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Macroeconomics_Elasticity and its Applications

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This chapter discusses elasticity, which measures how responsive buyers and sellers are to changes in price. It defines price elasticity of demand as the percentage change in quantity demanded divided by the percentage change in price. Factors that make demand more elastic include availability of substitutes, whether a good is a necessity or luxury, how broadly the market is defined, and the time period considered. Price elasticity of supply is defined similarly for quantity supplied. Factors that make supply more elastic include the ability to change production and longer time periods. The chapter examines how elasticity relates to total revenue and applies elasticity concepts to different markets.

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Chapter 5Chapter 5 Elasticity and its Applications © 2002 by Nelson, a division of Thomson Canada Limited© 2002 by Nelson, a division of Thomson Canada Limited
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 2 • Learn the meaning of the elasticity of demand. • Examine what determines the elasticity of demand. • Learn the meaning of the elasticity of supply. • Examine what determines the elasticity of supply. • Apply the concept of elasticity in three different markets. • Learn the meaning of the elasticity of demand. • Examine what determines the elasticity of demand. • Learn the meaning of the elasticity of supply. • Examine what determines the elasticity of supply. • Apply the concept of elasticity in three different markets. In this chapter you will…In this chapter you will…
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 3 • … allows us to analyze supply and demand with greater precision. • … is a measure of how much buyers and sellers respond to changes in market conditions • … allows us to analyze supply and demand with greater precision. • … is a measure of how much buyers and sellers respond to changes in market conditions THE ELASTICITY OF DEMANDTHE ELASTICITY OF DEMAND
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 4 • Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. • Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. • Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. • Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. Price Elasticity of DemandPrice Elasticity of Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 5 • Availability of Close Substitutes • Necessities versus Luxuries • Definition of the Market • Time Horizon • Availability of Close Substitutes • Necessities versus Luxuries • Definition of the Market • Time Horizon The Price Elasticity of Demand and ItsThe Price Elasticity of Demand and Its DeterminantsDeterminants
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 6 • Demand tends to be more elastic: – the larger the number of close substitutes. – if the good is a luxury. – the more narrowly defined the market. – the longer the time period. • Demand tends to be more elastic: – the larger the number of close substitutes. – if the good is a luxury. – the more narrowly defined the market. – the longer the time period. The Price Elasticity of Demand and ItsThe Price Elasticity of Demand and Its DeterminantsDeterminants
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 7 • The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. • The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. Computing the Price Elasticity of DemandComputing the Price Elasticity of Demand Priceelasticity of demand= Percentagechangeinquantity demanded Percentagechangeinprice
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 8 • The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. • point Method: A Better Way to Calculate Percentage Changes and Elasticities • The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. • point Method: A Better Way to Calculate Percentage Changes and Elasticities The Midpoint Method: A Better Way toThe Midpoint Method: A Better Way to Calculate Percentage Changes and ElasticitiesCalculate Percentage Changes and Elasticities (Q2 - Q1) / [(Q2 + Q1) / 2] (P2 - P1) / [(P2 + P1) / 2] Price elasticity of demand =
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 9 • From Point A to Point B: Price rise = 50% and Quantity fall = 33% • From Point B to Point A: Price fall = 33% and Quantity rise = 50% • From Point A to Point B: Price rise = 50% and Quantity fall = 33% • From Point B to Point A: Price fall = 33% and Quantity rise = 50% The Midpoint Method: A Better Way toThe Midpoint Method: A Better Way to Calculate Percentage Changes and ElasticitiesCalculate Percentage Changes and Elasticities (80 - 120) /[(80 + 120)/ 2] (6 - 4) / [(6 + 4)/ 2] Price elasticity of demand = • Point A: Price = $4 Quantity = 120 • Point B: Price = $6 Quantity = 80 • Point A: Price = $4 Quantity = 120 • Point B: Price = $6 Quantity = 80 = 1 Mid point method
