Download AP Micro 2-6 Elasticity

Unit 2: Supply, Demand, and
Consumer Choice
Supply and Demand Review
1. Define the Law of Demand
2. Define the Law of Supply
3. What is the difference between a change in
demand and a change in quantity
demanded?
4. What happens if price is above equilibrium?
5. What happens if price is below equilibrium?
6. Define Consumer’s and Producer’s Surplus
7. Review the rules for double shifts in S&D
8. Explain the results of an excise tax
9. Define Dead Weight Loss
See what you already know…
Match these goods to their demand curves:
• Milk
• Steak
• Insulin (life-saving medicine on which diabetics depend)
3
THE LAW OF DEMAND SAYS...
Consumers will buy more when prices
go down and less when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?
4
Elasticity
Elasticity shows how sensitive quantity is
to a change in price.
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1. Price Elasticity of Demand
Elasticity of Demand• Measurement of consumers
responsiveness to a change in price.
• What will happen if price increase? How
much will it effect Quantity Demanded
Who cares?
• Used by firms to help determine prices
and sales
• Used by the government to decide how to
tax
Inelastic Demand
Inelastic Demand
INelastic = Quantity is
INsensitive to a change in price.
•If price increases, quantity
20%
demanded will fall a little
•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
•Insulin
•Medical Care
•Toilet paper
Inelastic Demand
General Characteristics
of INelastic Goods:
20%
•Few Substitutes
•Necessities
•Small portion of
income
•Required now, rather
than later
•Elasticity coefficient
less than 1
5%
Elastic Demand
Elastic Demand
Elastic = Quantity is 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 sensitive to price.
An ELASTIC demand curve is flat!
Examples:
•Soda
•Boats
•Beef
•Real Estate
•Pizza
•Gold
Elastic Demand
General Characteristics
of Elastic Goods:
• Many Substitutes
• Luxuries
• Large portion of
income
• Plenty of time to
decide
• Elasticity coefficient
greater than 1
Elastic or Inelastic?
BeefGasolineReal EstateMedical CareElectricityGold-
What about the
Elastic- 1.27
demand for insulin for
INelastic - .20
diabetics?
Elastic- 1.60
INelastic - .31
What if % change in
INelastic - .13 quantity demanded equals
% change in price?
Elastic - 2.6
Perfectly INELASTIC
(Coefficient = 0)
Unit Elastic (Coefficient =1)
Total Revenue Test
Uses elasticity to show how changes in price will
affect total revenue (TR).
(TR = Price x Quantity)
Ex: If demand for milk is INelastic, what will happen to
expenditures on milk if price increases?
Demand
Elastic Demand
Inelastic
Unit Elastic
Price
Total Revenue
Increase
Decrease
Decrease
Increase
Increase
Increase
Decrease
Decrease
Increase
Unchanged
Decrease
Unchanged
2. Price Elasticity of Supply
Elasticity of Supply• Elasticity of supply shows how sensitive producers
are to a change in price.
Elasticity of supply is based on time limitations.
Producers need 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
3. Cross-Price Elasticity of Demand
• Cross-Price elasticity shows how sensitive a product
is to a change in price of another good
• It shows if two goods are substitutes or complements
% change in quantity of product “b”
% change in price of product “a”
P increases 20%
Q decreases 15%
• If coefficient is negative (shows inverse relationship)
then the goods are complements
• If coefficient is positive (shows direct relationship)
then the goods are substitutes
4. Income-Elasticity of Demand
• Income elasticity shows how sensitive a product is to
a change in INCOME
• It shows if goods are normal or inferior
% change in quantity
% change in income
Income increases 20%, and quantity decreases 15%
then the good is a… INFERIOR GOOD
• If coefficient is negative (shows inverse relationship)
then the good is inferior
• If coefficient is positive (shows direct relationship)
then the good is normal
Ex: If income falls 10% and quantity falls 20%…
Calculating Elasticity
• If you calculate elasticity using the following method
only, you will get a different elasticity moving up and
down the graph. Let’s look…
% change in quantity
% change in price
4. Using the Mid-Point Method
• To get an accurate measurement, we use the
midpoint method:
% change in quantity=
(New quant.-initial quant.)
x 100
(New quant. + initial quant.) / 2
% change in price = (New price-initial price)
x 100
(New price + initial price) / 2
Calculating Elasticity
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How does elasticity help
us?
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Scenario 1
Sarah owns a gas station. Right now her gas is
priced at $2 a gallon. She’s wondering
whether or not she should increase the price to
$3 a gallon. Should she?
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Scenario 2
Ricky sells designer watches. Right now, he is
charging $600 per watch and he’s selling
about 4 a day. He is thinking about dropping
his price to $500. Should he?
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Elasticity and Excise Taxes
Who ends up paying for an excise
tax?
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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
27
EXCISE TAX ON CIGARETTES
P
$10
S1
S
8
$6.50 =Pconsumers 7
6
5
$4.50 = Pproducers 4
CS After
Amount Consumers Pay
$2 TAX on
Producers
Amount Producers Pay
2
D
9 10
Quantity Doesn’t Fall VERY Much!!!
Q
28
EXCISE TAX ON YACHTS
P
$10
Demand- Elastic
Supply- Unitary
S
8
$2 TAX on
Producers
6
5
4
D
2
8 10
Q
29
EXCISE TAX ON YACHTS
P
$10
S1
S
8
$2 TAX on
Producers
6
Pc 5
4
Pp
DWL?
D
2
7
10
Quantity Falls A lot!!!
Q
30