Chapter 5 Professor Chen 1 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elasticity of Demand and Supply

2 5-1 Price Elasticity of Demand © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1a Calculating Price Elasticity of Demand Mid-point formula: 3 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Percent formula:

Exhibit 1 4 Demand Curve for Cheese D 10 9 Q 0 $1.00 Price of cheese per pound $2.00 b a © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1a Calculating Price Elasticity of Demand Find E D between point a and b. 5 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Exhibit 2 6 Demand Curve for candy 10 2 Q 0 $1 Price of candy $2 b a © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1a Calculating Price Elasticity of Demand Find E D between point a and b. 7 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1b Categories of E D a) E D between 0 and 1: Inelastic demand –Demand curve is more steep –Determinants: necessities few substitutes need it in short time small proportion of income spent b) E D = 1: Unit elastic demand –D is rectangular hyperbola, or midpoint of a straight line –Movies, shoes, cars 8 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1b Categories of E D c) E D greater than 1: Elastic demand –D is flatter –Determinants: Luxuries many substitutes longer time to adjust Large proportion of income spent d) E D = 0: Perfectly inelastic demand -D is vertical e) E D = ∞: Perfectly elastic demand –D is horizontal (example in next slide) 9 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Constant Elasticity Demand Curves Perfectly elastic demand curve Any price increase would reduce quantity demanded to zero –Consumers don’t tolerate price increases –Example: Assume you notice the gas price is $1.65 in several gas stations when you drive around town. As you try to add gas from your favorite gas station, you see the price there is $1.75! You decide to get gas somewhere else. Your quantity demanded for gas from your favorite gas station drops to zero when you see the price is higher - Your demand is perfectly elastic 10

5-1d Price Elasticity and Linear Demand Curve Linear demand curve (straight line) –Constant slope but varying elasticity Demand becomes less elastic as we move downward –Upper half: elastic –Lower half: inelastic –Midpoint: unit elastic 11 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Exhibit 3 12 Demand for cheese D 10 1 Price per unit $11 ? 2 b a d e ? 21 Q (a) Demand and price elasticity Unit elastic, E D =1 Elastic, E D >1 Inelastic, E D <1 c © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1c Elasticity and Total Revenue Total revenue = (price)(Qd at this price) TR= p ˣ q As price decreases –If demand is elastic, TR increases –If demand is inelastic, TR decreases –If demand is unit elastic, TR constant Vice Versa. 13 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1c Elasticity and Total Revenue Question 1. Refer to the demand for cheese. Suppose the store is selling the product at $2. If the owner wants to increase sales, should he increase the price to $3, or decrease the price to $1? 14 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Case Study Case 1. Price = $2TR = $2x9 =$18 Price = $3TR = $3x8 = $24 Price = $1TR = $1x10 = $10 Answer: TR increase if he increases the price to $3. Case 2. What if the price is increased to $4? To $5? Case 3. Which price maximize TR? 15 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Exhibit 4 16 Total Revenue reaches the maximum at the midpoint D 10 1 Price per unit $ b a d e 2 1 Quantity Total revenue $ Quantity per period 11 0 (a) Demand and price elasticity (b) Total revenue Total revenue Unit elastic, E D =1 Elastic, E D >1 Inelastic, E D <1 Where the demand curve is elastic, a lower price increases total revenue. Total revenue reaches a maximum at the rate of output where the demand curve is unit elastic. c Where the demand curve is inelastic, further decreases in price reduce total revenue. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-1c Elasticity and Total Revenue Classroom activity. Refer to the demand for candy. Suppose the store is selling the product at $2. If the owner wants to increase sales, 1.Should he increase the price to $3, or decrease the price to $1? 2.Which price maximizes total revenue? 17 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-3 Price Elasticity of Supply Price elasticity of supply –Responsiveness of quantity supplied to a price change 18 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-3 Price Elasticity of Supply E S positive 19 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Exhibit 5 20 Price Elasticity of Supply S Price per unit 2.00 $2.50 The diagram above contains information to solve Question 2 in the following slide. Quantity per period © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-3 Price Elasticity of Supply Question 2. Refer to Exhibit 7-1 in the previous slide. If the price increases from $2.00 to $2.50, the quantity supplied increases from 100 to 200. What is the price elasticity of supply? 21 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Answers Question © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-3 Price Elasticity of Supply Categories: a)E S between 0 and 1: Inelastic supply Curve is more steep Determinants: cost a lot to increase Q, time too short to adjust b) E S = 1: Unit elastic supply Straight line goes through origin 23 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5-3 Price Elasticity of Supply Categories: c) E S greater than 1: Elastic supply Curve is flat Determinant: cost a little, longer adjustment time d) E S = 0: Perfect inelastic supply Curve is vertical e) E S = ∞: Perfect elastic supply Curve is horizontal 24 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Exhibit 6 25 Supply Becomes More Elastic Over Time SwSw Price per unit 1.00 $1.25 Quantity per day SmSm SySy © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Question Question 3. What is the price elasticity of supply for paintings by Van Gogh? E s = 0 The supply of paintings by Van Gogh is perfectly inelastic because no matter how high the price goes, Van Gogh can’t be alive again and paint more. The quantity supplied can’t be changed. 26 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.