1. Elasticity of Supply & Demand

2. Consumers will buy more when prices go down and less when prices go up
PRICE ELASTICITY OF DEMAND
THE LAW OF DEMAND SAYS...
Consumers will buy more when prices go down and less when prices go up
HOW MUCH MORE OR LESS?
Price Elasticity Provides an Answer

3. .10 .20 PRICE ELASTICITY OF DEMAND
Measures Responsiveness to Price Changes P
The percentage change in quantity
The percentage change in price
.10
.20 P2 P1
Elasticity is .5 D Q2 Q1 Q

4.   % Q % P Commonly Expressed as… PRICE ELASTICITY OF DEMAND P D Q
The percentage change in quantity
The percentage change in price %  Q d  % P P2 P1
Elasticity is .5 D Q2 Q1 Q

5.  Ed = Ed = Elimination of the Minus Sign PRICE ELASTICITY OF DEMAND
The Price-Elasticity Coefficient and Formula
Ed =
Percentage change in quantity
demanded of product X
Percentage change in price
of product X
Or equivalently…
Ed =
Change in quantity demanded of X
Original quantity demanded of X
Change in price of X 
Original price of X
Elimination of the Minus Sign

6.  Price Elasticity is... Inelastic 0 < X < 1
PRICE ELASTICITY OF DEMAND
Price Elasticity is...
Inelastic 0 < X < 1
Typical of necessities one must have
Elastic from 1 < X < 
Typical of luxuries one wants
Unit elastic when exactly = 1
Quantity change offsets Price change

7. .04 .02 .01 .02 .02 = 2 = .5 = 1 Interpretations of Ed Elastic Demand
PRICE ELASTICITY OF DEMAND
Interpretations of Ed
Elastic Demand
Ed =
.04
.02
= 2
Inelastic Demand
Ed =
.01
.02
= .5
Unit Elasticity
Ed =
.02
= 1

8. Extreme Cases PRICE ELASTICITY OF DEMAND Perfectly Inelastic Demand
Ed = 0 Q
Perfectly Elastic Demand P D2
Ed =  Q

9. DETERMINANTS OF PRICE ELASTICITY OF DEMAND
Substitutability
Proportion of Income
Luxuries versus Necessities
Time

10.   Ed Ed = = More Accurate Calculation – The Midpoint Formula
PRICE ELASTICITY OF DEMAND
More Accurate Calculation –
The Midpoint Formula Ed =
Change in
quantity
Sum of
Quantities/2
price
prices/2  Ed = ΔQ
AVG Q ΔP
AVG P 

11. Lemonade Stand
You sell 24 glasses for $.50 each. P x Q = Total Revenue (TR) $.50 x 24 = $12 = Total Revenue -$4 = Total Cost $8 = Profit

12. Total Revenue
Total Revenue (TR): The total dollars received by a firm for selling a product.
AKA Consumer Expenditures

13. CIRCULAR FLOW MODEL $ COSTS $ INCOMES RESOURCES INPUTS GOODS &
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION 13

14. P D Q PRICE ELASTICITY & TOTAL REVENUE When prices are low,
So is total revenue P TR D Q
Quantity Demanded

15. P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises
with price to a
point... P TR D Q
Quantity Demanded

16. P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises
with price to a
point...
then declines P TR D Q
Quantity Demanded

17. P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises
with price to a
point...
then declines P TR D Q
Quantity Demanded

18. P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises
with price to a
point...
then declines P TR D Q
Quantity Demanded

19. P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises
with price to a
point...
then declines P TR
Inelastic
Demand D
Inelastic
Demand Q
Quantity Demanded

20. P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises
with price to a
point...
then declines P TR
Elastic
Demand
Inelastic
Demand D
Elastic
Demand
Inelastic
Demand Q
Quantity Demanded

21. P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises
with price to a
point...
then declines P TR
Elastic
Demand
Unit
Elastic
Inelastic
Demand D
Elastic
Demand
Inelastic
Demand Q
Quantity Demanded

22. TOTAL REVENUE TEST Another way to determine elasticity P x Q = TR
P and Q move opposite each other
So how do we know what happens to TR?
If P and TR move together demand is inelastic
If Q and TR move together demand is elastic
If TR doesn’t move demand is unit elastic

