Download Chapter 20 Demand & Supply: Elasticities & Applications

CHAPTER TWENTY
Demand & Supply:
Elasticities & Applications
Eat up idiots!
Eat – Up - Idiots
LAW OF DEMAND
 As
Price Falls…
…Quantity Demanded Rises
 As Price Rises…
…Quantity Demanded Falls
An inverse relationship exists between
price and quantity demanded
Eat up idiots!
LAW OF DEMAND or
Why Demand Curves Slope Down!
Diminishing Marginal Utility
Income Effect
 Substitution Effect
 Demand Curve
 Individual and Market
Demand

Eat up idiots!
PIPES/c
 Population
 Income
 Preference
 Expectations
 Substitutes &
Complements
Eat up idiots!
Supply v Quantity Supplied
Supply is producers
 Supply is stuff


Qs v S
 The
mind of the
producer???
– Price up? Good or Bad
– Wages up? Good or Bad
Eat up idiots!
LAW OF SUPPLY
 As
Price Rises…
…Quantity Supplied Rises
 As Price Falls…
…Quantity Supplied Falls
A direct relationship exists between
price and quantity supplied
Eat up idiots!
Supply - DIGTS



Disaster
Input Prices
Government Policies
– Taxes
– Subsidies
– Regulations


Eat up idiots!
Technology
Size
Disequilibrium: SURPLUS
P
The result of
imposing a
Price that
is too
HIGH! Ph
D
S
SURPLUS
Prices above
Equilibrium cause
Surplus!
P
S
Surpluses put pressure on producers to
lower price!!
Eat up idiots!
D
Qd = Q = Qs
Q
Disequilibrium: SHORTAGE
P
D
S
P
Pl
S
Shortages put pressure on producers to
raise price!!
Eat up idiots!
SHORTAGE
Qs = Q = Qd
D
Q
Would these two AP Econ students rate Pizza the same?
Would these two AP Econ students rate shoes the same?
Would these two AP Econ students rate soda the same?
Would these two AP Econ students rate homework the same?
Eat up idiots!
Consumer Surplus
n
n
n
If a slice of pizza costs $1.50, but Adam would
pay $2.00 for the slice of pizza than Adam’s
consumer surplus is $0.50.
If a new pair of football shoes costs $64.50,
and Andy would pay $70.00 for a pair of
football shoes than his consumer surplus is
$5.50.
They would feel good about their lucky
purchases! Both have received some
UTILITY!
Eat up idiots!
Price
$40
$30
At a price of $30!
$20
$10
AP Tests 2000, 2003 & 2004
Not in our Text or the
AP curriculum until last
year - Activity #9 C.
Quantity
Eat up idiots!
Demand & Supply
Price of Corn
CORN
P
$1
2
3
4
5
QD
80
55
35
20
10
P$5
CORN
P QS
4
Market
P1 3
Clearing
Equilibrium
2
1
o
Eat up idiots!
S
D
10
20
30 3540
Q1
50
60 70 80
Quantity of Corn
Q
$1
2
3
4
5
5
20
35
50
60
Consumer Surplus in Total
Producer
Surplus
in
Total
P
S
All buyers who would have
paid a price higher than the
market clearing price are
happy and receive a
Consumer Surplus!
All sellers who would have
sold at a price lower than
the market clearing price
are happy and receive a
Producer Surplus!
P
AP Tests 2000
2003, & 2004
not in our Text
New to AP
Packet in 2005:
9C & 12C
Eat up idiots!
D
Q
Q
Dead Weight Loss
P
S
Price Floor
Farm Subsidy
Dairy Farmers
P2
P1
AP Tests 2000
2003, & 2004
not in our Text
New to AP
Packet in 2005:
#22
Eat up idiots!
D
Q2
Q1
Q
Dead Weight Loss
P
S
D
Price Ceiling
Rent Control
P1
A Maximum Price
P2
S
D
Qs
Eat up idiots!
