1. Demand and Supply Guest Lodge
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2. Elasticisity of Supply and Demand
Chapter 5
Elasticisity of Supply and Demand

3. Elasticity of Demand
Would you buy the new Sony Play Station 4 if it was
$2000
$1500
$1000
$800
$600
$500
$100
$20

4. Elasticity of Demand
Imagine that you are asthmatic. Would you buy medication if it was
$200
$180
$300
$400
$500
$600
$1000

5. Elasticity of Demand
Imagine that you are NOT asthmatic. Would you buy medication if it was
$1000
$800
$500
$200
$180 $5 $1

6. Elasticity of demand – measures how responsive demand is to price.

7. Elasticity of demand As prices rise =>quantity demanded falls
Law of demand
But by how much will sales fall?
Demand for the PS4 is elastic
a change in price will lead to a large change in quantity demand (5% change in price = 10% change in demand)
Demand for the asthma medication is inelastic
a change in price will lead to a small change in quantity demand (5% change in price = 2% change in demand)

8. Elastic Demand
When a percentage change in price causes a larger percentage change in quantity purchased
i.e. A 10% increase in price causes a 50% decrease in amount purchased
Buyers are price sensitive
Ex Chicken
Other goods that would have elastic demand?

9. Elastic Demand & Revenue
When prices rise total revenue falls
Revenue = Quantity x Price
Decrease in Quantity will be greater than Increase in Price
When prices fall total revenue rises
Increase in Quantity will be greater than decrease in Price

10. Inelastic Demand & Revenue
When prices rises total revenue rises
Revenue = Quantity x Price
Decrease in Quantity will be smaller than Increase in Price
When prices fall total revenue falls
Increase in Quantity will be smaller than decrease in Price

11. % Change in Quantity Demanded
Elasticity of Demand
A measure of the actual change in quantity demanded for a product who’s price has changed
Coefficient of
Demand Elasticity
% Change in Quantity Demanded
% Change in Price = OR
Coefficient of
Demand Elasticity
∆Qd
∆ Pd =

12. Elasticity of Demand The Cause is in the denominator
The Effect is in the numerator

13. Coefficient 1 > x : Inelastic coefficient
Change in quantity demanded will be smaller than the change in price
1 < x : Elastic coefficient
Change in quantity demanded will be greater than change in price
1 = x : Unitary coefficient
Change in quantity demanded will be equal to change in price (5% change in price = 5% change in demand)

14. Problem to solve
A large gas station sells 10 million/L of gas/month at a price of $0.50/L. If the station’s owners raise their price to $0.54/L the quantity demanded by the stations customers falls to 9.5 million litres. With this information can we calculate a coefficient that the station owners will find useful in making their pricing decision?

15. Turn to page 95 Work through the equations on page 95 and 96.
Fill in the table 5.1 on page 96.

16. What we know: 1st step: calculate % of change in Qd
Change in price is 4 cents which = a change of 8%
1st step: calculate % of change in Qd
8% of $0.50 (orig. price): 4/50 X 100 = 8%
7.4% of $0.54 (new price) 4/54 X 100 = 7.4%
2nd step: we must compromise by using the average price - $0.52 and divide it by 4
4 / $0.52 X 100 = 7.69% (will serve as the denominator in the equation)

17. The average is 9.75 million/L of gas demanded
3rd step: Similar to the prior 2 steps we must determine the per cent change in quantity demanded 10 million/L vs 9.5 million/L
The average is 9.75 million/L of gas demanded
The change in quantity is -0.5 million/L
Therefore percent change is
-0.5 / 9.75 X 100 = or 5.13%

18. Therefore… %change in quantity demanded = 5.13% or 0.67
% change in price %
Has a co-efficient of 0.67 = inelastic

19. Lets look at table on pg. 96

22. Factors Affecting DEMAND ELASTICITY
1. Availability of Substitutes
More substitutes more elastic

23. Factors Affecting DEMAND ELASTICITY
2. Nature of Item
Necessities tend to be more inelastic
Luxuries tend to be more elastic

24. Factors Affecting DEMAND ELASTICITY
3. Fraction of income spent on item
Big ticket item are more elastic
House, Cars

25. Factors Affecting DEMAND ELASTICITY
4. Amount of time Available
Inelastic in the short run
Elastic in the long run
Example: Yasin works downtown. He lives in a 3 bedroom house all alone in Kanata. He drives a Hummer. The price of gas has gone up to $2 a litre. He is really feeling the pinch.
What can he do in the short term?
What can he do in the long term?