23. Other Elasticities

24. PRICE ELASTICITY OF SUPPLY
Es=
%ΔQS
%ΔP

25. PRICE ELASTICITY OF SUPPLY
Immediate Market period P Sm
An increase in
demand without
enough time to
change supply
causes… Po D1 Q Qo

26. PRICE ELASTICITY OF SUPPLY
Immediate Market period P Sm
An increase in
demand without
enough time to
change supply
causes… an
increase in price Pm Po D2 D1 Q Qo

27. PRICE ELASTICITY OF SUPPLY
Short Run P Ss
An increase in
demand with
more elastic
supply causes... Po D1 Qo Q

28. PRICE ELASTICITY OF SUPPLY
Short Run P Ss
An increase in
demand with
more elastic
supply causes... a smaller
increase in price Ps Po D2 D1 Qo Qs Q

29. PRICE ELASTICITY OF SUPPLY
Long Run
An increase in
demand in the
long run allows
greater change
causing... P SL Po D1 Qo Q

30. PRICE ELASTICITY OF SUPPLY
Long Run
An increase in
demand in the
long run allows
greater change
causing... P SL PL
Even more elastic
response - less
price increase Po D2 D1 Qo QL Q

31. CROSS PRICE ELASTICITY OF DEMAND
Exy =
%ΔQDX
%ΔPY
Positive Sign
Goods are Substitutes
Negative Sign
Goods are Complementary
Zero or Near-Zero Value
Goods are Unrelated

32. Ei = Goods are Normal or Superior Goods are Inferior %ΔQD %Δ Income
INCOME ELASTICITY OF DEMAND
Ei =
%ΔQD
%Δ Income
Positive Sign
Goods are Normal or Superior
Negative Sign
Goods are Inferior

33. Price Controls

34. PRICE CONTROLS
Enacted when policymakers believe the market price is unfair to buyers or sellers. 3 3

35. CONTROLS ON PRICES Price Ceiling Price Floor
A legal maximum on the price at which a good can be sold.
Price Floor
A legal minimum on the price at which a good can be sold. 4 4

36. How Price Ceilings Affect Market Outcomes
Two possibilities:
Not binding (not effective)
Binding (effective) 5 5

37. A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding
Price of
Ice-Cream
Cone
Supply
Demand $4
Price
ceiling 3
100
Equilibrium
price
Quantity of
Ice-Cream
Equilibrium
quantity
Cones

38. A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Supply
Demand
Equilibrium
price $3 2
Price
ceiling 75
125
Shortage
Quantity of
Ice-Cream
Quantity
supplied
Quantity
demanded
Cones

39. How Price Ceilings Affect Market Outcomes
A binding price ceiling creates
A shortage because QD > QS.
Non-price rationing
Long lines
Discrimination 11 14

40. CASE STUDY: Lines at the Gas Pump
In the early 1970s the government placed a price ceiling on gas.
In 1973, OPEC raised the price of crude oil (input for gas).

41. The Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Price of
Gasoline
Demand
Supply, S1
1. Initially,
the price
ceiling
is not
binding . . .
Price ceiling P1 Q1
Quantity of
Gasoline

42. The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Price of S2
Gasoline
but when
supply falls . . .
Demand S1 P2 QS QD
Price ceiling
resulting
in a
shortage.
the price
ceiling becomes
binding . . . P1 Q1
Quantity of
Gasoline

43. Rent Control

44. How Price Floors Affect Market Outcomes
Two possibilities:
Not binding
Binding 12 15

45. A Market with a Price Floor
(a) A Price Floor That Is Not Binding
Price of
Ice-Cream
Supply
Cone
Demand
Equilibrium
price $3
100 2
Price
floor
Quantity of
Ice-Cream
Equilibrium
quantity
Cones

46. A Market with a Price Floor
(b) A Price Floor That Is Binding
Price of
Ice-Cream
Supply
Cone
Demand
Surplus $4
Price
floor 80
120 3
Equilibrium
price
Quantity of
Ice-Cream
Quantity
demanded
Quantity
supplied
Cones

47. How Price Floors Affect Market Outcomes
A binding price floor causes . . .
A surplus because QS > QD.
Non-price rationing 15 25