Q1
Qd
Q
P
True Market
Price!
Deadweight Loss
When a Product is Taxed
s + Tax
Excise
Tax
S
New market price
paid by consumers
Dead Weight Loss
From 2003 Essay!
Free Market
Price too Low!
Activity 21
Amount of
Tax needed
to correct
Negative
externality!
D
0
Eat up idiots!
Qd = Q s
Over allocation – too much bad stuff
Q
Signals Graphs
Eat up idiots!
The
Product Market
S
Individual Firms
Households
Signals
D
Eat up idiots!
Individual Firm
Product Market
Household
s = MC
S
P*
d = MR
q*
P*
Q*
P*
s
D
d
q*
The Product Market signals both Households and Individual Firm
the price of products. The signals indicate P* to both.
Based on its cost of producing one more firms determine how much.
Based on their demand consumer determine how many.
Eat up idiots!
Workers
Factor Market
Labor
Individual Firms
s = MSC
S
P*
d = MSB
P*
P*
D
q*
MRC
Q*
MRP
q*
The Factor Market signals both Workers and Individual Firms
the price of labor & the wage of labor. The signals indicate P* to both.
Based on its revenue/worker(mrp) vs. its costs(mrc) firms determine how
many workers to hire (mrp=mrc). Based on their Marginal Benefit vs.
Marginal Cost workers determine whether or not they will work for this
wage (msc=msb).
Eat up idiots!
Demand & Supply
Price of Corn
P$5
S
What if
Demand
Increases?
4
3
2
1
o
Eat up idiots!
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
Demand & Supply
Price of Corn
P$5
S
Increase
in Quantity
Supplied
Increase
in
Demand
4
3
2
D’
1
o
Eat up idiots!
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
Demand & Supply
Price of Corn
P$5
S
What if
Demand
Decreases?
4
3
2
D’
1
o
Eat up idiots!
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
Demand & Supply
Price of Corn
Decrease
in Quantity
Supplied
P$5
S
4
3
Decrease
in
Demand
2
1
D’
o
Eat up idiots!
10
20
30
40
50
60 70 80
Quantity of Corn
D
Q
Demand & Supply
Price of Corn
P$5
S
What if
Supply
Increases?
4
3
2
1
o
Eat up idiots!
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
Demand & Supply
Price of Corn
P$5
Increase
in
Supply
4
S
S’
Increase
in Quantity
Demanded
3
2
1
o
Eat up idiots!
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
Demand & Supply
Price of Corn
P$5
S
S’
What if
Supply
Decreases?
4
3
2
1
o
Eat up idiots!
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
Demand
&
Supply
Decrease
S’
Price of Corn
P$5
S
in
Supply
4
Decrease
in Quantity
Demanded
3
2
1
o
Eat up idiots!
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
What if both demand and supply increase?
What if both demand and supply decrease?
P
S1
S2
P2? P1
D1
Eat up idiots!
Q1
Q2
D2
Q
Demand & Supply
Price of Corn
CORN
P
$1
2
3
4
5
QD
80
55
35
20
10
P$5
4
CORN
P QS
$1
2
supplied than
3
demanded
4
5
more is being
3
2
1
o
Eat up idiots!
Surplus
S
At a $5 price
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
5
20
35
50
60
Demand & Supply
Price of Corn
CORN
P
$1
2
3
4
5
QD
80
55
35
20
10
P$5
4
CORN
P QS
$1
2
demanded than
3
supplied
4
Shortage
5
more is being
3
2
1
o
Eat up idiots!
S
At a $1 price
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
5
20
35
50
60
Think About It...
THE LAW OF DEMAND SAYS...
Eat up idiots!
Think About It...
THE LAW OF DEMAND SAYS...
As price changes Qd changes…
...HOW MUCH MORE OR LESS?
Eat up idiots!
Think About It...
THE LAW OF DEMAND SAYS...
As price changes Qd changes…
...HOW MUCH MORE OR LESS?
DOES IT MATTER?
