1. Application on Demand and Supply
Chapter 4
Application on Demand and Supply

2. Dr Mohamed I. Migdad Associate Professor in Economics
Chapter 4
Dr Mohamed I. Migdad
Associate Professor in Economics

3. Application of supply and demand
4.1 price elasticity of demand and supply
4.2 price ceiling and price floor
4.3 other topics, minimum wages, price control

4. Elasticity
Elasticity is a general concept that can be used to quantify the response in one variable when another variable changes.

5. How to measure elasticity

6. Price Elasticity of Demand
A popular measure of elasticity is price elasticity of demand measures how responsive consumers are to changes in the price of a product.

7. How to measure P.E.D
Price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in price of the product.

8. How to measure P.E.D

9. The absolute term
The value of demand elasticity is always negative, but it is stated in absolute terms.

10. The negative sign
The negative sign of the P.E.D show the negative relation between price and quantity demanded.

11. Slope and Elasticity
The value of the slope of the demand curve and the value of elasticity are not the same.
Unlike the value of the slope, the value of elasticity is a useful measure of responsiveness.

12. Slope and Elasticity

13. Slope and Elasticity when we calculate slope in the two graphs:
The slope of the first graph equals
change in price / change in quantity
= -1/5 = -20%
The slope of the second graph equals / 80 = -1.25%

14. Slope and Elasticity
But when we calculate elasticity in the two graphs:
The elasticity of the first graph = % change in quantity / % change in price = q2-q1/q1 divided by p2-p1/p1= 10-5 / 5 divided 2-3/3 = 1/ = -3
The elasticity of the second graph = /80 divided 2-3/3 =1/-0.33 = -3

15. continue
Changing the units of measure yields a very different value of the slope, yet the behavior of buyers in both diagrams is identical.
And as a result the elasticity is the same, in both graphs and equals -3

16. Types of Elasticity
Unitary elasticity = -1
Elastic demand > -1
Inelastic demand < -1
Perfectly elastic demand = ∞
Perfectly inelastic demand = 0

17. Hypothetical Demand Elasticity for Four products
Types of Elasticity
Hypothetical Demand Elasticity for Four products

18. % CHANGE IN QUANTITY DEMANDED (%DQD) ELASTICITY (%DQD d %DP)
Hypothetical Demand Elasticities for Four Products
PRODUCT
% CHANGE IN PRICE (%DP)
% CHANGE IN QUANTITY DEMANDED (%DQD)
ELASTICITY (%DQD d %DP)
Insulin
+10% 0%
0.0
Perfectly inelastic
Basic telephone service
-1%
-0.1
Inelastic
Beef
-10%
-1.0
Unitarily elastic
Bananas
-30%
-3.0
Elastic

19. Elastic and Inelastic Demand Curves
Different graphs that show different types of elasticity

20. Perfectly Elastic and Perfectly Inelastic Demand Curves

21. Perfect inelasticity
When demand does not respond at all to a change in price, demand is perfectly inelastic, this is the horizontal demand curve.

22. Perfect elasticity
Demand is perfectly elastic when quantity demanded drops to zero at the slightest increase in price, this is the vertical demand curve.

23. Calculating Elasticities
The elasticity of the first graph = % change in quantity / % change in price
= q2-q1/q1 divided by p2-p1/p1

24. % change in Quantity

25. Calculating Elasticities

26. Calculating Elasticities

27. Elasticity is a ratio of percentages.
Using the values on the graph to compute elasticity, using percentage changes yields the following result:

28. Price Elasticity

29. Calculating Elasticities

30. The midpoint formula
A more accurate way of computing elasticity than percentage changes is the midpoint formula:

31. The midpoint formula

32. The midpoint formula

33. Interpret Elasticities
Here is how to interpret two different values of elasticity:
When e = 0.2, a 10% increase in price leads to a 2% decrease in quantity demanded.
When e = 2.0, a 10% increase in price leads to a 20% decrease in quantity demanded.

34. Elasticity Changes along a Straight-Line Demand Curve

35. Elasticity along a Straight-Line
Price elasticity of demand decreases as we move downward along a straight line demand curve. This is because quantity is large.

36. Elasticity along a Straight-Line
Demand is elastic in the upper range and inelastic in the lower range of the line, this is because quantity is small .

38. Elasticity
Along the elastic range, elasticity values are greater than one.
Along the inelastic range, elasticity values are less than one.
And in the middle elasticity equals one

39. Elasticity and Total Revenue

40. Change in quantity versus change in price
Type of demand
Value of Ed
Change in quantity versus change in price
Effect of an increase in price on total revenue P↑
Effect of a decrease in price on total revenue P ↓
Elastic
Greater than 1.0
Larger percentage change in quantity
Total revenue decreases
Total revenue increases
Inelastic
Less than 1.0
Smaller percentage change in quantity
Unitary elastic
Equal to 1.0
Same percentage change in quantity and price
Total revenue does not change

41. Elasticity and Total Revenue
When demand is inelastic, price and total revenues are directly & positively related.
Price increases generate higher revenues.

42. Price increases generate lower revenues.
continue
When demand is elastic, price and total revenues are indirectly & negatively related.
Price increases generate lower revenues.

43. The Determinants of Demand Elasticity
Availability of substitutes - demand is more elastic when there are more substitutes for the product.
Time dimension -- demand becomes more elastic over time.

44. continue
Importance of the item in the budget -- demand is more elastic when the item is a more significant portion of the consumer’s budget.

45. Home Exam
Define economics and it main branches.
What is elasticity, and what is its application?
Give example to calculate price elasticity of demand & explain its importance.

46. Exam
Explain the relation between elasticity & revenue? How to use the relation in decision making? Give numerical examples.
What are factors determines the elasticity?
Use Graphs and numerical examples as much as you can in answers.

47. Other Important Elasticities
Income elasticity of demand – measures the responsiveness of demand to changes in income.

48. The form

49. Other Important Elasticities
Cross-price elasticity of demand: A measure of the response of the quantity of one good demanded to a change in the price of another good.

50. The form

51. Other Important Elasticities
Elasticity of supply: A measure of the response of quantity of a good supplied to a change in price of that good. Likely to be positive in output markets.

52. The form

53. Other Important Elasticities
Elasticity of labor supply: A measure of the response of labor supplied to a change in the price of labor.

54. The form

55. Constraints on the Market
A price ceiling is a maximum price that sellers may charge for a good, usually set by government.

56. price ceiling
In 1974, the government set a price ceiling to distribute the available supply of gasoline.
At an imposed price of 57 cents per gallon, the result was excess demand.

58. Prices and the Allocation of Resources
Price changes resulting from shifts of demand cause profits to rise or fall.
Profits attract capital; losses lead to disinvestment.

59. price ceiling
Higher wages attract labor and encourage workers to acquire skills.
At the core of the system, supply, demand, and prices in input and output markets determine the allocation of resources and the ultimate combinations of things produced.

60. Price Floors
A price floor is a minimum price below which exchange is not permitted.
The most common example of a price floor is the minimum wage, which is a floor set under the price of labor.

61. Price Floors
The result of setting a price floor will be excess supply, or higher quantity supplied than quantity demanded.

62. Impact of tax and subsidies on price and quantity
Taxes shift supply curve up to the left
And we reach a new equilibrium point
Pe will increase and Qe will decrease

63. How tax or tariffs on imports affect foreign trade
This depend on the elasticity of demand and supply.

64. Energy price control
An example for government intervention comes when the Gov. legislates a maximum price ceiling.