48. CASE STUDY: MINIMUM WAGE
Minimum wage laws dictate the lowest price possible for labor that any employer may pay.

49. How the Minimum Wage Affects the Labor Market
Supply
Labor
demand
Equilibrium
employment
wage
Quantity of
Labor

50. How the Minimum Wage Affects the Labor Market
Supply
Labor
demand
Labor surplus
(unemployment)
Minimum
wage
Quantity
demanded
Quantity
supplied
Quantity of
Labor

51. How Price Controls Affect Total Surplus
Demand
Supply PF Q2 PC
Price
Floor
Ceiling A F B D C E P1 Q1
Price
Quantity

52. Price Controls on Drugs

53. Taxation & Deadweight Loss

54. Application: The Costs of Taxation
Review
Buyers and sellers receive benefits from taking part in the market.
The equilibrium in a market maximizes the total welfare of buyers and sellers.

55. THE DEADWEIGHT LOSS OF TAXATION
When a tax is levied on a good
Price paid by buyers rises
Price received by sellers falls

56. The Effects of a Tax Price Demand Supply Price buyers pay
Price sellers
receive
Quantity
with tax
Size of tax
Price
without tax
Quantity
Quantity

57. How a Tax Affects Market Participants
A tax places a wedge between the price buyers pay and sellers receive.
The quantity sold falls below the pre-tax equilibrium.

58. How a Tax Affects Market Participants
Tax Revenue
T = the size of the tax
Q = the quantity of the good sold
T  Q = Tax Revenue

59. Tax Revenue Price Demand Supply Quantity with tax Price buyers pay
Price sellers
receive
Tax
revenue
(T × Q)
Size of tax (T)
Quantity
without tax
Quantity
sold (Q)
Quantity

60. How a Tax Affects Market Participants
Changes in Welfare
Deadweight loss is the fall in total surplus.

61. How a Tax Affects Welfare
Price
Demand
Supply = PB Q2 PS
Price
buyers
pay
sellers
receive A F B D C E = P1 Q1
Price
without tax
Quantity

62. DETERMINANTS OF DEADWEIGHT LOSS
What determines whether the deadweight loss from a tax is large or small?
Elasticities of Demand & Supply
More elastic curves bring more loss

63. Tax Incidence
Who pays for the tax?
The more inelastic curve pays more

64. Tax Distortions and Elasticities
Price
Demand
Supply
Size of tax
Quantity

65. Tax Distortions and Elasticities
Price
Demand
Size of
tax
Supply
Quantity

66. Tax Distortions and Elasticities
Price
Supply
Demand
Size of tax
Quantity

67. Tax Distortions and Elasticities
Price
Supply
Demand
Size of
tax
Quantity

68. How a Tax Affects Market Participants
The combined welfare losses to buyers and sellers exceed the revenue raised by the government.

69. The Effects of a Tariff
A tariff is a tax on goods produced abroad and sold domestically.
Tariffs raise the price of imported goods by the amount of the tariff.

70. The Effects of a Tariff Price of Steel Domestic demand Domestic supply
Equilibrium
without trade
Price
with tariff Q S Q D
Tariff
Price
without tariff
World
price Q S Q D
Imports
with tariff
Quantity
Imports
without tariff
of Steel

71. The Effects of a Tariff Consumer surplus before tariff
Price
of Steel
Domestic
demand
Consumer surplus
before tariff
Domestic
supply
Producer surplus
before tariff
Equilibrium
without trade
Price
without tariff
World
price Q S Q D
Quantity
Imports
without tariff
of Steel

72. The Effects of a Tariff Tariff Revenue Price of Steel Domestic demand
supply
Tariff Revenue
Price
with tariff
Imports
with tariff Q S D E
Tariff
Price
without tariff
World Q S Q D
price
Quantity
Imports
without tariff
of Steel

73. The Effects of a Tariff Deadweight Loss Price of Steel A Domestic
demand
Domestic
supply
Deadweight Loss B
Price
with tariff C G D F Q S E Q D
Tariff
Price
without tariff
World Q S Q D
Imports
with tariff
price
Quantity
Imports
without tariff
of Steel

74. Consumer Behavior & Utility Maximization

75. LAW OF DIMINISHING MARGINAL UTILITY
Subjective
Difficult to Quantify
Total Utility
Marginal Utility
graphically examined...

