© 2011 Thomson South-Western RECAP: DEMAND Quantity demanded is the amount of a good that buyers are willing and able to purchase.Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of DemandLaw of Demand The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises.The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises.

© 2011 Thomson South-Western RECAP: SUPPLY Quantity supplied is the amount of a good that sellers are willing and able to sell.Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of SupplyLaw of Supply The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises.The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises.

© 2011 Thomson South-Western RECAP: SUPPLY AND DEMAND TOGETHER Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. Law of supply and demandLaw of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

© 2011 Thomson South-Western 2.D shifts left A C T I V E L E A R N I N G 3: A. Fall in price of CDs P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 The market for music downloads P2P2 Q2Q2 1.D curve shifts 3.P and Q both fall. STEPS

© 2011 Thomson South-Western

You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opportunity cost of your time), so you consider raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase? You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opportunity cost of your time), so you consider raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase? A scenario…

© 2011 Thomson South-Western Elasticity... … is a measure of how much buyers and sellers respond to changes in market conditions… is a measure of how much buyers and sellers respond to changes in market conditions … allows us to analyze supply and demand with greater precision. … allows us to analyze supply and demand with greater precision.

© 2011 Thomson South-Western THE ELASTICITY OF DEMAND The price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.The price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.

© 2011 Thomson South-Western THE ELASTICITY OF DEMAND When we talk about elasticity, that responsiveness is always measured in percentage terms.When we talk about elasticity, that responsiveness is always measured in percentage terms. Specifically, the price elasticity of demand isSpecifically, the price elasticity of demand is –the percentage change in quantity demanded due to a percentage change in the price.

© 2011 Thomson South-Western The Price Elasticity of Demand and Its Determinants Availability of Close SubstitutesAvailability of Close Substitutes iPad in 2010 vs. 2013?iPad in 2010 vs. 2013? Necessities versus LuxuriesNecessities versus Luxuries Prescription medication vs. Weekend in the BerkshiresPrescription medication vs. Weekend in the Berkshires Definition of the MarketDefinition of the Market Market for cell phones vs. Market for iPhonesMarket for cell phones vs. Market for iPhones Time HorizonTime Horizon Response to rising gas prices will be different tomorrow than it will be next year, why?Response to rising gas prices will be different tomorrow than it will be next year, why?

© 2011 Thomson South-Western What determines price elasticity? To learn the determinants of price elasticity, we look at a series of examples. Each compares two common goods. In each example: Suppose the prices of both goods rise by 20%.Suppose the prices of both goods rise by 20%. The good for which Q d falls the most (in percent) has the highest price elasticity of demand. Which good is it? Why?The good for which Q d falls the most (in percent) has the highest price elasticity of demand. Which good is it? Why? What lesson does the example teach us about the determinants of the price elasticity of demand?What lesson does the example teach us about the determinants of the price elasticity of demand?

© 2011 Thomson South-Western EXAMPLE 1: Rice Krispies vs. Eggs The prices of both of these goods rise by 20%. For which good does Q d drop the most? Why?The prices of both of these goods rise by 20%. For which good does Q d drop the most? Why? Rice Krispies has lots of close substitutes (e.g., Cap’n Crunch, Count Chocula), so buyers can easily switch if the price rises.Rice Krispies has lots of close substitutes (e.g., Cap’n Crunch, Count Chocula), so buyers can easily switch if the price rises. Eggs have no close substitutes, so consumers would probably not buy much less if its price rises.Eggs have no close substitutes, so consumers would probably not buy much less if its price rises. Lesson: Price elasticity is higher when close substitutes are available.Lesson: Price elasticity is higher when close substitutes are available.

© 2011 Thomson South-Western EXAMPLE 2: Insulin vs. Caribbean Cruises The prices of both of these goods rise by 20%. For which good does Q d drop the most? Why?The prices of both of these goods rise by 20%. For which good does Q d drop the most? Why? To millions of diabetics, insulin is a necessity. A rise in its price would cause little or no decrease in demand.To millions of diabetics, insulin is a necessity. A rise in its price would cause little or no decrease in demand. A cruise is a luxury. If the price rises, some people will forego it.A cruise is a luxury. If the price rises, some people will forego it. Lesson: Price elasticity is higher for luxuries than for necessities.Lesson: Price elasticity is higher for luxuries than for necessities.

