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Demand and Supply Guest Lodge
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Chapter 5
Elasticisity of Supply and Demand
Elasticity of Demand
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Would you buy the new Sony Play Station 4 if it
was
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$2000
$1500
$1000
$800
$600
$500
$100
$20
Elasticity of Demand
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Imagine that you are asthmatic. Would you buy
medication if it was
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$200
$180
$300
$400
$500
$600
$1000
Elasticity of Demand
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Imagine that you are NOT asthmatic. Would you
buy medication if it was
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$1000
$800
$500
$200
$180
$5
$1
Elasticity of demand – measures
how responsive demand is to
price.
Elasticity of demand
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As prices rise =>quantity demanded falls
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But by how much will sales fall?
Demand for the PS4 is elastic
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Law of demand
a change in price will lead to a large change in
quantity demand (5% change in price = 10% change
in demand)
Demand for the asthma medication is inelastic
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a change in price will lead to a small change in
quantity demand (5% change in price = 2% change
in demand)
Elastic Demand
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When a percentage change in price
causes a larger percentage change in
quantity purchased
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i.e. A 10% increase in price causes a 50%
decrease in amount purchased
Buyers are price sensitive
Ex Chicken
Other goods that would have elastic
demand?
Elastic Demand & Revenue
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When prices rise total revenue falls
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Revenue = Quantity x Price
Decrease in Quantity will be greater than
Increase in Price
When prices fall total revenue rises
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Revenue = Quantity x Price
Increase in Quantity will be greater than
decrease in Price
Inelastic Demand & Revenue
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When prices rises total revenue rises
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Revenue = Quantity x Price
Decrease in Quantity will be smaller than
Increase in Price
When prices fall total revenue falls
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Revenue = Quantity x Price
Increase in Quantity will be smaller than
decrease in Price
Elasticity of Demand
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A measure of the actual change in
quantity demanded for a product who’s
price has changed
Coefficient of = % Change in Quantity Demanded
Demand Elasticity
% Change in Price
OR
Coefficient of =
Demand Elasticity
∆Qd
∆ Pd
Elasticity of Demand
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The Cause is in the denominator
The Effect is in the numerator
Coefficient
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1 > x : Inelastic coefficient
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1 < x : Elastic coefficient
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Change in quantity demanded will be smaller than
the change in price
Change in quantity demanded will be greater than
change in price
1 = x : Unitary coefficient
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Change in quantity demanded will be equal to
change in price (5% change in price = 5% change in
demand)
Problem to solve
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A large gas station sells 10 million/L of
gas/month at a price of $0.50/L. If the
station’s owners raise their price to
$0.54/L the quantity demanded by the
stations customers falls to 9.5 million
litres. With this information can we
calculate a coefficient that the station
owners will find useful in making their
pricing decision?
Turn to page 95
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Work through the equations on page 95
and 96.
Fill in the table 5.1 on page 96.
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What we know:
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1st step: calculate % of change in Qd
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Change in price is 4 cents which = a change of 8%
8% of $0.50 (orig. price): 4/50 X 100 = 8%
7.4% of $0.54 (new price) 4/54 X 100 = 7.4%
2nd step: we must compromise by using the average
price - $0.52 and divide it by 4
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4 / $0.52 X 100 = 7.69% (will serve as the denominator in
the equation)
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3rd step: Similar to the prior 2 steps we must
determine the per cent change in quantity
demanded 10 million/L vs 9.5 million/L
The average is 9.75 million/L of gas
demanded
The change in quantity is -0.5 million/L
Therefore percent change is
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-0.5 / 9.75 X 100 = -5.128 or 5.13%
Therefore…
%change in
quantity demanded = 5.13% or 0.67
% change in price
7.69%
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Has a co-efficient of 0.67 = inelastic
Lets look at table on pg. 96
Factors Affecting DEMAND
ELASTICITY
1. Availability of Substitutes
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More substitutes more elastic
Factors Affecting DEMAND
ELASTICITY
2. Nature of Item
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Necessities tend to be more inelastic
Luxuries tend to be more elastic
Factors Affecting DEMAND
ELASTICITY
3. Fraction of income spent on item
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Big ticket item are more elastic
House, Cars
Factors Affecting DEMAND
ELASTICITY
4. Amount of time Available
 Inelastic in the short run
 Elastic in the long run
 Example: Yasin works downtown. He lives in a 3
bedroom house all alone in Kanata. He drives a
Hummer. The price of gas has gone up to $2 a litre.