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 10 • Inelastic Demand – Quantity demanded does not respond strongly to price changes. – Price elasticity of demand is less than one. • Elastic Demand – Quantity demanded responds strongly to changes in price. – Price elasticity of demand is greater than one. • Inelastic Demand – Quantity demanded does not respond strongly to price changes. – Price elasticity of demand is less than one. • Elastic Demand – Quantity demanded responds strongly to changes in price. – Price elasticity of demand is greater than one. A Variety of Demand CurvesA Variety of Demand Curves
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 11 • Perfectly Inelastic – Quantity demanded does not respond to price changes. • Perfectly Elastic – Quantity demanded changes infinitely with any change in price. • Unit Elastic – Quantity demanded changes by the same percentage as the price. • Perfectly Inelastic – Quantity demanded does not respond to price changes. • Perfectly Elastic – Quantity demanded changes infinitely with any change in price. • Unit Elastic – Quantity demanded changes by the same percentage as the price. A Variety of Demand CurvesA Variety of Demand Curves
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 12 • Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. • Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. A Variety of Demand CurvesA Variety of Demand Curves
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 13 E = 0 0 Quantity Price Demand 100 1. An increase in price… $4.00 $5.00 2. …leaves the quantity demanded unchanged. Figure 5-1 a): Perfectly Inelastic DemandFigure 5-1 a): Perfectly Inelastic Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 14 E < 1 0 Quantity Price 100 1. A 22% increase in price… $5.00 2. … Leads to a 11% decrease in quantity demanded. Demand $4.00 90 Figure 5-1 b): Inelastic DemandFigure 5-1 b): Inelastic Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 15 E = 1 0 Quantity Price 100 1. A 22% increase in price… $5.00 2. … Leads to a 22% decrease in quantity demanded. Demand $4.00 80 Figure 5-1 c): Unit Elastic DemandFigure 5-1 c): Unit Elastic Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 16 E > 1 0 Quantity Price 100 1. A 22% increase in price… $5.00 2. … Leads to a 67% decrease in quantity demanded. Demand $4.00 50 Figure 5-1 d): Elastic DemandFigure 5-1 d): Elastic Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 17 E = ∞ 0 Quantity Price 2. At exactly $4, consumers will buy any quantity. $4.00 Demand 1. At any price above $4, quantity demanded is zero. 3. At any price below $4, quantity demanded is infinite. Figure 5-1 e): Perfectly Elastic DemandFigure 5-1 e): Perfectly Elastic Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 18 • Total revenue is the amount paid by buyers and received by sellers of a good. • Computed as the price of the good times the quantity sold. TR = P x Q • Total revenue is the amount paid by buyers and received by sellers of a good. • Computed as the price of the good times the quantity sold. TR = P x Q Total Revenue and the Price Elasticity ofTotal Revenue and the Price Elasticity of DemandDemand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 19 Price Quantity0 100 Demand P x Q = $400 (revenue) $4.00 Figure 5-2: Total RevenueFigure 5-2: Total Revenue
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 20 Price Quantity0 80 Demand $3.00 P x Q = $400 (revenue) P x Q = $100 (revenue) $1.00 100 Figure 5-3: How Total Revenue ChangesFigure 5-3: How Total Revenue Changes When Prices Changes: Inelastic DemandWhen Prices Changes: Inelastic Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 21 Price Quantity Change in Total Revenue when Price Changes 0 50 Demand $4.00 $5.00 20 Revenue = $100 Revenue = $200 Figure 5-4: How Total Revenue ChangesFigure 5-4: How Total Revenue Changes When Prices Changes: Elastic DemandWhen Prices Changes: Elastic Demand
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 22 • With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases. • With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases. Elasticity and Total Revenue along a LinearElasticity and Total Revenue along a Linear Demand CurveDemand Curve
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 23 Table 5-1. Elasticity and Total RevenueTable 5-1. Elasticity and Total Revenue along a Linear Demand Curvealong a Linear Demand Curve
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 24 Price Quantity 2 4 6 8 10 120 6 5 4 3 2 1 7 14 Elasticity is larger than 1. Elasticity is smaller than 1. Figure 5-5: A Linear Demand CurveFigure 5-5: A Linear Demand Curve