26. Pg. 95 Homework Beef – slightly or unitarily elastic
Other meats can substitute if prices rise
Steak – elastic, as non-essential meat;
other substitutes are available if prices rise
Soft drinks – inelastic
a near-essential, non alcoholic drink
Coca-Cola – elastic
Other cola drinks are available

27. p.95. continued Pencils – inelastic Public transportation – inelastic
as an essential item and a small part of most budgets
Public transportation – inelastic
An essential service in most areas
Hair cuts – inelastic
Inelastic as an essential service for most people

28. 3) Price falls and demand is elastic - revenues will increase
2) Food is inelastic because it is essential. When the price of an inelastic item rises, so do revenues
3) Price falls and demand is elastic - revenues will increase
Price rises and demand is inelastic – revenues will increase
Price rises and demand is elastic – revenues will decrease
Price falls and demand is inelastic – revenues will decrease
Price rises and demand is unitary – revenues will stay the same

29. Pg. 95 4)
A) A co-efficient of 1.5 is elastic, therefore a lower price would increase revenues
B) A 0.9 coefficient indicates that the item is inelastic. The economist would recommend maintaining the present price, or if possible, raising the price, because revenues would increase for the seller (so long as the increase in price doesn’t equal a coefficient greater than 1.

30. Slope of elasticity and Inelasticity demand curves

31. A unitary demand curve

32. Homework Quantity Demanded Sales Revenue Elasticity Price $1.00 $0.90
$0.80
$0.70
$0.60
$0.50
300
400
500
600
700
800
$300
$360
$400
$420
Elastic
Unitary
Inelastic

33. Elasticity of Supply
Elasticity of supply measures how responsive the quantity supplied by a seller is to rise or fall in price.

34. Supply Coefficient 1>x = inelastic 1<x = elastic 1=x = unitary
seller cannot increase the quantity supplied by a greater percentage than the percent increase in price
1<x = elastic
Seller can increase the quantity supplied by a greater percentage than the percent increase in price
1=x = unitary
Seller is able to match a price increase by the same percentage increase in quantity supplied.

35. Elasticity of Supply Eqn.
Coefficient %change in
of supply = quantity supplied
elasticity % change in price

36. Factors Affecting Supply Elasticity
Ease of storage
When the price drops they can either sell at a low price or put it in inventory until the price rises
Time
The more time a seller has to increase production the more elastic supply will be
(ex. farmers can’t increase production of corn over night therefore short term = inelastic and long term = elastic)
Cost Factors
increasing supply may be costly. Supply is more elastic in in industries that are not costly to manufacture and where production can be easily expanded if demand increases

37. Inelastic supply curve

38. Elastic supply curve

39. Unitary supply curve

40. HW pg. 101 1)
A) A coefficient of 0.8 is bad news for sellers, because it indicates that supply is inelastic. Thus, sellers will be slow to increase supply to take advantage of rising prices (ex. fruits and vegetables)
B) A coefficient of 1.5 is good news for sellers because it indicates that supply is elastic. Thus sellers can quickly increase supply to take advantage or rising prices (ex. steel)

41. p.101 #2
Price per cone
Short-term supply
Coefficient
Long-term supply $1
300
0.75
1000
2.0 $2
500
0.825
5000
1.66 $3
700
10000

42. Utility Theory Utility = satisfaction Marginal = extra
Marginal utility = extra satisfaction

43. Example of Marginal Utility
Richard loves to eat pizza and cheeseburgers. Over the last week he has consumed 3 cheeseburgers and no pizza. While out for dinner he is looking at the menu and sees both pizza and cheeseburgers on the menu. What is he more likely to choose to eat, pizza or a cheeseburger?

