Unit 2: Supply, Demand, and Consumer Choice

Supply and Demand Review 1.Define the Law of Demand 2.Define the Law of Supply 3.What is the difference between a change in demand and a change in quantity demanded?

HOW MUCH MORE OR LESS? THE LAW OF DEMAND SAYS... Consumers will buy more when P and less when prices 3

Elasticity Elasticity shows how much quantity will change, when price changes.

2 Types of Elasticity 1.Elasticity of Demand 2.Elasticity of Supply

1. Elasticity of Demand Elasticity of Demand- Measurement of consumers change in QD (quantity demanded) when P (price) changes. What will happen if P ? How much will it effect QD

Inelastic Demand

If price, QD will fall a little If price, QD increases a little. ~people will continue to buy it. 20% 5% INelastic = Quantity changes little to a change in price. Examples: Gasoline Milk A INELASTIC demand curve is steep! (looks like an “I”) Medical Care Toilet paper

Inelastic Demand 20% 5% General Characteristics of INelastic Goods: Few Substitutes Necessities Required now Elasticity coefficient( 系数 ) < 1

Elastic Demand

If price, QD will fall a lot If price, QD increases a lot. Price changes little~ QD changes a lot Elastic = Quantity is sensitive to a change in price. An ELASTIC demand curve is flat! Examples: Soda Cars Beef Pizza Gold

Elastic Demand General Characteristics of Elastic Goods: Many Substitutes Luxury goods Large part of income Lots of time to decide Elasticity coefficient > than 1

Price Elasticity of Demand Price elasticity of demand equals P Q D Q2Q2 P2P2 P1P1 Q1Q1 P rises by 10% Q falls by 15% 15% 10% = 1.5 Price elasticity of demand = % change in Q d % change in P Example:

Calculating Percentage Changes we use the midpoint method: P2 – P1 (P2 + P1)/2 x 100% % change in P = % change in Q = Q2 – Q1 (Q2 + Q1)/2 x 100%

1. Calculating Percentage Changes Using the midpoint method, the % change in P equals $250 – $200 $225 x 100% = 22.2% P1 200 Q1 8 P2 250 Q2 12 % change in P = P2 – P1 (P2 + P1)/2 x 100%

1. Calculating Percentage Changes  The % change in Q equals 12 – 8 10 x 100% = 40.0% P1 200 Q1 8 P2 250 Q2 12 % change in Q = Q2 – Q1 (Q2 + Q1)/2 x 100%

1. Calculating Elasticity Using the midpoint method, the % change in P equals  The price elasticity of demand equals 40/22.2 = 1.8 % Δ Q % Δ P = Elasticity Coefficient

Elasticity Coefficients Elasticity Coefficients: Greater than 1 = Elastic (ΔP < ΔQ) Less than 1 = Inelastic (ΔP > ΔQ) = 1= Unit Elastic (ΔP = ΔQ)

ACTIVE LEARNING Calculate an elasticity ACTIVE LEARNING 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 © 2012 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.

ACTIVE LEARNING Answers ACTIVE LEARNING 1 Answers Use midpoint method to calculate % change in Q d (5000 – 3000)/4000 = 50% % change in P ($90 - $70)/$80 = 25% The price elasticity of demand equals © 2012 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. 50% 25% = 2.0

Elastic or Inelastic? Beef- Gasoline- Real Estate- Medical Care- Electricity- Gold- Elastic INelastic -.20 Elastic INelastic -.31 INelastic -.13 Elastic What about the demand for medicine? Perfectly INELASTIC (Coefficient = 0) What if % change in quantity demanded equals % change in price? Unit Elastic (Coefficient =1) 45 Degrees

Total Revenue Test Uses elasticity to show how changes in price will affect total revenue (TR). (TR = Price x Quantity) Elastic Demand- Price increase causes TR to decrease Price decrease causes TR to increase Inelastic Demand- Price increase causes TR to increase Price decrease causes TR to decrease Unit Elastic- Price changes and TR remains unchanged Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases?

Is the range between A and B, elastic, inelastic, or unit elastic? A B 10 x 100 =$1000 Total Revenue 5 x 225 =$1125 Total Revenue Price decreased and TR increased, so… Demand is ELASTIC 125% 50%

2. Price Elasticity of Supply Elasticity of Supply- Elasticity of supply shows how sensitive producers are to a change in price. Elasticity of supply is based on time limitations. Producers need time to produce more. INelastic = Insensitive to a change in price (Steep curve) Most goods have INelastic supply in the short-run Elastic = Sensitive to a change in price (Flat curve) Most goods have elastic supply in the long-run Perfectly Inelastic = Q doesn’t change (Vertical line) Set quantity supplied

1.Demand 2.Substitute 3.Elastic 4.Total Revenue Test

1.Supply 2.Inelastic 3.Elasticity Coefficient

Elasticity Practice 27