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 25 • Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. • It is computed as the percentage change in the quantity demanded divided by the percentage change in income. • Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. • It is computed as the percentage change in the quantity demanded divided by the percentage change in income. Other Demand ElasticitiesOther Demand Elasticities I n c o m e e l a s t i c i t y o f d e m a n d = P e r c e n t a g e c h a n g e i n q u a n t i t y d e m a n d e d P e r c e n t a g e c h a n g e i n i n c o m e
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 26 • Types of Goods – Normal Goods – Inferior Goods • Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. • Types of Goods – Normal Goods – Inferior Goods • Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. Other Demand ElasticitiesOther Demand Elasticities
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 27 • Goods consumers regard as necessities tend to be income inelastic – Examples include food, fuel, clothing, utilities, and medical services. • Goods consumers regard as luxuries tend to be income elastic. – Examples include sports cars, furs, and expensive foods. • Goods consumers regard as necessities tend to be income inelastic – Examples include food, fuel, clothing, utilities, and medical services. • Goods consumers regard as luxuries tend to be income elastic. – Examples include sports cars, furs, and expensive foods. Other Demand ElasticitiesOther Demand Elasticities
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 28 • Cross-Price elasticity of demand measures how much the quantity demanded of a good responds to a change in the price of another good. • It is computed as the percentage change in the quantity demanded divided by the percentage change in the price of the second good. • Cross-Price elasticity of demand measures how much the quantity demanded of a good responds to a change in the price of another good. • It is computed as the percentage change in the quantity demanded divided by the percentage change in the price of the second good. Other Demand ElasticitiesOther Demand Elasticities Income elasticity of demand = Percentage change in quantity demanded Percentage change inthe price of good 2.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 29 • Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. • Price elasticity of supply is the percentage change in quantity supplied given a percent change in the price. • Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. • Price elasticity of supply is the percentage change in quantity supplied given a percent change in the price. PRICE ELASTICITY OF SUPPLYPRICE ELASTICITY OF SUPPLY
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 30 • Ability of sellers to change the amount of the good they produce. – Beach-front land is inelastic. – Books, cars, or manufactured goods are elastic. • Time period. – Supply is more elastic in the long run. • Ability of sellers to change the amount of the good they produce. – Beach-front land is inelastic. – Books, cars, or manufactured goods are elastic. • Time period. – Supply is more elastic in the long run. The Price Elasticity of Supply and ItsThe Price Elasticity of Supply and Its DeterminantsDeterminants
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 31 • The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. • The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. Computing the Price Elasticity of SupplyComputing the Price Elasticity of Supply P r i c e e l a s t i c i t y o f s u p p l y = P e r c e n t a g e c h a n g e i n q u a n t i t y s u p p l i e d P e r c e n t a g e c h a n g e i n p r i c e
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 32 • … using the midpoint method, we calculate the percent change in the price as (2.10 - 1.90) / 2.00 x 100 = 10% • Similarly, we calculate the percent change in the quantity supplied as (11 000 - 9000) / 10 000 x 100 = 20% • … using the midpoint method, we calculate the percent change in the price as (2.10 - 1.90) / 2.00 x 100 = 10% • Similarly, we calculate the percent change in the quantity supplied as (11 000 - 9000) / 10 000 x 100 = 20% 20% Price elasticity of supply = • Suppose an increase in the price of milk from $1.90 to $2.10 a litre raises the amount that dairy farmers produce from 9000 to 11 000 L per month… • Suppose an increase in the price of milk from $1.90 to $2.10 a litre raises the amount that dairy farmers produce from 9000 to 11 000 L per month… = 2.0 Computing the Price Elasticity of SupplyComputing the Price Elasticity of Supply 10%
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 33 E = 0 0 Quantity Price Supply 1. An increase in price… $5.00 2. …leaves the quantity supplied unchanged. 100 $4.00 Figure 5-6 a): Perfectly Inelastic SupplyFigure 5-6 a): Perfectly Inelastic Supply