© 2011 Thomson South-Western EXAMPLE 3: “Blue Jeans” vs. “Clothing” The prices of both goods rise by 20%. For which good does Q d drop the most? Why?The prices of both goods rise by 20%. For which good does Q d drop the most? Why? For a narrowly defined good such as blue jeans, there are many substitutes (khakis, shorts, Speedos).For a narrowly defined good such as blue jeans, there are many substitutes (khakis, shorts, Speedos). There are fewer substitutes available for broadly defined goods. (There are no substitutes for clothing?)There are fewer substitutes available for broadly defined goods. (There are no substitutes for clothing?) Lesson: Price elasticity is higher for narrowly defined goods than broadly defined ones.Lesson: Price elasticity is higher for narrowly defined goods than broadly defined ones.

© 2011 Thomson South-Western EXAMPLE 4: Gasoline in the Short Run vs. Gasoline in the Long Run The price of gasoline rises 20%. Does Q d drop more in the short run or the long run? Why?The price of gasoline rises 20%. Does Q d drop more in the short run or the long run? Why? There’s not much people can do in the short run, other than ride the bus or carpool.There’s not much people can do in the short run, other than ride the bus or carpool. In the long run, people can buy smaller cars or live closer to where they work.In the long run, people can buy smaller cars or live closer to where they work. Lesson: Price elasticity is higher in the long run than the short run.Lesson: Price elasticity is higher in the long run than the short run.

© 2011 Thomson South-Western The Price Elasticity of Demand and Its Determinants Demand tends to be more elastic:Demand tends to be more elastic: the larger the number of close substitutes.the larger the number of close substitutes. if the good is a luxury.if the good is a luxury. the more narrowly defined the market.the more narrowly defined the market. the longer the time period.the longer the time period.

© 2011 Thomson South-Western Computing the Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

© 2011 Thomson South-Western Calculating Percentage Changes P Q D $250 8 B $ A Standard method of computing the percentage (%) change: End value – Start value Start value x 100% Going from A to B, the % change in P equals ($250–$200)/$200 = 25%

© 2011 Thomson South-Western Computing the Price Elasticity of Demand Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:

© 2011 Thomson South-Western Calculating Percentage Changes P Q D $250 8 B $ A Problem: The standard method gives different answers depending on where you start. From A to B, P rises 25%, Q falls 33%, Elasticity = 33/25 = 1.33 From B to A, P falls 20%, Q rises 50%, Elasticity = 50/20 = 2.50

© 2011 Thomson South-Western Calculating Percentage Changes So, we instead use the midpoint method: End value – Start value Midpoint x 100 The midpoint is the number halfway between the start & end values, also the average of those values. It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way!

© 2011 Thomson South-Western The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the price change.The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the price change.

© 2011 Thomson South-Western The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

© 2011 Thomson South-Western A C T I V E L E A R N I N G 1 : Calculate an elasticity Use the following information to calculate the price elasticity of demand for hotel rooms: if P = $70, Q d = 5000 if P = $90, Q d = 3000

© 2011 Thomson South-Western A C T I V E L E A R N I N G 1 : Answers Use midpoint method to calculate % change in Q d (5000 – 3000)/4000 = 50% % change in P ($70 – $90)/$80 = 25% The price elasticity of demand equals 50% 25% = 2.0

© 2011 Thomson South-Western The Variety of Demand Curves Inelastic DemandInelastic Demand Quantity demanded does not respond strongly to price changes.Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one.Price elasticity of demand is less than one. Elastic DemandElastic Demand Quantity demanded responds strongly to changes in price.Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one.Price elasticity of demand is greater than one.

© 2011 Thomson South-Western Computing the Price Elasticity of Demand Demand is price elastic. $5 4 Demand Quantity Price

© 2011 Thomson South-Western The Variety of Demand Curves Perfectly InelasticPerfectly Inelastic Quantity demanded does not respond to price changes.Quantity demanded does not respond to price changes. Perfectly ElasticPerfectly Elastic Quantity demanded changes infinitely with any change in price.Quantity demanded changes infinitely with any change in price. Unit ElasticUnit Elastic Quantity demanded changes by the same percentage as the price.Quantity demanded changes by the same percentage as the price.

