D
1
2
3
4
5
6
7
8
9
10
11
12
Quantity in pounds
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-16
Determinants of the Degree of
Elasticity of Demand
• The availability of substitutes is the most
important influence on the elasticity of
demand
• The question of necessity versus luxury
• The product’s cost relative to the buyer’s
income
• The passage of time
• The number of uses
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-17
Advertising
• Purpose
– To make the demand for a product greater
– To make the demand for a product more
inelastic
D
D
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-18
Elasticity and Total Revenue
Elastic Demand and Total Revenue
Prices were raised from $10 to $12 and quantity demanded fell from 20 to 12
Calculate Ep
Solution: P1 = 10; P2 = 12; Q1 = 20; Q2 = 12
.
.
12-20 12+10 8 22
=
12+20 12-10 32 2
Price
QD
=
.25 X 11 = 2.75
TR
$10
20
$200
12
12
144
When demand is elastic, a price increase will lead to a
fall in total revenue!
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-19
Elasticity and Total Revenue
Elastic Demand and Total Revenue
Prices were raised from $10 to $12 and quantity demanded fell from 20 to 12
Calculate Ep
Solution: P1 = 10; P2 = 12; Q1 = 20; Q2 = 12
.
.
12-20 12+10 8 22
=
12+20 12-10 32 2
Price
QD
=
.25 X 11 = 2.75
TR
$10
20
$200
12
12
144
When demand is elastic, a price decrease will lead to a
rise in total revenue!
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-20
Elasticity and Total Revenue
Inelastic Demand and Total Revenue
Prices were raised from $2 to $3 and quantity demanded fell from 9 to 8
Calculate Ep
Solution: P1 = 2; P2 = 3; Q1 = 9; Q2 = 8
8-9
8+9
Price
. 33+2-2
-
QD
-1
.125
=17
= -.0588235
X 5 = 0.29
TR
$2
9
$18
$3
8
$24
When demand is inelastic, a price increase will lead to
a rise in total revenue!
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-21
Elasticity and Total Revenue
Inelastic Demand and Total Revenue
Prices were raised from $2 to $3 and quantity demanded fell from 9 to 8
Calculate Ep
Solution: P 1= 2; P2 = 3; Q1 = 9; Q2 = 8
8-9
8+9
Price
. 33+2-2
QD
1
.125
=17
=
.0588235 X 5 = 0.29
TR
$2
9
$18
$3
8
$24
When demand is inelastic, a price decrease will lead to
a fall in total revenue!
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-22
Elasticity of Supply
• Elasticity of supply is the responsiveness of
quantity to changes in price
– Elasticity of supply parallels the elasticity of
demand
– Elasticity of supply measures the responsiveness of
quantity supplied to changes in price
• An elasticity of 10 means a 1% change in price brings
about a 10% change in quantity supplied
• An elasticity of 0.2 means a 10% change in price gives rise
to just a .2% change in quantity supplied
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-23
Perfectly Elastic Supply
Perfectly Inelastic Supply
Curve
Curve
S
S
Quantity
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Quantity
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Relative Elasticities of Supply
S1
S2
Quantity
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-25
Elasticity over Time
• Remember, supply grows more elastic over
time, especially when enough time has passed
for new firms to enter the industry and for
existing firms to increase their output
• Economists have identified three distinct time
periods
– The market period
– The short run
– The long run
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-26
The Market Period
• The market period is the time
immediately after a change in market
price during which the sellers can’t
respond by changing the quantity
supplied
– During this period the supply curve may be
perfectly inelastic or with some positive slope
because firms have limited ability to increase
output
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-27
The Short Run
• In the short run a firm has an essentially
fixed productive capacity
– A firm has some ability to increase output
• A firm could go from two 8-hour shifts to three 8hour shifts
• Store hours could probably be extended
• And so, an increase in demand will result in
more output
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-28
The Long Run
• In the long run there is sufficient time for a
firm to alter its productive capacity
– The firm can leave the industry
– New firms can enter the industry
– When a rise in demand is considered to be long
lasting, some existing firms will add to their plant
and equipment
– If demand falls, some or all firms will cut back on
their plant and equipment, while others may leave
the industry
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-29
Tax Incidence
(tells us who really pays the tax)
S2
$10
A tax increase
lowers the supply
S1
8
6
How much is the
tax??
4
(hint . . . measure it
vertically)
Price
D
2
0
0
Answer: $3
2
4
6
Output
8
10
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12
18-30
Tax Incidence
(tells us who really pays the tax)
S2
$10
S1
A tax increase
lowers the supply
8
Who pays the tax?
6
S1/D P=$6; QD=6
Price
4
2
0
0
2
4
6
Output
8
10
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
S2/D P=$7; QD=4
D The Customer
pays an additional
$1
The Supplier
12 absorbed the rest
($2)
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Tax Incidence
$10
(tells us who really pays the tax)
The demand curve is perfectly inelastic
The burden falls
S2
entirely on the
S1
buyer
8
Who pays the tax?
6
S1/D P=$6; QD=6
Price
4
S2/D P=$9; QD= 6
2
The buyer pays
and additional $3
0
0
D
2
4
6
Output
8
10
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Seller absorbs
12 ($0)
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Tax Incidence
(tells us who really pays the tax)
The supply curve is more elastic than the demand curve
The burden falls
$10
S2
mainly on the
buyer
8
S1 Who pays the tax?
S1/D P=$6; QD=6
6
S2/D P=$8.30
Price
QD=2
4
D
The buyer pays and
2
additional $2.30
0
0
2
4
6
Output
8
10
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Seller absorbs $.70
12
18-33
Summary
• When the supply is perfectly inelastic, the seller
bears the entire tax burden
• When supply is perfectly elastic, the buyer
bears entire tax burden
• As the elasticity of demand rises, the tax
burden is shifted from the buyer to the seller
• As the elasticity of supply rises, the tax burden
is shifted from the seller to the buyer
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18-34