1. Elasticity of Demand and Supply 1 © 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.

2. 2 Price Elasticity of Demand Elasticity –Responsiveness Price elasticity of demand –How responsive quantity demanded is to a price change –Percentage change in quantity demanded divided by percentage change in price © 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.

3. Price Elasticity of Demand %Δq – percentage change in quantity – Δq – change in quantity %Δp – percentage change in price – Δp – change in price 3 © 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.

4. 4 Price Elasticity of Demand Price elasticity of demand, E D –Law of demand Price and quantity demanded are inversely related –E D negative –Absolute value of E D positive © 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.

5. Exhibit 1 5 Demand Curve for Tacos D 10595 Thousands per day 0 0.90 Price per taco $1.10 b a If the price of tacos drops from $1.10 to $0.90, the quantity demanded increases from 95,000 to 105,000. © 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.

6. Categories of E D If %∆q < %∆p –A change in price has relatively little effect on quantity demanded –E D between 0 and 1 –Inelastic demand If %∆q = %∆p –E D = 1 –Unit elastic demand 6 © 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.

7. Categories of E D If %∆q > %∆p –A change in price has a relatively large effect on quantity demanded –E D greater than 1 –Elastic demand 7 © 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.

8. Elasticity and Total Revenue Total revenue = price * quantity demanded at this price TR= p ˣ q As price decreases –If demand is elastic, TR increases –If demand is inelastic, TR decreases –If demand is unit elastic, TR constant 8 © 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.

9. Price Elasticity and Linear Demand Curve Linear demand curve –Straight line demand curve –Constant slope –Varying elasticity Demand becomes less elastic as we move downward –Upper half: elastic –Lower half: inelastic –Midpoint: unit elastic 9 © 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.

10. Exhibit 2 10 Demand, Price Elasticity, and Total Revenue D 90 60 10 70 Price per unit $100 80 50 40 30 20 b a d e 800500200100 Quantity per period 1,000 0900 Total revenue $25,000 500 Quantity per period 1,000 0 (a) Demand and price elasticity (b) Total revenue Total revenue Unit elastic, E D =1 Elastic, E D >1 Inelastic, E D <1 Where the demand curve is elastic, a lower price increases total revenue. Total revenue reaches a maximum at the rate of output where the demand curve is unit elastic. c Where the demand curve is inelastic, further decreases in price reduce total revenue. © 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.

11. Constant Elasticity Demand Curves Perfectly elastic demand curve –Horizontal line Any price increase would reduce quantity demanded to zero –E D = ∞ –Consumers don’t tolerate price increases 11 © 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.

12. Constant Elasticity Demand Curves Perfectly inelastic demand curve –Vertical line Any price change has no effect on the quantity demanded –E D = 0 –‘Price is no object’ 12 © 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.

13. Constant Elasticity Demand Curves Unit-elastic demand curve –Everywhere along the demand curve % Δp causes an equal but offsetting % Δq Total revenue remains the same –E D = 1 Constant-elasticity demand curve –Price elasticity is the same everywhere along the curve –Elasticity value is unchanged 13 © 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.

14. Exhibit 3 14 Constant-Elasticity Demand Curves 0 Quantity per period Price per unit p E D = ∞ (a) Perfectly elastic D Price per unit E D’ = 0 (b) Perfectly inelastic E D’’ = 1 (c) Unit elastic D’ 0 Quantity per period Q Price per unit $10 6 0 Quantity per period 60100 D’’ a b The three panels show constant-elasticity demand curves, so named because the elasticity value does not change along the demand curve. Along the perfectly elastic, or horizontal, demand curve of panel (a), consumers demand all that is offered for sale at price p, but demand nothing at a price above p. Along the perfectly inelastic, or vertical, demand curve of panel (b), consumers demand amount Q regardless of price. Along the unit-elastic demand curve of panel (c), total revenue is the same for each price-quantity combination. © 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.

15. Exhibit 4 15 Summary of Price Elasticity of Demand © 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.

16. Determinants of Price Elasticity of D E D is greater: –The greater the availability of substitutes, and the more similar the substitutes –The more important the good as a share of the consumer’s budget –The longer the period of adjustment (time) 16 © 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.

17. Exhibit 5 17 Demand Becomes More Elastic Over Time DwDw Price per unit $1.25 1.00 DmDm Quantity per day9510075500 DyDy e D w is the demand curve one week after a price increase from $1.00 to $1.25. Along this curve, quantity demanded per day falls from 100 to 95. One month after the price increase, quantity demanded has fallen to 75 along D m. One year after the price increase, quantity demanded has fallen to 50 along D y. At any given price, D y is more elastic than D m, which is more elastic than D w. © 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.

18. Elasticity Estimates Short run –Consumers have little time to adjust Long run –Consumers can fully adjust to a price change Demand is more elastic in the long run 18 © 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.

19. Exhibit 6 19 Selected Price Elasticities of Demand (Absolute Values) © 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.