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 34 E < 0 0 Quantity Price Supply 100 1. A 22% increase in price… $5.00 2. …leads to a 10% increase in quantity supplied. $4.00 110 Figure 5-6 b): Inelastic SupplyFigure 5-6 b): Inelastic Supply
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 35 E = 1 0 Quantity Price Supply 100 1. A 22% increase in price… $5.00 2. …leads to a 22% increase in quantity supplied. $4.00 125 Figure 5-6 c): Unit Elastic SupplyFigure 5-6 c): Unit Elastic Supply
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 36 E > 1 0 Quantity Price Supply 100 1. A 22% increase in price… $5.00 2. …leads to a 67% increase in quantity supplied. $4.00 200 Figure 5-6 d): Elastic SupplyFigure 5-6 d): Elastic Supply
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 37 E = ∞ 0 Quantity Price 2. At exactly $4, producers will supply any quantity. $4.00 Supply 1. At any price above $4, quantity supplied is infinite. 3. At any price below $4, quantity supplied is zero. Figure 5-6 e): Perfectly Elastic SupplyFigure 5-6 e): Perfectly Elastic Supply
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 38 0 Quantity Price $3 100 $4 200 $12 500 $15 525 Elasticity is greater than 1 Elasticity is less than 1 Figure 5-7:Figure 5-7: How the price elasticity of supplyHow the price elasticity of supply can varycan vary
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 39 • Good news bad news for farmers • OPEC • Drugs and crime • Good news bad news for farmers • OPEC • Drugs and crime THREE APPLICATIONS OF SUPPLY,THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITYDEMAND, AND ELASTICITY
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 40 Increase in Supply Demand S1 $3 Quantity of Wheat Price of Wheat S2 2. … leads to a fall in price… 3. …and a proportionately smaller increase in quantity sold. As a result revenue falls from $300 to $220. 1. When demand is inelastic, an increase in supply… 110100 $2 Figure 5-8:Figure 5-8: An Increase in Supply in theAn Increase in Supply in the Market for WheatMarket for Wheat
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 41 Demand S1 Quantity of Oil Price of Oil S2 1. In the short run, when supply and demand are inelastic, a shift in supply… 2. … leads to a large increase in price… P1 P2 Demand S1 Quantity of Oil S2 1. In the long run, when supply and demand are elastic, a shift in supply… 2. … leads to a small increase in price… P1 P2 Price of Oil (a) Oil Market in the Short Run (b) Oil Market in the Long Run Figure 5-9:Figure 5-9: A Reduction in Supply in theA Reduction in Supply in the World Market for OilWorld Market for Oil
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 42 Demand S1 Quantity of Drugs Price of Drugs S2 1. Drug interdiction reduces the supply of drugs… 2. … which raises the price… P1 P2 D1 Supply 1. Drug education reduces the demand for drugs… 2. … which reduces the price… (a) Drug Interdiction (b) Drug Education Q1Q2 3. … and reduces the quantity sold. Q2 3. … and reduces the quantity sold. Quantity of Drugs Price of Drugs D2 P1 Q1 P2 Figure 5-10:Figure 5-10: Policies to Reduce the of IllegalPolicies to Reduce the of Illegal DrugsDrugs
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 43 • Price elasticity of demand measures how much the quantity demanded responds to changes in the price. • Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. • If a demand curve is elastic, total revenue falls when the price rises. • If it is inelastic, total revenue rises as the price rises. • Price elasticity of demand measures how much the quantity demanded responds to changes in the price. • Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. • If a demand curve is elastic, total revenue falls when the price rises. • If it is inelastic, total revenue rises as the price rises. SummarySummary
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 44 • The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. • The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good. • The price elasticity of supply measures how much the quantity supplied responds to changes in the price. • The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. • The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good. • The price elasticity of supply measures how much the quantity supplied responds to changes in the price. SummarySummary
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 45 • In most markets, supply is more elastic in the long run than in the short run. • The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. • The tools of supply and demand can be applied in many different types of markets. • In most markets, supply is more elastic in the long run than in the short run. • The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. • The tools of supply and demand can be applied in many different types of markets. SummarySummary