© 2011 Thomson South-Western The Variety of Demand Curves Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. But it is not the same thing as the slope!But it is not the same thing as the slope! Slope is actual changesSlope is actual changes Elasticity looks at percentage changesElasticity looks at percentage changes

© 2011 Thomson South-Western Figure 1 The Price Elasticity of Demand (a) Perfectly Inelastic Demand: Elasticity Equals 0 $5 4 Quantity Demand An increase in price leaves the quantity demanded unchanged. Price

© 2011 Thomson South-Western Figure 1 The Price Elasticity of Demand (b) Inelastic Demand: Elasticity Is Less Than 1 Quantity 0 $5 90 Demand 1. A 22% increase in price... Price leads to an 11% decrease in quantity demanded

© 2011 Thomson South-Western Figure 1 The Price Elasticity of Demand leads to a 22% decrease in quantity demanded. (c) Unit Elastic Demand: Elasticity Equals 1 Quantity Price $ A 22% increase in price... Demand

© 2011 Thomson South-Western Figure 1 The Price Elasticity of Demand (d) Elastic Demand: Elasticity Is Greater Than 1 Demand Quantity Price $ A 22% increase in price leads to a 67% decrease in quantity demanded.

© 2011 Thomson South-Western Figure 1 The Price Elasticity of Demand (e) Perfectly Elastic Demand: Elasticity Equals Infinity Quantity 0 Price $4 Demand 2. At exactly $4, consumers will buy any quantity. 1. At any price above $4, quantity demanded is zero. 3. At a price below $4, quantity demanded is infinite.

© 2011 Thomson South-Western Total Revenue and the Price Elasticity of Demand Total revenue is the amount paid by buyers and received by sellers of a good.Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold.Computed as the price of the good times the quantity sold.

© 2011 Thomson South-Western Figure 2 Total Revenue Demand Quantity Q P 0 Price P × Q = $400 (revenue) $4 100 When the price is $4, consumers will demand 100 units, and spend $400 on this good.

© 2011 Thomson South-Western Elasticity and Total Revenue along a Linear Demand Curve With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller.With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.Thus, total revenue increases.

© 2011 Thomson South-Western Figure 3 How Total Revenue Changes When Price Changes: Inelastic Demand Demand Quantity 0 Price Revenue = $100 Quantity 0 Price Revenue = $240 Demand $1 100 $3 80 An Increase in price from $1 to $3 … … leads to an Increase in total revenue from $100 to $240

© 2011 Thomson South-Western Elasticity and Total Revenue along a Linear Demand Curve With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger.With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.Thus, total revenue decreases.

© 2011 Thomson South-Western Figure 3 How Total Revenue Changes When Price Changes: Elastic Demand Demand Quantity 0 Price Revenue = $200 $4 50 Demand Quantity 0 Price Revenue = $100 $5 20 An Increase in price from $4 to $5 … … leads to an decrease in total revenue from $200 to $100 Note that with each price increase, the Law of Demand still holds – an increase in price leads to a decrease in the quantity demanded. It is the change in TR that varies!

© 2011 Thomson South-Western Elasticity of a Linear Demand Curve

© 2011 Thomson South-Western $7 Demand is elastic; demand is responsive to changes in price. Demand is inelastic; demand is not very responsive to changes in price. When price increases from $4 to $5, TR declines from $24 to $20. When price increases from $2 to $3, TR increases from $20 to $24. Elasticity is > 1 in this range. Elasticity is < 1 in this range. Price Quantity Figure 4 Elasticity of a Linear Demand Curve

© 2011 Thomson South-Western A C T I V E L E A R N I N G 2 : Elasticity and expenditure/revenue A.Pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall? B.As a result of a fare war, the price of a luxury cruise falls 20%. Does luxury cruise companies’ total revenue rise or fall?

© 2011 Thomson South-Western A C T I V E L E A R N I N G 2 : Answers A.Pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall? Expenditure = P x Q Since demand is inelastic, Q will fall less than 10%, so expenditure rises.

© 2011 Thomson South-Western A C T I V E L E A R N I N G 2 : Answers B.As a result of a fare war (price competition), the price of a luxury cruise falls 20%. Does luxury cruise companies’ total revenue rise or fall? Revenue = P x Q The fall in P reduces revenue, but Q increases, which increases revenue. Which effect is bigger? Since demand is elastic, Q will increase more than 20%, so revenue rises.