76. 1 10 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility,
Utils
Marginal
Utility,
Utils 30 20 10 1 10
Total Utility (utils)
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils)
Units consumed per meal

77. 1 10 10 TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total
Utils
Marginal
Utility,
Utils 30 20 10 1 10
Total Utility (utils) 10
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils)
Units consumed per meal

78. 1 2 10 18 10 8 TOTAL AND MARGINAL UTILITY Tacos consumed per meal
Utils
Marginal
Utility,
Utils 30 20 10 1 2 10 18
Total Utility (utils) 10 8
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils)
Units consumed per meal

79. 1 2 3 10 18 24 10 8 6 TOTAL AND MARGINAL UTILITY Tacos consumed
per meal
Total
Utility,
Utils
Marginal
Utility,
Utils 30 20 10 1 2 3 10 18 24
Total Utility (utils) 10 8 6
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils)
Units consumed per meal

80. 1 2 3 4 10 18 24 28 10 8 6 4 TOTAL AND MARGINAL UTILITY Tacos consumed
per meal
Total
Utility,
Utils
Marginal
Utility,
Utils 30 20 10 1 2 3 4 10 18 24 28
Total Utility (utils) 10 8 6 4
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils)
Units consumed per meal

81. 1 2 3 4 5 10 18 24 28 30 10 8 6 4 2 TOTAL AND MARGINAL UTILITY Tacos
consumed
per meal
Total
Utility,
Utils
Marginal
Utility,
Utils 30 20 10 1 2 3 4 5 10 18 24 28 30
Total Utility (utils) 10 8 6 4 2
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils)
Units consumed per meal

82. 1 2 3 4 5 6 10 18 24 28 30 10 8 6 4 2 TOTAL AND MARGINAL UTILITY Tacos
consumed
per meal
Total
Utility,
Utils
Marginal
Utility,
Utils 30 20 10 1 2 3 4 5 6 10 18 24 28 30
Total Utility (utils) 10 8 6 4 2
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils)
Units consumed per meal

83. 1 2 3 4 5 6 7 10 18 24 28 30 10 8 6 4 2 -2 TOTAL AND MARGINAL UTILITYTU
Tacos
consumed
per meal
Total
Utility,
Utils
Marginal
Utility,
Utils 30 20 10 1 2 3 4 5 6 7 10 18 24 28 30
Total Utility (utils) 10 8 6 4 2 -2
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils) MU
Units consumed per meal

84. Observe Diminishing Marginal Utility
TOTAL AND MARGINAL UTILITY TU
Tacos
consumed
per meal
Total
Utility,
Utils
Marginal
Utility,
Utils 30 20 10
Observe
Diminishing
Marginal
Utility 1 2 3 4 5 6 7 10 18 24 28 30
Total Utility (utils) 10 8 6 4 2 -2
Units consumed per meal 10 8 6 4 2 -2
Marginal Utility (utils) MU
Units consumed per meal

85. Utility Maximizing Rule
THEORY OF CONSUMER BEHAVIOR
Utility Maximizing Rule
The consumer’s income should be allocated so that the last dollar spent on each product yields the same amount of marginal utility.
Illustrated...

86. How should the $10 income be allocated?
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
How should the $10
income be allocated?

87. Examine the two marginal utilities
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Examine the two
marginal utilities

88. Examine the two marginal utilities …per dollar
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Examine the two
marginal utilities
…per dollar

89. Decision: Buy 1 Product B for $2
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Decision: Buy 1
Product B for $2

90. What next? First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
What next?

91. What next? Buy one of each
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
What next?
Buy one of each

92. and then... ($5 left) First 10 10 24 12 Second 8 8 20 10
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
and then...
($5 left)

93. third unit of product B First 10 10 24 12 Second 8 8 20 10
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
third unit of
product B

94. $3 left... First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
$3 left...

95. $3 left... Buy both! First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
$3 left...
Buy both!

96. the last dollar spent on
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
Income is gone...
the last dollar spent on
each good gave the same
utility (8) per dollar

97. Algebraic Restatement of the Utility Maximization Rule
Consumption Bundles
Algebraic Restatement of the
Utility Maximization Rule
MU of A
Price of A
MU of B
Price of B =
8 Utils $1
16 Utils $2 =