18 Extensions of Demand and Supply Analysis.

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Presentation transcript:

18 Extensions of Demand and Supply Analysis

Chapter Objectives Price Elasticity of Demand and How It Can Be Applied The Usefulness of the Total Revenue Test for Price Elasticity of Demand Price Elasticity of Supply and How It Can Be Applied Cross Elasticity of Demand and Income Elasticity of Demand Consumer Surplus, Producer Surplus, and Efficiency Losses

Price Elasticity of Demand Measuring Responsiveness to Price Changes Relatively Elastic or Inelastic Price-Elasticity Coefficient and Formula Percentage Change in Quantity Demanded of Product X Ed = Percentage Change in Price of Product X

Price Elasticity of Demand Formula Restated Change in Quantity Demanded of X Ed = Original Quantity Demanded of X Change in Price of X ÷ Original Price of X Using Averages Midpoint Formula W 18.1 Change in Quantity Ed = Sum of Quantities/2 ÷ Change in Price Sum of Prices/2

Price Elasticity of Demand Why Use Percentages? Elimination of the Minus Sign Interpretations of Ed Elastic Demand Ed = .04 .02 = 2 Inelastic Demand Ed = .01 .02 = .5 Unit Elasticity Ed = .02 = 1

Price Elasticity of Demand Extreme Cases Perfectly Inelastic Demand P Q D1 Perfectly Inelastic Demand (Ed = 0) Perfectly Elastic Demand P Q D2 Perfectly Elastic Demand (Ed = ∞)

The Total Revenue Test Total Revenue (TR) TR = P x Q Elastic Demand P W 18.2 $3 2 1 0 10 20 30 40 Q P a b D1

The Total Revenue Test Total Revenue (TR) TR = P x Q Inelastic Demand W 18.2 $4 3 2 1 0 10 20 Q P c d D2

The Total Revenue Test Total Revenue (TR) TR = P x Q Unit-Elastic P e W 18.2 $3 2 1 0 10 20 30 Q P e f D3

Elasticity on a Linear Demand Curve G 18.1 Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test (1) Total Quantity of Tickets Demanded Per Week, Thousands (3) Elasticity Coefficient (Ed) (4) Total Revenue (1) X (2) (5) Total-Revenue Test (2) Price Per Ticket 1 2 3 4 5 6 7 8 8 7 6 5 4 3 2 1 $8,000 14,000 18,000 20,000 8,000 ] 5.00 2.60 1.57 1.00 0.64 0.38 0.20 ] Elastic Unit Elastic Inelastic Graphically…

Price Elasticity and the Total-Revenue Curve 1 2 3 4 5 6 7 8 Quantity Demanded Price (Thousands of Dollars) Total Revenue $20 18 16 14 12 10 $8 Elastic Ed > 1 a b c d e f g h Unit Elastic Ed = 1 Inelastic Ed < 1 D Elastic Ed > 1 Unit Elastic Ed = 1 TR Inelastic Ed < 1

Determinants of Price Elasticity of Demand Substitutability Proportion of Income Luxuries versus Necessities Time Applications: Large Crop Yields Excise Taxes Decriminalization of Illegal Drugs

Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Unit Elastic Supply Es = 1 Market Period: Not Enough Time to Shift Resources P Q Sm Greatest Price Impact Pm P0 D1 D2 Q0

Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Inelastic Supply Es < 1 Short Run: Resources Not Easily Shifted to Alternative Uses P Q Ss Lower Price Impact Ps P0 D1 D2 Q0 Qs

Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Elastic Supply Es > 1 Long Run: Resources Easily Shifted to Alternative Uses P Q Sl Least Price Impact Pl P0 D1 D2 Q0 Ql

Price Elasticity of Supply Applications Antiques and Reproductions Volatile Gold Prices

Cross Elasticity of Demand Percentage Change in Quantity Demanded of Product X Exy = Percentage Change in Price of Product Y Substitute Goods – Positive Sign Complementary Goods- Negative Sign Independent Goods – Zero or Near-Zero Value

Income Elasticity of Demand Percentage Change in Quantity Demanded Ei = Percentage Change in Income Normal Goods – Positive Sign Inferior Goods- Negative Sign Insights into the Economy

Consumer and Producer Surplus Consumer Surplus O 18.3 Consumer Surplus Equilibrium Price = $8 Price (Per Bag) P1 D Q1 Quantity (Bags)

Consumer and Producer Surplus Equilibrium Price = $8 Price (Per Bag) P1 Producer Surplus Q1 Quantity (Bags)

Consumer and Producer Surplus Efficiency Revisited S W 18.3 Consumer Surplus Equilibrium Price = $8 Price (Per Bag) P1 Producer Surplus D Q1 Quantity (Bags)

Consumer and Producer Surplus Efficiency Revisited Efficiency Losses (Deadweight Losses) S Efficiency Losses Price (Per Bag) P1 D Q2 Q1 Q3 Quantity (Bags)

Elasticity and Pricing Power: Word Why Different Consumers Pay Different Prices All Buyers in a Highly Competitive Market Pay the Same Price Regardless of Their Elasticities Difficulty in Applying Different Prices Observe Differences in Group Elasticities Business Travelers Leisure Travelers Discounting for Children Different Net Prices for College Tuition

Key Terms price elasticity of demand midpoint formula elastic demand inelastic demand unit elasticity perfectly inelastic demand perfectly elastic demand total revenue test (TR) total-revenue test price elasticity of supply market period short run long run cross-elasticity of demand income elasticity of demand consumer surplus producer surplus efficiency losses (deadweight losses)

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