44. Since the marginal utility of buying a pizza will be greater than the marginal utility of buying cheeseburger, Richard will choose to buy a pizza.

45. Richard is really hungry so he orders 5
Consumes 1st cheeseburger = high marginal utility
Consumes 2nd cheeseburger = marginal utility drops a bit
Consumes 3rd cheeseburger = marginal utilty drops even more
By the time Richard consumes his last cheeseburger his marginal utility or extra satisfaction he gets from each additional burger is less and less.
Note:
Total utility increases but less and less as each additional cheeseburger is consumed.

46. Pizza
Total utility
Marginal Utility
Cheese –
burgers
Total Utility 1 10 11 2 18 8 7 3 24 6 22 4 28 25 5 30 26

47. Utils – units of satisfaction
If Richard has $10 and a Pizza costs $2 and a cheeseburger costs $1, what purchase combination would provide him with the most satisfaction?

48. First we need to know
Marginal Utility = MU
Price

49. Pizza $2
Total Utility
Marginal Utility MU
price
Cheese-burgers $1 1 10
10 = 5 $2 11
11 = 11 $1 2 18 8
8 = 4 7
7 = 7 3 24 6
6 = 3 23 5
5 = 5 4 28
4 = 2 25
3 = 3 30
2 = 1 26
1 = 1

50. Richard’s best combination to maximize satisfaction is;
Purchasing 3 pizzas and 4 cheeseburgers
Has maximum satisfaction: 49 utils
Consumer Equilibrium – receiving the same amount of satisfaction per dollar of each item
Where does consumer equilibrium occur for Richard?

51. Pg. 105 HW
1) The total satisfaction from consumeing several soft drinks is higher than consuming just one, but the extra satisfaction gained from each drink after the first one drops steadily

52. Pg. 105 HW
Units Consumed
Total Utility
Marginal Utility - 1 6 2 14 8 3 24 10 4 34 5 42 48

53. 3) Enrique’s consumer surplus is $2 because he would have paid $10 for one movie, but now he has to pay only $8.

54. Consumer Surplus
Consumer surplus – the difference between what consumers are wiling to pay for an item and what they actually pay
Ex.
IPAD 3 is $800 but you would have paid $1000 = consumer surplus of $200

55. Ceiling Price
A price restriction place by government in order to prevent the price of a product from rising above a certain level
Results in a shortage if the ceiling price is lower than the equilibrium price
Ex Gas Prices, Rent Control

56. Ceiling Price
Price S1 E1
Price Ceiling
Shortage D1 Qs Qd
Quantity

57. Shortage

58. Consequence of Price Ceilings
Pros
Equitable access to good and services
Cons
Long line ups
Black market
Decrease in quality

59. Floor Price
A price restriction placed by government in order to prevent the price of a product from falling below a certain level
Results in a surplus if the price is above the equilibrium price
Ex Minimum Wage

60. Floor Price
Price S1
Price Floor E1
Surplus D1 Qd Qs
Quantity

61. Consequence of Price Floor
Pros
Stable Price
Food Security
Living wage for manufacturers
Secures local industry
Cons
Overproduction of product
Waste
Sold or given away
Higher taxes to pay for surplus
Higher prices for consumers

62. Subsidies
A grant of money made to particular industry by the government
Results in a supply shift to the right
Example
Farm Subsidies
Research and Development
New Industry (Infant Industry)
Environmental

63. Subsidies Price = $100 -Cost = $110 Profit = -$10 Price = $100
+ Subsidy = $20
Profit = $10

64. Subsidies S1
Price S2 E1 P1 E2 P2
Subsidy D1 Q1 Q2
Quantity

65. Subsidies