20. Price Elasticity of Supply Elasticity –Responsiveness Price elasticity of supply –Responsiveness of quantity supplied to a price change –Percentage change in quantity supplied divided by percentage change in price 20 © 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.

21. Price Elasticity of Supply Law of supply E S positive 21 © 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.

22. Exhibit 7 22 Price Elasticity of Supply S Price per unit p p’ If the price increases from p to p’, the quantity supplied increases from q to q’. Price and quantity supplied move in the same direction, so the price elasticity of supply is a positive number. Quantity per periodqq’0 © 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.

23. Categories of E S If %∆q < %∆p –A change in price has relatively little effect on quantity supplied –E S between 0 and 1 –Inelastic supply If %∆q = %∆p –E S = 1 –Unit elastic supply 23 © 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.

24. Categories of E S If %∆q > %∆p –A change in price has a relatively large effect on quantity supplied –E S greater than 1 –Elastic supply 24 © 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.

25. Constant Elasticity Supply Curves Perfectly elastic supply curve –Horizontal line Any price decrease drops the quantity supplied to zero –E S = ∞ Unit-elastic supply curve, E S =1 – %∆p causes an identical %∆q –Straight line from the origin 25 © 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.

26. Constant Elasticity Supply Curves Perfectly inelastic supply curve –Vertical line A price change has no effect on the quantity supplied –E S = 0 –Goods in fixed supply 26 © 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.

27. Exhibit 8 27 Constant-Elasticity Supply Curves 0 Quantity per period Price per unit p E S = ∞ (a) Perfectly elastic S Price per unit E S’ = 0 (b) Perfectly inelastic E S’’ = 1 (c) Unit elastic S’ 0 Quantity per period Q Price per unit $10 5 0 Quantity per period 1020 In each of the three panels is a constant-elasticity supply curve, so named because the elasticity value does not change along the curve. Supply curve S in panel (a) is perfectly elastic, or horizontal. Along S, firms supply any amount of output demanded at price p, but supply none at prices below p. Supply curve S’ is perfectly inelastic, or vertical. S’ shows that the quantity supplied is independent of the price. In panel (c), S”, a straight line from the origin, is a unit-elastic supply curve. Any percentage change in price results in the same percentage change in quantity supplied. S’’ © 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.

28. Determinants of Supply Elasticity E S is greater: –If the marginal cost rises slowly as output expands –The longer the period of adjustment (time) 28 © 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.

29. Exhibit 9 29 Supply Becomes More Elastic Over Time SwSw Price per unit 1.00 $1.25 Quantity per day 1102000100140 SmSm SySy The supply curve one week after a price increase, S w, is less elastic, at a given price, than the supply curve one month later, S m, which is less elastic than the supply curve one year later, S y. Given a price increase from $1.00 to $1.25, quantity supplied per day increases to 110 units after one week, to 140 units after one month, and to 200 units after one year. © 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.

30. Income Elasticity of Demand Income elasticity of demand –Demand responsiveness to a change in consumer income –Percentage change in demand divided by the percentage change in income that caused it 30 © 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.

31. Income Elasticity of Demand Inferior goods –Negative income elasticity Normal goods –Positive income elasticity –Income inelastic, necessities Elasticity between 0 and 1 –Income elastic, luxuries Elasticity > 1 31 © 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.

32. Exhibit 10 32 Selected Income Elasticities of Demand © 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.

33. Cross-Price Elasticity of Demand Cross-price elasticity of demand –The percentage change in the demand of one good, divided by the percentage change in the price of another good –Positive for substitutes –Negative for complements –Zero for unrelated goods 33 © 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.

34. Appendix Price Elasticity and Tax Incidence Tax –Decrease in supply by the amount of tax Tax incidence –Consumers : high price –Producers: lower net-of-tax receipt 34 © 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.

35. Appendix Price Elasticity and Tax Incidence The more price elastic the demand: –The more tax producers pay –The less tax consumers pay The more elastic the supply: –The less tax producers pay –The more tax consumers pay 35 © 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.

36. Exhibit 13 36 Effects of Price Elasticity of Demand on Tax Incidence StSt S D’ StSt S D $0.20 Tax Price per ounce $1.15 1.00 0.95 Millions of ounces per day 1090 $0.20 Tax Price per ounce $1.05 1.00 0.85 (a) Less elastic demand(b) More elastic demand The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to S t. In panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the more the tax is paid by producers in the form of a lower net-of-tax receipt. 107 Millions of ounces per day © 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.

37. Exhibit 14 37 Effects of Price Elasticity of Supply on Tax Incidence St’St’ S’ D’’ $0.20 Tax Price per ounce $1.15 1.00 0.95 (a) More elastic supply St”St” S” D’’ $0.20 Tax 109 Price per ounce $1.05 1.00 0.85 (b) Less elastic supply Millions of ounces per day 1080 The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to S t. In panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the more the tax is paid by producers in the form of a lower net-of-tax receipt. © 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.