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 46 The EndThe End

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Macroeconomics_Elasticity and its Applications

  • 1. Chapter 5Chapter 5 Elasticity and its Applications © 2002 by Nelson, a division of Thomson Canada Limited© 2002 by Nelson, a division of Thomson Canada Limited
  • 2. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 2 • Learn the meaning of the elasticity of demand. • Examine what determines the elasticity of demand. • Learn the meaning of the elasticity of supply. • Examine what determines the elasticity of supply. • Apply the concept of elasticity in three different markets. • Learn the meaning of the elasticity of demand. • Examine what determines the elasticity of demand. • Learn the meaning of the elasticity of supply. • Examine what determines the elasticity of supply. • Apply the concept of elasticity in three different markets. In this chapter you will…In this chapter you will…
  • 3. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 3 • … allows us to analyze supply and demand with greater precision. • … is a measure of how much buyers and sellers respond to changes in market conditions • … allows us to analyze supply and demand with greater precision. • … is a measure of how much buyers and sellers respond to changes in market conditions THE ELASTICITY OF DEMANDTHE ELASTICITY OF DEMAND
  • 4. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 4 • Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. • Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. • Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. • Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. Price Elasticity of DemandPrice Elasticity of Demand
  • 5. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 5 • Availability of Close Substitutes • Necessities versus Luxuries • Definition of the Market • Time Horizon • Availability of Close Substitutes • Necessities versus Luxuries • Definition of the Market • Time Horizon The Price Elasticity of Demand and ItsThe Price Elasticity of Demand and Its DeterminantsDeterminants
  • 6. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 6 • Demand tends to be more elastic: – the larger the number of close substitutes. – if the good is a luxury. – the more narrowly defined the market. – the longer the time period. • Demand tends to be more elastic: – the larger the number of close substitutes. – if the good is a luxury. – the more narrowly defined the market. – the longer the time period. The Price Elasticity of Demand and ItsThe Price Elasticity of Demand and Its DeterminantsDeterminants
  • 7. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 7 • The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. • The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. Computing the Price Elasticity of DemandComputing the Price Elasticity of Demand Priceelasticity of demand= Percentagechangeinquantity demanded Percentagechangeinprice
  • 8. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 8 • The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. • point Method: A Better Way to Calculate Percentage Changes and Elasticities • The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. • point Method: A Better Way to Calculate Percentage Changes and Elasticities The Midpoint Method: A Better Way toThe Midpoint Method: A Better Way to Calculate Percentage Changes and ElasticitiesCalculate Percentage Changes and Elasticities (Q2 - Q1) / [(Q2 + Q1) / 2] (P2 - P1) / [(P2 + P1) / 2] Price elasticity of demand =
  • 9. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 9 • From Point A to Point B: Price rise = 50% and Quantity fall = 33% • From Point B to Point A: Price fall = 33% and Quantity rise = 50% • From Point A to Point B: Price rise = 50% and Quantity fall = 33% • From Point B to Point A: Price fall = 33% and Quantity rise = 50% The Midpoint Method: A Better Way toThe Midpoint Method: A Better Way to Calculate Percentage Changes and ElasticitiesCalculate Percentage Changes and Elasticities (80 - 120) /[(80 + 120)/ 2] (6 - 4) / [(6 + 4)/ 2] Price elasticity of demand = • Point A: Price = $4 Quantity = 120 • Point B: Price = $6 Quantity = 80 • Point A: Price = $4 Quantity = 120 • Point B: Price = $6 Quantity = 80 = 1 Mid point method
  • 10. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 10 • Inelastic Demand – Quantity demanded does not respond strongly to price changes. – Price elasticity of demand is less than one. • Elastic Demand – Quantity demanded responds strongly to changes in price. – Price elasticity of demand is greater than one. • Inelastic Demand – Quantity demanded does not respond strongly to price changes. – Price elasticity of demand is less than one. • Elastic Demand – Quantity demanded responds strongly to changes in price. – Price elasticity of demand is greater than one. A Variety of Demand CurvesA Variety of Demand Curves