Eat up idiots!
Think About It...
THE LAW OF DEMAND SAYS...
As price changes Qd changes…
...HOW MUCH MORE OR LESS?
DOES IT MATTER?
to whom?
Eat up idiots!
Price Elasticity is...
P
AS PRICE INCREASES FROM
P1 TO P2 QUANTITY
DECREASES FROM Q1 TO Q2
P2
P1
D
Q2 Q1 Q
Eat up idiots!
Price Elasticity is...
P
AS PRICE INCREASES FROM
P1 TO P2 QUANTITY
DECREASES FROM Q1 TO Q2
By what percentage
did price change?
P2
P1
D
Q2 Q1 Q
Eat up idiots!
Price Elasticity is...
P
AS PRICE INCREASES FROM
P1 TO P2 QUANTITY
DECREASES FROM Q1 TO Q2
By what percentage
did price change?
P2
P1
By what percentage
D
did quantity change?
Q2 Q1 Q
Eat up idiots!
Price Elasticity is...
P
If the percentage
price change was 4...
P2
P1
D
Q2 Q1 Q
Eat up idiots!
Price Elasticity is...
P
If the percentage
price change was 4...
and the percentage
quantity change was 2...
P2
P1
D
Q2 Q1 Q
Eat up idiots!
Price Elasticity is...
P
If the percentage
price change was 4...
and the percentage
quantity change was 2...
P2
P1
Elasticity
is
D
Q2 Q1 Q
Eat up idiots!
.5
Price Elasticity is...
P
If the percentage
price change was 4...
and the percentage
quantity change was 2...
P2
P1
Elasticity
is
D
Q2 Q1 Q
Eat up idiots!
.5
Demand & Supply
Price of Corn
CORN
P
$1
2
3
4
5
QD
80
55
35
20
10
P$5
4
CORN
P QS
$1
2
supplied than
3
demanded
4
5
more is being
3
2
1
o
Eat up idiots!
Surplus
S
At a $5 price
D
10
20
30
40
50
60 70 80
Quantity of Corn
Q
5
20
35
50
60
P
Price Elasticity is...
The percentage change in quantity
2
P2
P1
D
Q2 Q1 Q
Eat up idiots!
P
Price Elasticity is...
The percentage change in quantity
The percentage change in price
2
4
P2
P1
D
Q2 Q1 Q
Eat up idiots!
P
Price Elasticity is...
The percentage change in quantity
The percentage change in price
2
P2
P1
4
D Elasticity is
Q2 Q1 Q
Eat up idiots!
.5
P
Price Elasticity is...
Commonly expressed as...
% D Qd
%D P
P2
P1
D
Q2 Q1 Q
Eat up idiots!
P
Price Elasticity is...
NOTES:
Commonly
expressed as...
Ignore minus
sign in the
resulting
calculation
% D Qd
P2
P1
%D P
D
Q2 Q1 Q
Eat up idiots!
P
Price Elasticity is...
Commonly expressed as...
% D Qd
%D P
P2
P1
D
Q2 Q1 Q
Eat up idiots!
but what does
it mean?
P
Price Elasticity is...
also expressed by its impact
upon total revenue
P2
P1
D
Q2 Q1 Q
Eat up idiots!
P
Price Elasticity is...
also expressed by its impact
upon total revenue
When price is zero...
P2
P1
D
Q2 Q1 Q
Eat up idiots!
P
Price Elasticity is...
also expressed by its impact
upon total revenue
When price is zero...
P2
P1
Total revenue is...
D
Q2 Q1 Q
Eat up idiots!
P
Price Elasticity is...
When prices
are low, so
is total revenue
D
Q
Eat up idiots!
Total Revenue
Quantity Demanded
P
Price Elasticity is...
Total revenue rises TR
with price to a
point...
D
Q
Eat up idiots!
Quantity Demanded
P
Price Elasticity is...
Total revenue rises TR
with price to a
point...
D
Q
Eat up idiots!
then declines
Quantity Demanded
P
Price Elasticity is...