© 2011 Thomson South-Western Other Demand Elasticities Income Elasticity of DemandIncome Elasticity of Demand Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income.Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

© 2011 Thomson South-Western Other Demand Elasticities Other Demand Elasticities Computing Income ElasticityComputing Income Elasticity Remember, all elasticities are measured by dividing one percentage change by another

© 2011 Thomson South-Western Other Demand Elasticities Income ElasticityIncome Elasticity Types of GoodsTypes of Goods Normal GoodsNormal Goods Inferior GoodsInferior Goods Higher income:Higher income: raises the quantity demanded for normal goods (positive elasticity)raises the quantity demanded for normal goods (positive elasticity) but lowers the quantity demanded for inferior goods (negative elasticity)but lowers the quantity demanded for inferior goods (negative elasticity)

© 2011 Thomson South-Western Other Demand Elasticities Income Elasticity (for normal goods)Income Elasticity (for normal goods) Goods consumers regard as necessities tend to be income inelasticGoods consumers regard as necessities tend to be income inelastic Examples include food, fuel, clothing, utilities, and medical services.Examples include food, fuel, clothing, utilities, and medical services. Goods consumers regard as luxuries tend to be income elasticGoods consumers regard as luxuries tend to be income elastic Examples include sports cars, furs, and expensive foods.Examples include sports cars, furs, and expensive foods.

© 2011 Thomson South-Western Other Demand Elasticities Cross-price elasticity of demandCross-price elasticity of demand A measure of how much the quantity demanded of one good responds to a change in the price of another good,A measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second goodcomputed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good

© 2011 Thomson South-Western Other Demand Elasticities Cross-price elasticity of demandCross-price elasticity of demand If the elasticity is positive, then the two goods are substitutesIf the elasticity is positive, then the two goods are substitutes If the elasticity is negative, then the two goods are complementsIf the elasticity is negative, then the two goods are complements

© 2011 Thomson South-Western THE ELASTICITY OF SUPPLY Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good.Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Price elasticity of supply is the percentage change in quantity supplied resulting from a percentage change in price.Price elasticity of supply is the percentage change in quantity supplied resulting from a percentage change in price.

© 2011 Thomson South-Western Figure 5 The Price Elasticity of Supply (a) Perfectly Inelastic Supply: Elasticity Equals 0 $5 4 Supply Quantity An increase in price leaves the quantity supplied unchanged. Price

© 2011 Thomson South-Western Figure 5 The Price Elasticity of Supply (b) Inelastic Supply: Elasticity Is Less Than $ Quantity 0 1. A 22% increase in price... Price leads to a 10% increase in quantity supplied. Supply

© 2011 Thomson South-Western Figure 5 The Price Elasticity of Supply (c) Unit Elastic Supply: Elasticity Equals $ Quantity 0 Price leads to a 22% increase in quantity supplied. 1. A 22% increase in price... Supply (If SUPPLY is unit elastic and linear, it will begin at the origin.)

© 2011 Thomson South-Western Figure 5 The Price Elasticity of Supply (d) Elastic Supply: Elasticity Is Greater Than 1 Quantity 0 Price 1. A 22% increase in price leads to a 67% increase in quantity supplied $5 200 Supply

© 2011 Thomson South-Western Figure 5 The Price Elasticity of Supply (e) Perfectly Elastic Supply: Elasticity Equals Infinity Quantity 0 Price $4 Supply 3. At a price below $4, quantity supplied is zero. 2. At exactly $4, producers will supply any quantity. 1. At any price above $4, quantity supplied is infinite.

© 2011 Thomson South-Western The Price Elasticity of Supply and Its Determinants Ability of sellers to change the amount of the good they produce.Ability of sellers to change the amount of the good they produce. Beach-front land is inelastic.Beach-front land is inelastic. Books, cars, or manufactured goods are elastic.Books, cars, or manufactured goods are elastic. Time periodTime period Supply is more elastic in the long run.Supply is more elastic in the long run.

© 2011 Thomson South-Western Computing the Price Elasticity of Supply The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

© 2011 Thomson South-Western A C T I V E L E A R N I N G 3 : Elasticity and changes in equilibrium The supply of beachfront property is inelastic. The supply of new cars is elastic. Suppose population growth causes demand for both goods to double (at each price, Q d doubles). For which product will P change the most? For which product will Q change the most?

© 2011 Thomson South-Western A C T I V E L E A R N I N G 3 : Answers Beachfront property (inelastic supply): P Q D1D1 D2D2 S Q1Q1 P1P1 A B Q2Q2 P2P2 When supply is inelastic, an increase in demand has a bigger impact on price than on quantity.