  • 11. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 11 • Perfectly Inelastic – Quantity demanded does not respond to price changes. • Perfectly Elastic – Quantity demanded changes infinitely with any change in price. • Unit Elastic – Quantity demanded changes by the same percentage as the price. • Perfectly Inelastic – Quantity demanded does not respond to price changes. • Perfectly Elastic – Quantity demanded changes infinitely with any change in price. • Unit Elastic – Quantity demanded changes by the same percentage as the price. A Variety of Demand CurvesA Variety of Demand Curves
  • 12. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 12 • Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. • Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. A Variety of Demand CurvesA Variety of Demand Curves
  • 13. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 13 E = 0 0 Quantity Price Demand 100 1. An increase in price… $4.00 $5.00 2. …leaves the quantity demanded unchanged. Figure 5-1 a): Perfectly Inelastic DemandFigure 5-1 a): Perfectly Inelastic Demand
  • 14. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 14 E < 1 0 Quantity Price 100 1. A 22% increase in price… $5.00 2. … Leads to a 11% decrease in quantity demanded. Demand $4.00 90 Figure 5-1 b): Inelastic DemandFigure 5-1 b): Inelastic Demand
  • 15. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 15 E = 1 0 Quantity Price 100 1. A 22% increase in price… $5.00 2. … Leads to a 22% decrease in quantity demanded. Demand $4.00 80 Figure 5-1 c): Unit Elastic DemandFigure 5-1 c): Unit Elastic Demand
  • 16. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 16 E > 1 0 Quantity Price 100 1. A 22% increase in price… $5.00 2. … Leads to a 67% decrease in quantity demanded. Demand $4.00 50 Figure 5-1 d): Elastic DemandFigure 5-1 d): Elastic Demand
  • 17. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 17 E = ∞ 0 Quantity Price 2. At exactly $4, consumers will buy any quantity. $4.00 Demand 1. At any price above $4, quantity demanded is zero. 3. At any price below $4, quantity demanded is infinite. Figure 5-1 e): Perfectly Elastic DemandFigure 5-1 e): Perfectly Elastic Demand
  • 18. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 18 • Total revenue is the amount paid by buyers and received by sellers of a good. • Computed as the price of the good times the quantity sold. TR = P x Q • Total revenue is the amount paid by buyers and received by sellers of a good. • Computed as the price of the good times the quantity sold. TR = P x Q Total Revenue and the Price Elasticity ofTotal Revenue and the Price Elasticity of DemandDemand
  • 19. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 19 Price Quantity0 100 Demand P x Q = $400 (revenue) $4.00 Figure 5-2: Total RevenueFigure 5-2: Total Revenue
  • 20. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 20 Price Quantity0 80 Demand $3.00 P x Q = $400 (revenue) P x Q = $100 (revenue) $1.00 100 Figure 5-3: How Total Revenue ChangesFigure 5-3: How Total Revenue Changes When Prices Changes: Inelastic DemandWhen Prices Changes: Inelastic Demand
  • 21. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 21 Price Quantity Change in Total Revenue when Price Changes 0 50 Demand $4.00 $5.00 20 Revenue = $100 Revenue = $200 Figure 5-4: How Total Revenue ChangesFigure 5-4: How Total Revenue Changes When Prices Changes: Elastic DemandWhen Prices Changes: Elastic Demand
  • 22. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 22 • With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases. • With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases. Elasticity and Total Revenue along a LinearElasticity and Total Revenue along a Linear Demand CurveDemand Curve
  • 23. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 23 Table 5-1. Elasticity and Total RevenueTable 5-1. Elasticity and Total Revenue along a Linear Demand Curvealong a Linear Demand Curve
  • 24. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 24 Price Quantity 2 4 6 8 10 120 6 5 4 3 2 1 7 14 Elasticity is larger than 1. Elasticity is smaller than 1. Figure 5-5: A Linear Demand CurveFigure 5-5: A Linear Demand Curve
  • 25. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 25 • Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. • It is computed as the percentage change in the quantity demanded divided by the percentage change in income. • Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. • It is computed as the percentage change in the quantity demanded divided by the percentage change in income. Other Demand ElasticitiesOther Demand Elasticities I n c o m e e l a s t i c i t y o f d e m a n d = P e r c e n t a g e c h a n g e i n q u a n t i t y d e m a n d e d P e r c e n t a g e c h a n g e i n i n c o m e