Total revenue rises TR
with price to a
point...
D
Q
Eat up idiots!
then declines
Quantity Demanded
P
Price Elasticity is...
Total revenue rises TR
with price to a
point...
then declines
Total Revenue Test
D
Q
Eat up idiots!
Quantity Demanded
P
Price Elasticity is...
Total revenue rises TR
with price to a
point...
Inelastic
Demand
Eat up idiots!
D
Q
Inelastic
Demand
Quantity Demanded
P
Price Elasticity is...
Total revenue rises TR
with price to a
point...
then declines
Elastic
Demand
Inelastic
Demand
Eat up idiots!
D
Q
Elastic Inelastic
Demand Demand
Quantity Demanded
P
Price Elasticity is...
Total revenue rises TR
with price to a
point...
Elastic
Demand
Unit
Elastic
Inelastic
Demand
Eat up idiots!
then declines
D
Q
Elastic Inelastic
Demand Demand
Quantity Demanded
Price Elasticity is...
Inelastic from 0 to 1
Typical of necessities one must have,
few subs, items small % of DI
Elastic from 1 to 
Typical of luxuries one wants, many
subs, items large % of DI
Unit elastic when exactly = 1
Price change does not reduce total
revenue
Eat up idiots!
Price Elasticity is...
P
D1
Perfectly
inelastic
demand
Q
Eat up idiots!
Price Elasticity is...
P
D1
Perfectly
inelastic
demand
D2
Perfectly
elastic
demand
Q
Eat up idiots!
Refinement: Midpoint Formula
Ed =
Eat up idiots!
Change in
quantity
Sum of
Quantities/2
..
Change in
price
Sum of
prices/2
Determinants of Price Elasticity of Demand
• Substitutability
The more substitutes there are for a product the greater the
Elasticity of demand. Big Macs. Consumers are more
responsive to price changes in either direction.
Eat up idiots!
Determinants of Price Elasticity of Demand
• Substitutability
• Proportion of Income
The higher the price of a good is relative to an individual’s
Income the greater the elasticity of demand. Trips to Europe.
Individuals are more responsive to price changes.
Eat up idiots!
Determinants of Price Elasticity of Demand
• Substitutability
• Proportion of Income
• Luxuries versus Necessities
Necessities are price inelastic. You need to the good so you are
not as responsive to the price changes. Luxuries are the opposite.
Eat up idiots!
Determinants of Price Elasticity of Demand
• Substitutability
• Proportion of Income
• Luxuries versus Necessities
• Time
The more time you have to weigh your alternatives in response
to a price change the more elastic your demand for that product.
GM announces price reductions lasting until June 1st.
Eat up idiots!
Determinants of Price Elasticity of Demand
• Substitutability
• Proportion of Income
• Luxuries versus Necessities
• Time
Applications...
Bumper crops
Drugs and Street Crime
Airline deregulation
Eat up idiots!
Price Elasticity of Supply
Es=
Percentage change in quantity
supplied of good X
Percentage change in
the price of good X
Es >1 Elastic
Eat up idiots!
< 1 Inelastic = 1 Unit Elastic
Price Elasticity is...
P
S1
Perfectly
inelastic
supply
S2
Perfectly
elastic
supply
Q
Eat up idiots!
Price Elasticity of Supply
Es=
Percentage change in quantity
supplied of good X
Percentage change in
the price of good X
now compare the market period
short-run, and long run...
Eat up idiots!
Price Elasticity of Supply
Immediate market period
P
Sm
An increase in
demand without
enough time to
change supply
causes…
Po
D1
Q
Copyright McGraw-Hill, Inc.,
Price Elasticity of Supply
Immediate market period
P
Sm
Pm
An increase in
demand without
enough time to
change supply
causes… an
increase in price
Po
D2
D1
Copyright McGraw-Hill, Inc.,
Qo
Q
Price Elasticity of Supply
Short run
P
Ss
An increase in
demand with
less intensity
supply use
causes...