He is really feeling the pinch.
 What can he do in the short term?
 What can he do in the long term?
Pg. 95 Homework
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Beef – slightly or unitarily elastic
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Steak – elastic, as non-essential meat;
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other substitutes are available if prices rise
Soft drinks – inelastic
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Other meats can substitute if prices rise
a near-essential, non alcoholic drink
Coca-Cola – elastic
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Other cola drinks are available
p.95. continued
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Pencils – inelastic
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Public transportation – inelastic
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as an essential item and a small part of most budgets
An essential service in most areas
Hair cuts – inelastic
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Inelastic as an essential service for most people
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2) Food is inelastic because it is
essential. When the price of an inelastic
item rises, so do revenues
3) Price falls and demand is elastic - revenues will increase
Price rises and demand is inelastic – revenues will increase
Price rises and demand is elastic – revenues will decrease
Price falls and demand is inelastic – revenues will decrease
Price rises and demand is unitary – revenues will stay the same
Pg. 95
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4)
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A) A co-efficient of 1.5 is elastic, therefore a lower
price would increase revenues
B) A 0.9 coefficient indicates that the item is
inelastic. The economist would recommend
maintaining the present price, or if possible, raising
the price, because revenues would increase for the
seller (so long as the increase in price doesn’t equal
a coefficient greater than 1.
Slope of elasticity and
Inelasticity demand curves
A unitary demand curve
Homework
Price
Quantity
Demanded
$1.00
300
Sales
Revenue
Elasticity
$300
Elastic
$0.90
400
$360
Elastic
$0.80
500
$400
Unitary
$0.70
600
$420
Inelastic
$0.60
700
$420
Inelastic
$0.50
800
$400
Elasticity of Supply
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Elasticity of supply measures how
responsive the quantity supplied by a
seller is to rise or fall in price.
Supply Coefficient
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1>x = inelastic
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1<x = elastic
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seller cannot increase the quantity supplied by a greater
percentage than the percent increase in price
Seller can increase the quantity supplied by a greater
percentage than the percent increase in price
1=x = unitary
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Seller is able to match a price increase by the same
percentage increase in quantity supplied.
Elasticity of Supply Eqn.
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Coefficient
%change in
of supply
= quantity supplied
elasticity
% change in price
Factors Affecting Supply
Elasticity
Ease of storage
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When the price drops they can either sell at a low price or put it in
inventory until the price rises
Time
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The more time a seller has to increase production the more
elastic supply will be
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(ex. farmers can’t increase production of corn over night therefore
short term = inelastic and long term = elastic)
Cost Factors
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increasing supply may be costly. Supply is more elastic in in
industries that are not costly to manufacture and where
production can be easily expanded if demand increases
Inelastic supply curve
Elastic supply curve
Unitary supply curve
HW pg. 101
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1)
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A) A coefficient of 0.8 is bad news for sellers,
because it indicates that supply is inelastic. Thus,
sellers will be slow to increase supply to take
advantage of rising prices (ex. fruits and vegetables)
B) A coefficient of 1.5 is good news for sellers
because it indicates that supply is elastic. Thus
sellers can quickly increase supply to take
advantage or rising prices (ex. steel)
p.101
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#2
Price per
cone
Short-term
supply
$1
300
Coefficient
Long-term
supply
1000
0.75
$2
500
2.0
5000
0.825
$3
700
Coefficient
1.66
10000
Utility Theory
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Utility = satisfaction
Marginal = extra
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Marginal utility = extra satisfaction
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Example of Marginal Utility
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Richard loves to eat pizza and
cheeseburgers. Over the last week he
has consumed 3 cheeseburgers and no
pizza. While out for dinner he is looking at
the menu and sees both pizza and
cheeseburgers on the menu. What is he
more likely to choose to eat, pizza or a
cheeseburger?