  • 26. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 26 • Types of Goods – Normal Goods – Inferior Goods • Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. • Types of Goods – Normal Goods – Inferior Goods • Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. Other Demand ElasticitiesOther Demand Elasticities
  • 27. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 27 • Goods consumers regard as necessities tend to be income inelastic – Examples include food, fuel, clothing, utilities, and medical services. • Goods consumers regard as luxuries tend to be income elastic. – Examples include sports cars, furs, and expensive foods. • Goods consumers regard as necessities tend to be income inelastic – Examples include food, fuel, clothing, utilities, and medical services. • Goods consumers regard as luxuries tend to be income elastic. – Examples include sports cars, furs, and expensive foods. Other Demand ElasticitiesOther Demand Elasticities
  • 28. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 28 • Cross-Price elasticity of demand measures how much the quantity demanded of a good responds to a change in the price of another good. • It is computed as the percentage change in the quantity demanded divided by the percentage change in the price of the second good. • Cross-Price elasticity of demand measures how much the quantity demanded of a good responds to a change in the price of another good. • It is computed as the percentage change in the quantity demanded divided by the percentage change in the price of the second good. Other Demand ElasticitiesOther Demand Elasticities Income elasticity of demand = Percentage change in quantity demanded Percentage change inthe price of good 2.
  • 29. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 29 • Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. • Price elasticity of supply is the percentage change in quantity supplied given a percent change in the price. • Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. • Price elasticity of supply is the percentage change in quantity supplied given a percent change in the price. PRICE ELASTICITY OF SUPPLYPRICE ELASTICITY OF SUPPLY
  • 30. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 30 • Ability of sellers to change the amount of the good they produce. – Beach-front land is inelastic. – Books, cars, or manufactured goods are elastic. • Time period. – Supply is more elastic in the long run. • Ability of sellers to change the amount of the good they produce. – Beach-front land is inelastic. – Books, cars, or manufactured goods are elastic. • Time period. – Supply is more elastic in the long run. The Price Elasticity of Supply and ItsThe Price Elasticity of Supply and Its DeterminantsDeterminants
  • 31. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 31 • The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. • The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. Computing the Price Elasticity of SupplyComputing the Price Elasticity of Supply P r i c e e l a s t i c i t y o f s u p p l y = P e r c e n t a g e c h a n g e i n q u a n t i t y s u p p l i e d P e r c e n t a g e c h a n g e i n p r i c e
  • 32. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 32 • … using the midpoint method, we calculate the percent change in the price as (2.10 - 1.90) / 2.00 x 100 = 10% • Similarly, we calculate the percent change in the quantity supplied as (11 000 - 9000) / 10 000 x 100 = 20% • … using the midpoint method, we calculate the percent change in the price as (2.10 - 1.90) / 2.00 x 100 = 10% • Similarly, we calculate the percent change in the quantity supplied as (11 000 - 9000) / 10 000 x 100 = 20% 20% Price elasticity of supply = • Suppose an increase in the price of milk from $1.90 to $2.10 a litre raises the amount that dairy farmers produce from 9000 to 11 000 L per month… • Suppose an increase in the price of milk from $1.90 to $2.10 a litre raises the amount that dairy farmers produce from 9000 to 11 000 L per month… = 2.0 Computing the Price Elasticity of SupplyComputing the Price Elasticity of Supply 10%
  • 33. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 33 E = 0 0 Quantity Price Supply 1. An increase in price… $5.00 2. …leaves the quantity supplied unchanged. 100 $4.00 Figure 5-6 a): Perfectly Inelastic SupplyFigure 5-6 a): Perfectly Inelastic Supply
  • 34. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 34 E < 0 0 Quantity Price Supply 100 1. A 22% increase in price… $5.00 2. …leads to a 10% increase in quantity supplied. $4.00 110 Figure 5-6 b): Inelastic SupplyFigure 5-6 b): Inelastic Supply