Po
D1
Copyright McGraw-Hill, Inc.,
Qo
Q
Price Elasticity of Supply
Short run
P
Ss
An increase in
demand with
less intensity
supply use
causes...a lower
increase in price
Ps
Po
D2
D1
Copyright McGraw-Hill, Inc.,
QoQs
Q
Price Elasticity of Supply
Long run
P
An increase in
demand in the
long run allows
greater change
causing...
SL
Po
D1
Copyright McGraw-Hill, Inc.,
Qo
Q
Price Elasticity of Supply
Long run
P
PL
Po
An increase in
demand in the
long run allows
greater change
causing...
SL
Even more elastic
response - less
price increase
D2
D1
Copyright McGraw-Hill, Inc.,
Qo
QL
Q
Cross Elasticity of Demand
Exy =
Eat up idiots!
Percentage change in quantity
demanded of good X
Percentage change in
the price of good y
Cross Elasticity of Demand
Exy =
Percentage change in quantity
demanded of good X
Percentage change in
the price of good y
Substitute Goods - Positive Sign
Eat up idiots!
Cross Elasticity of Demand
Exy =
Percentage change in quantity
demanded of good X
Percentage change in
the price of good y
Substitute Goods - Positive Sign
Complementary Goods - Negative Sign
Eat up idiots!
Cross Elasticity of Demand
Exy =
Percentage change in quantity
demanded of good X
Percentage change in
the price of good y
Substitute Goods - Positive Sign
Complementary Goods - Negative Sign
Independent Goods - Zero or near-zero value
Eat up idiots!
Income Elasticity of Demand
Ei =
Eat up idiots!
Percentage change in
quantity demanded
Percentage change
in income
Income Elasticity of Demand
Ei =
Percentage change in
quantity demanded
Percentage change
in income
Normal Goods - Positive Sign
Eat up idiots!
Income Elasticity of Demand
Ei =
Percentage change in
quantity demanded
Percentage change
in income
Normal Goods - Positive Sign
Inferior Goods - Negative Sign
Eat up idiots!
Applications...
Price Ceiling
P
D
The result of
imposing a
legal price
ceiling is a...
P
S
Copyright McGraw-Hill, Inc.,
S
D
Q
Applications...
Price Ceiling
P
D
P
Pc
Legal Price Ceiling
S
Copyright McGraw-Hill, Inc.,
S
SHORTAGE
D
Q
Applications...
Price Ceiling
P
D
S
With shortages comes...
Rationing Problems
and
P
Legal Price Ceiling
Black
Markets
Pc
S
Copyright McGraw-Hill, Inc.,
SHORTAGE
D
Q
Applications...
Price Ceiling
Rent Controls
Copyright McGraw-Hill, Inc.,
Applications...
Price Ceiling
Rent Controls
Credit Card Interest Ceilings
Copyright McGraw-Hill, Inc.,
Applications...
Price Ceiling
Rent Controls
Credit Card Interest Ceilings
Rock Concerts
Copyright McGraw-Hill, Inc.,
Applications...
P
The result of
imposing a
legal price
floor is a...
D
S
P
S
Copyright McGraw-Hill, Inc.,
D
Q
Q
Applications...
P
The result of
imposing a
legal price
floor is a...
Pf
D
S
SURPLUS
Legal Price Floor
P
S
Copyright McGraw-Hill, Inc.,
D
Qd Q
Qs
Q
Questions
and
Discussion
Eat up idiots!
n
n
n
n
n
n
n
n
price elasticity of demand
elastic demand
inelastic demand
unit elasticity
perfectly inelastic demand
perfectly elastic demand
total revenue
total-revenue test
Eat up idiots!
n
n
n
n
n
n
n
n
price elasticity of supply
market period
short run
long run
cross elasticity of demand
income elasticity of demand
price ceiling
price floor
Next:
Chapter 21
Consumer Behavior
and
Utility Maximization
Eat up idiots!