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Since the marginal utility of buying a
pizza will be greater than the marginal
utility of buying cheeseburger, Richard
will choose to buy a pizza.
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Richard is really hungry so he orders 5
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Consumes 1st cheeseburger = high marginal utility
Consumes 2nd cheeseburger = marginal utility drops a bit
Consumes 3rd cheeseburger = marginal utilty drops even
more
By the time Richard consumes his last cheeseburger his
marginal utility or extra satisfaction he gets from each
additional burger is less and less.
Note:
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Total utility increases but less and less as each
additional cheeseburger is consumed.
Pizza
Total
utility
Marginal
Utility
Cheese –
burgers
Total
Utility
Marginal
Utility
1
10
10
1
11
11
2
18
8
2
18
7
3
24
6
3
22
4
4
28
4
4
25
3
5
30
2
5
26
1
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Utils – units of satisfaction
If Richard has $10 and a Pizza costs $2
and a cheeseburger costs $1, what
purchase combination would provide him
with the most satisfaction?
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First we need to know
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Marginal Utility = MU
Price
Pizza $2
Total
Utility
Marginal
Utility
MU
price
Cheeseburgers
$1
Total
Utility
Marginal
Utility
MU
price
1
10
10
10 = 5
$2
1
11
11
11 = 11
$1
2
18
8
8 =4
$2
2
18
7
7=7
$1
3
24
6
6=3
$2
3
22
5
5=5
$1
4
28
4
4=2
$2
4
25
3
3=3
$1
5
30
2
2=1
$2
5
26
1
1=1
$1
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Richard’s best combination to maximize
satisfaction is;
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Purchasing 3 pizzas and 4 cheeseburgers
Has maximum satisfaction: 49 utils
Consumer Equilibrium – receiving the same
amount of satisfaction per dollar of each item
Where does conumer equilibrium occur for
Richard?
Consumer Surplus
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Consumer surplus – the difference
between what consumers are wiling to
pay for an item and what they actually
pay
Ex.
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IPAD 3 is $800 but you would have paid $1000 =
consumer surplus of $200
Ceiling Price
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A price restriction place by government in
order to prevent the price of a product
from rising above a certain level
Results in a shortage if the ceiling price is
lower than the equilibrium price
Ex Gas Prices, Rent Control
Ceiling Price
Price
S1
E1
Price
Ceiling
Shortage
D1
Qs
Qd
Quantity
Shortage
Consequence of Price Ceilings
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Pros
Equitable access to
good and services
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Cons
Long line ups
Black market
Decrease in quality
Floor Price
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A price restriction placed by government
in order to prevent the price of a product
from falling bellow a certain level
Results in a surplus if the price is above
the equilibrium price
Ex Minimum Wage
Floor Price
Price
S1
Price
Floor
E1
Surplus
D1
Qd
Qs
Quantity
Consequence of Price Floor
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Pros
Stable Price
Food Security
Living wage for
manufacturers
Secures local
industry
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Cons
Overproduction of
product
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Waste
Sold or given away
Higher taxes to pay
for surplus
Higher prices for
consumers
Subsidies
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A grant of money made to particular
industry by the government
Results in a supply shift to the right
Example
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Farm Subsidies
Research and Development
New Industry (Infant Industry)
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Environmental
Subsidies
Price = $100
-Cost = $110
Profit = -$10
Price = $100
- Cost = $110
+ Subsidy = $20
Profit = $10
Subsidies
S1
Price
S2
E1
P1
E2
P2
Subsidy
D1
Q1
Q2
Quantity
Subsidies
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