  • 35. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 35 E = 1 0 Quantity Price Supply 100 1. A 22% increase in price… $5.00 2. …leads to a 22% increase in quantity supplied. $4.00 125 Figure 5-6 c): Unit Elastic SupplyFigure 5-6 c): Unit Elastic Supply
  • 36. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 36 E > 1 0 Quantity Price Supply 100 1. A 22% increase in price… $5.00 2. …leads to a 67% increase in quantity supplied. $4.00 200 Figure 5-6 d): Elastic SupplyFigure 5-6 d): Elastic Supply
  • 37. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 37 E = ∞ 0 Quantity Price 2. At exactly $4, producers will supply any quantity. $4.00 Supply 1. At any price above $4, quantity supplied is infinite. 3. At any price below $4, quantity supplied is zero. Figure 5-6 e): Perfectly Elastic SupplyFigure 5-6 e): Perfectly Elastic Supply
  • 38. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 38 0 Quantity Price $3 100 $4 200 $12 500 $15 525 Elasticity is greater than 1 Elasticity is less than 1 Figure 5-7:Figure 5-7: How the price elasticity of supplyHow the price elasticity of supply can varycan vary
  • 39. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 39 • Good news bad news for farmers • OPEC • Drugs and crime • Good news bad news for farmers • OPEC • Drugs and crime THREE APPLICATIONS OF SUPPLY,THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITYDEMAND, AND ELASTICITY
  • 40. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 40 Increase in Supply Demand S1 $3 Quantity of Wheat Price of Wheat S2 2. … leads to a fall in price… 3. …and a proportionately smaller increase in quantity sold. As a result revenue falls from $300 to $220. 1. When demand is inelastic, an increase in supply… 110100 $2 Figure 5-8:Figure 5-8: An Increase in Supply in theAn Increase in Supply in the Market for WheatMarket for Wheat
  • 41. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 41 Demand S1 Quantity of Oil Price of Oil S2 1. In the short run, when supply and demand are inelastic, a shift in supply… 2. … leads to a large increase in price… P1 P2 Demand S1 Quantity of Oil S2 1. In the long run, when supply and demand are elastic, a shift in supply… 2. … leads to a small increase in price… P1 P2 Price of Oil (a) Oil Market in the Short Run (b) Oil Market in the Long Run Figure 5-9:Figure 5-9: A Reduction in Supply in theA Reduction in Supply in the World Market for OilWorld Market for Oil
  • 42. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 42 Demand S1 Quantity of Drugs Price of Drugs S2 1. Drug interdiction reduces the supply of drugs… 2. … which raises the price… P1 P2 D1 Supply 1. Drug education reduces the demand for drugs… 2. … which reduces the price… (a) Drug Interdiction (b) Drug Education Q1Q2 3. … and reduces the quantity sold. Q2 3. … and reduces the quantity sold. Quantity of Drugs Price of Drugs D2 P1 Q1 P2 Figure 5-10:Figure 5-10: Policies to Reduce the of IllegalPolicies to Reduce the of Illegal DrugsDrugs
  • 43. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 43 • Price elasticity of demand measures how much the quantity demanded responds to changes in the price. • Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. • If a demand curve is elastic, total revenue falls when the price rises. • If it is inelastic, total revenue rises as the price rises. • Price elasticity of demand measures how much the quantity demanded responds to changes in the price. • Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. • If a demand curve is elastic, total revenue falls when the price rises. • If it is inelastic, total revenue rises as the price rises. SummarySummary
  • 44. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 44 • The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. • The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good. • The price elasticity of supply measures how much the quantity supplied responds to changes in the price. • The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. • The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good. • The price elasticity of supply measures how much the quantity supplied responds to changes in the price. SummarySummary
  • 45. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 45 • In most markets, supply is more elastic in the long run than in the short run. • The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. • The tools of supply and demand can be applied in many different types of markets. • In most markets, supply is more elastic in the long run than in the short run. • The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. • The tools of supply and demand can be applied in many different types of markets. SummarySummary
  • 46. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 5: Page 46 The EndThe End