Elasticity & Applications of Supply & Demand Analysis. UAPP693 Economics in the Public & Nonprofit Sectors Steven W. Peuquet, Ph.D.

Transcription

1 Elasticity & Applications of Supply & Demand Analysis UAPP693 Economics in the Public & Nonprofit Sectors Steven W. Peuquet, Ph.D. 1

2 These slides are for use only as part of a formal instructional course and may not be copied, scanned, or duplicated, in whole or in part for commercial purposes. Portions are copyrighted by Cengage Learning. All Rights Reserved. 2

3 Equilibrium of Supply & Demand 3

4 Disequilibrium of Supply & Demand 4

5 Price Elasticity of Demand Law of Demand: all things being equal, as the price of a good falls, quantity demanded rises. A note about effective demand The price elasticity of demand measures how much the quantity demanded responds to a change in price. For a particular good, it s how sensitive consumers are to changes in price. 5

6 Price Elasticity of Demand Demand for a good is elastic if the quantity demanded responds substantially to changes in price. Goods with close substitutes tend to have more elastic demand because it s easier for consumers to switch from that good to others. Butter and margarine are close substitutes Eggs do not have a close substitute Other examples? 6

7 Price Elasticity of Demand The opposite of elastic demand is inelastic demand, where the quantity demanded does not respond very much to changes in price. Goods that are necessities tend to have inelastic demand, but goods that are luxuries tend to have elastic demand. What are some examples of necessities and luxuries? What consumers deem to be a luxury or a necessity is dependent on consumer preferences. 7

8 Price Elasticity of Demand The way a market is defined will have an effect on the elasticity of demand. Narrowly defined markets will tend to have more elastic demand than broadly defined markets because it s easier to find close substitutes for narrowly defined goods. food vs. ice cream vs. vanilla ice cream entertainment vs. video games vs. combatoriented video games The time horizon also matters -- demand is usually more elastic over a long period than over a short time period (e.g., gasoline). 8

9 Price Elasticity of Demand PED = % Q % P Where: PED = price elasticity of demand = symbol for change in Q = quantity demanded P = price 9

10 Price Elasticity of Demand Example: a 5% increase in the price of whole milk in Delaware results in a 2% reduction in the quantity of milk demanded. What is PED of whole milk? % Q -.02 PED = = = -.4 % P.05 Important note: PED will always produce a negative number because QD and P are inversely related. However, it is common for the negative sign to be dropped when reporting the value of PED. 10

11 Price Elasticity of Demand When percentage change is calculated, you can get different results based on what base (denominator) you use. This problem is avoided by using the mid-point method for calculating PED. (See pages in the Mankiw textbook.) PED = (Q 2 Q 1 ) / [(Q 2 + Q 1 ) / 2] (P 2 P 1 ) / [(P 2 + P 1 ) / 2] 11

12 Price Elasticity of Demand PED = 0 = Perfectly inelastic demand PED < 1 = inelastic demand PED = 1 = unit elastic demand PED > 1 = elastic demand PED = = infinite elasticity Economists classify demand curves based on their elasticity! 12

13 Inelastic Demand 13

14 Unit Elasticity of Demand 14

15 Elastic Demand 15

16 Price Elasticity of Demand At different points alone a linear demand curve, the PED changes. While the slope of the linear demand curve is constant, its elasticity is not. 16

17 Price Elasticity of Demand Total Revenue and PED TR = P x Q Where: TR = total revenue P = price Q = quantity 17

18 Price Elasticity of Demand The impact of a price change on TR depends on PED Case of inelastic demand Case of elastic demand 18

19 Other Elasticities Cross-Price Elasticity of Demand: How the quantity demanded of one good is affected by a change in price of another good CPED = % Q x % P y Where: CPED = cross-price elasticity of demand = symbol for change in Q = quantity demanded of good x or y P = price 19

20 Other Elasticities Income Elasticity of Demand: How changes in income affect quantity demanded IED = % Q % I Where: IED = income elasticity of demand = symbol for change in Q = quantity demanded I = income 20

21 Price Elasticity of Supply Law of Supply: all things being equal, as the price of a good rises, quantity supplied also rises. The price elasticity of supply measures how much the quantity supplied responds to changes in price. For a particular good, it s how sensitive suppliers are to changes in price. 21

22 Price Elasticity of Supply The price elasticity of supply depends on the flexibility of sellers (producers) to change the amount of the good they produce. The supply of a good or service is elastic if the quantity supplied responds substantially to changes in price. The supply of a good or service is inelastic if the quantity supplied responds only slightly to changes in price. 22

23 Price Elasticity of Supply PES = % Q % P Where: PES = price elasticity of supply = symbol for change in Q = quantity demanded P = price 23

24 Price Elasticity of Supply PES = 0 = Perfectly inelastic supply PES < 1 = inelastic supply PES = 1 = unit elastic supply PES > 1 = elastic supply PES = = infinite supply Like Demand curves, economists classify supply curves based on their elasticity! 24

25 Inelastic Supply 25

26 Unit Elasticity of Supply 26

27 Elastic Supply 27

28 An Application of Supply & Demand Analysis 28

29 Example of Rent Control 29

30 That s it for today. Thanks! 30