1. Unit 2: Supply, Demand, and Consumer Choice

2. Supply and Demand Review
Define the Law of Demand
Define the Law of Supply
What is the difference between a change in demand and a change in quantity demanded?
What happens if price is above equilibrium?
What happens if price is below equilibrium?
Define Consumer’s and Producer’s Surplus
Explain the results of an excise tax
Define Dead Weight Loss
Excise tax impact = Such a tax may raise the price of the commodity to the consumer and reduce the net price received by the producer. It generally will do both and reduce the amount marketed and purchased.
DWL = is a loss of economic efficiency that can occur when equilibrium for a good or service is not achieved or is not achievable.

3. Consumers will buy more when prices go down and less when prices go up
THE LAW OF DEMAND SAYS...
Consumers will buy more when prices go down and less when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?

4. Elasticity shows how sensitive quantity is to a change in price.

5. 4 Types of Elasticity Elasticity of Demand Elasticity of Supply
Cross-Price Elasticity (Subs or Comp)
Income Elasticity (Norm or Inferior)

6. 1. Elasticity of Demand Elasticity of Demand-
Measurement of consumers’ responsiveness to a change in price.
What will happen if price increase? How much will it effect Quantity Demanded
Who cares?
Used by firms to help determine prices and sales
Used by the government to decide how to tax

7. Inelastic Demand

8. Inelastic Demand
INelastic = Quantity is INsensitive to a change in price.
If price increases, quantity demanded will fall a little
If price decreases, quantity demanded increases a little.
In other words, people will continue to buy it.
20% 5%
A INELASTIC demand curve is steep! (looks like an “I”)
Examples:
Gasoline
Milk
Diapers
Chewing Gum
Medical Care
Toilet paper

9. General Characteristics of INelastic Goods:
Inelastic Demand
General Characteristics of INelastic Goods:
Few Substitutes
Necessities
Small portion of income
Required now, rather than later
Elasticity coefficient less than 1
20% 5%

10. Elastic Demand

11. Elastic Demand An ELASTIC demand curve is flat!
Elastic = Quantity is sensitive to a change in price.
If price increases, quantity demanded will fall a lot
If price decreases, quantity demanded increases a lot.
In other words, the amount people buy is sensitive to price.
An ELASTIC demand curve is flat!
Examples:
Soda
Boats
Beef
Real Estate
Pizza
Gold

12. General Characteristics of Elastic Goods:
Elastic Demand
General Characteristics of Elastic Goods:
Many Substitutes
Luxuries
Large portion of income
Plenty of time to decide
Elasticity coefficient greater than 1

13. Elastic or Inelastic? What about the demand for insulin for diabetics?
Beef-
Gasoline-
Real Estate-
Medical Care-
Electricity-
Gold-
Elastic- 1.27
INelastic - .20
Elastic- 1.60
INelastic - .31
INelastic - .13
Elastic - 2.6
What if % change in quantity demanded equals % change in price?
Perfectly INELASTIC
(Coefficient = 0)
Unit Elastic (Coefficient =1)

14. 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?

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

17. 2. Price 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

18. 3. Cross-Price Elasticity of Demand
Cross-Price elasticity shows how sensitive a product is to a change in price of another good
It shows if two goods are substitutes or complements
% change in quantity of product “b”
% change in price of product “a”
P increases 20%
Q decreases 15%
If coefficient is negative (shows inverse relationship) then the goods are complements
If coefficient is positive (shows direct relationship) then the goods are substitutes

19. 4. Income-Elasticity of Demand
Income elasticity shows how sensitive a product is to a change in INCOME
It shows if goods are normal or inferior
% change in quantity
% change in income
Income increases 20%, and quantity decreases 15% then the good is a…
INFERIOR GOOD
If coefficient is negative (shows inverse relationship) then the good is inferior
If coefficient is positive (shows direct relationship) then the good is normal
Ex: If income falls 10% and quantity falls 20%…

20. Elasticity Practice 22

21. 23 $135 (1/2 x 3 x 90) (b)(i) $120 ($2 x 60) (ii) $4
(iii) $60 (1.2 x $2 x 60)
(c) Demand is price elastic as Total Revenue increases from $360 ($6 x 60 units) to $450 ($5 x 90 units) as price decreases from $6 to $5 OR change in price from $5 to $6 (20%) < change in quantity from 90 to 60 (33%).
(d) Allocative Efficiency = producing at a level desired by society, best for society.
Allocation is no longer efficient because of the loss of surplus (creation of deadweight loss) 23

22. (i)The price of tickets (ii)The quantity of tickets sold
1996 Micro FRQ #2
The Toledo arena holds a maximum of 40,000 people. Each year the circus performs in front of a sold out crowd.
(a) Analyze the effect on each of the following of the addition of a fantastic new death-defying trapeze act that increases the demand for tickets.
(i)The price of tickets
(ii)The quantity of tickets sold
(b) The city of Toledo institutes an effective price ceiling on tickets. Explain where the price ceiling would be set. Explain the impact of the ceiling on each of the following.
(i) The quantity of tickets demanded
(ii) The quantity of tickets supplied
(c) Will everyone who attends the circus pay the ceiling price set by the city of Toledo. Why or why not?
The trapeze act will cause an increase in demand (shift right in the demand curve) increasing
the price, but the quantity will remain the same because the quantity is fixed at 40,000 seats.
Grading Rubric: Part (A) = 2 points
Price increases as a result of the demand increases (1 point)
Quantity remains the same (1 point)
The price ceiling must be set below the equilibrium price with the new trapeze act (1 point).
The quantity demanded will increase (1/2 point), however the quantity supplied will remain
the same (fixed at 40,000) (1/2 point).
Grading Rubric: Part (B) = 2 points
Setting the price ceiling below the equilibrium price (1 point)
Quantity demand increases (1/2 point)
Quantity supplied unchanged (1/2 point)
No, a secondary market or reselling of tickets or scalping of tickets will have some circus goers
paying more than the ceiling price (1 point).
Grading Rubric: Part (C) = 1 point (some version of the above)
(Note: Radio give-aways, coupons and employees do not change with the existence of a price
ceiling; therefore that type of answer is incorrect.) 24