© 2011 Thomson South-Western A C T I V E L E A R N I N G 3 : Answers New cars (elastic supply): P Q D1D1 D2D2 S Q1Q1 P1P1 A Q2Q2 P2P2 B When supply is elastic, an increase in demand has a bigger impact on quantity than on price.

© 2011 Thomson South-Western Cross-Price Elasticities in the News “As Gas Costs Soar, Buyers Flock to Small Cars” -New York Times, 5/2/2008 “Gas Prices Drive Students to Online Courses” -Chronicle of Higher Education, 7/8/2008 “Gas prices knock bicycle sales, repairs into higher gear” -Associated Press, 5/11/2008 “Camel demand soars in India” (as a substitute for “gas-guzzling tractors”) -Financial Times, 5/2/2008 “High gas prices drive farmer to switch to mules” -Associated Press, 5/21/2008

© 2011 Thomson South-Western THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY Does drug interdiction increase or decrease drug- related crime?Does drug interdiction increase or decrease drug- related crime? Can good news for farming be bad news for farmers?Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?

© 2011 Thomson South-Western APPLICATION: Does Drug Interdiction Increase or Decrease Drug-Related Crime? One side effect of illegal drug use is crime: Users often turn to crime to finance their habit.One side effect of illegal drug use is crime: Users often turn to crime to finance their habit. We examine two policies designed to reduce illegal drug use and see what effects they have on drug- related crime.We examine two policies designed to reduce illegal drug use and see what effects they have on drug- related crime. For simplicity, we assume the total dollar value of drug-related crime equals total expenditure on drugs.For simplicity, we assume the total dollar value of drug-related crime equals total expenditure on drugs. Demand for illegal drugs is inelastic, due to addiction issues.Demand for illegal drugs is inelastic, due to addiction issues.

© 2011 Thomson South-Western Policy 1: Interdiction Price of Drugs Quantity of Drugs S1S1 S2S2 D1D1 P1P1 Q1Q1 P2P2 Q2Q2 Interdiction reduces the supply of drugs. Since demand for drugs is inelastic, P rises propor- tionally more than Q falls. Result: an increase in total spending on drugs, and in drug-related crime new value of drug- related crime initial value of drug- related crime

© 2011 Thomson South-Western Policy 2: Education Price of Drugs Quantity of Drugs D1D1 S P1P1 Q1Q1 D2D2 P2P2 Q2Q2 Education reduces the demand for drugs. P and Q fall. Result: A decrease in total spending on drugs, and in drug-related crime. initial value of drug- related crime new value of drug- related crime

© 2011 Thomson South-Western Can Good News for Farming Be Bad News for Farmers? Examine whether the supply or demand curve shifts.Examine whether the supply or demand curve shifts. Determine the direction of the shift of the curve.Determine the direction of the shift of the curve. Use the supply-and-demand diagram to see how the market equilibrium changes.Use the supply-and-demand diagram to see how the market equilibrium changes.

© 2011 Thomson South-Western Figure 7 An Increase in Supply in the Market for Wheat Quantity of Wheat 0 Price of Wheat and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220. Demand S1S1 S2S leads to a large fall in price When demand is inelastic, an increase in supply $3 100

© 2011 Thomson South-Western Why Did OPEC Fail to Keep the Price of Oil High? Supply and Demand can behave differently in the short run and the long runSupply and Demand can behave differently in the short run and the long run In the short run, both supply and demand for oil are relatively inelasticIn the short run, both supply and demand for oil are relatively inelastic But in the long run, both are elasticBut in the long run, both are elastic Production outside of OPECProduction outside of OPEC More conservation by consumersMore conservation by consumers

Summary © 2011 Thomson South-Western Price elasticity of demand measures how much the quantity demanded responds to changes in the price.Price elasticity of demand measures how much the quantity demanded responds to changes in the price. Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price.Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. –If a demand curve is elastic, total revenue falls when the price rises. –If it is inelastic, total revenue rises as the price rises.

Summary © 2011 Thomson South-Western The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income.The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good.The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good. The price elasticity of supply measures how much the quantity supplied responds to changes in the price.The price elasticity of supply measures how much the quantity supplied responds to changes in the price.

Summary © 2011 Thomson South-Western In most markets, supply is more elastic in the long run than in the short run.In most markets, supply is more elastic in the long run than in the short run. The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price.The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. The tools of supply and demand can be applied in many different types of markets.The tools of supply and demand can be applied in many different types of markets.