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Chapter 5 Price Elasticity of Demand and Supply Key Concepts Key Concepts Summary Practice Quiz Internet Exercises Internet Exercises ©2002 South-Western.

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Presentation on theme: "Chapter 5 Price Elasticity of Demand and Supply Key Concepts Key Concepts Summary Practice Quiz Internet Exercises Internet Exercises ©2002 South-Western."— Presentation transcript:

1 Chapter 5 Price Elasticity of Demand and Supply Key Concepts Key Concepts Summary Practice Quiz Internet Exercises Internet Exercises ©2002 South-Western College Publishing

2 2 How is the percent increase or decrease of two numbers calculated? Percent change is the difference between the two numbers divided by the original number

3 3 Suppose the price of a rock concert increases by 10%, what effect will this have on sales? That all depends on the price elasticity of demand for this rock concert

4 4 What is elasticity? A term economists use to describe responsiveness, or sensitivity, to a change in price

5 5 What is price elasticity of demand? The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price

6 6 %  in Q demanded %  in price E d = Price Elasticity of Demand

7 7 Supposing a university’s enrollment drops by 20% because tuition rises by 10%, what is the price elasticity of demand?

8 8 E d = -20% +10% = -.20 +.10 = 2

9 9 Why is elasticity 2 in the previous example and not -2? Economists drop the negative sign because we know from the law of demand that quantity demanded and price are inversely related

10 10 If there is an increase from 3 units to 5, what is the percentage increase? 2/3 = 66%

11 11 If there is a decrease from 5 units to 3, what is the percentage decrease? 2/5 = 40%

12 12 Problem - When we move along a demand curve between two points, we get different answers to elasticity depending on whether we are moving up or down the demand curve

13 13 A B 2 3 P Q D

14 14 Economists can solve this problem of different base points by using the midpoints as the base points of changes in prices and quantity demanded

15 15  in quantity demanded sum of quantities/2 divided by  in price sum of prices/2 Price elasticity equals the

16 16 What is elastic demand? A condition in which the percentage change in quantity demanded is greater than the percentage change in price

17 17 $40 $30 $20 $10 10203040 A B Elastic Demand E d > 1 P Q

18 18 Why is the demand curve in the previous slide elastic? The percentage change in the quantity demanded is greater than the percentage change in price

19 19 Price decrease Increase in total revenue Elastic Demand

20 20 10 15 =.66% change in Q = % change in P = 10 25 =.40 E d = % change in Q % change in P =.66.40 E d = 1.65

21 21 $40 $30 $20 $10 10203040 A B Inelastic Demand E d < 1

22 22 Why is the demand curve in the previous slide inelastic? The percentage change in the quantity demanded is less than the percentage change in price

23 23 Price decrease Decrease in total revenue Inelastic Demand

24 24 5 13 =.38 % change in Q = % change in P = 10 25 =.40 E d = % change in Q % change in P =.38.40

25 25 What is a unitary elastic demand curve? The percentage change in the quantity demanded is equal to the percentage change in price

26 26 $40 $30 $20 $10 10203040 E F Unitary Elastic Demand E d = 1 D

27 27 Price decrease No change in total revenue Unitary Elastic Demand

28 28 What is a perfectly elastic demand curve? A condition in which a small percentage change in price brings about an infinite percentage change in the quantity demanded

29 29 $40 $30 $20 $10 10203040 Perfectly Elastic Demand E d = 8

30 30 Price change Infinite change in quantity demanded Perfectly Elastic Demand

31 31 What is a perfectly inelastic demand curve? A condition in which the quantity demanded does not change as the price changes

32 32 $40 $30 $20 $10 10203040 Perfectly Inelastic Demand E d = 0

33 33 Price change Zero change in quantity demanded Perfectly Inelastic Demand

34 34 If demand is elastic - total revenue goes down If demand is inelastic - total revenue goes up If a college raises tuition, what happens to revenue?

35 35 If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1

36 36 If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1

37 37 If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1

38 38 $20 $15 $10 $5 5101520 $25 $30 $35 $40 2530354045 Price Elasticity of Demand Ranges Elastic Inelastic Unitary elastic

39 39 $200 $150 $100 $50 5101520 $250 $300 $350 $400 2530354045 Total Revenue Curve Elastic Inelastic Unitary Elastic

40 40 What factors influence demand sensitivity? Availability of substitutes Share of budget on the product Adjustment to a price change over time

41 41 What do substitutes have to do with a price change? The more substitutes a product has, the more sensitive consumers are to a price change, and the more elastic the demand curve

42 42 A B D D Which demand curve is for a vital medicine and which is for candy?

43 43 Why is A the demand curve for medicine? Because medicine is a necessity with few substitutes, and the price can change with little effect on the quantity demanded

44 44 Why is B the demand curve for candy? Because candy has many substitutes, a price change can bring about a big change in the quantity demanded

45 45 What does the share of one’s budget have to do with a price change? The larger the purchase is to one’s budget, the more sensitive consumers are to a price change, and the more elastic the demand curve

46 46 What does time have to do with sensitivity? The longer consumers have to adjust, the more sensitive they are to a price change, and the more elastic the demand curve

47 47 What are other elasticity measures? Income elasticity of demand Cross-elasticity of demand

48 48 What is Income elasticity of demand? The ratio of the percentage change in the quantity demanded of a good to a given percentage change in income

49 49 %  in Q demanded %  in income E d = Income Elasticity of Demand

50 50 What is cross- elasticity of demand? The ratio of the percentage change in quantity demanded of a good to a given percentage change in price of another good

51 51 %  Q demanded of good A %  price of good B E c = Cross-elasticity of Demand

52 52 What is the price elasticity of supply? The ratio of the percentage change in the quantity supplied of a product to the percentage change in its price

53 53 %  in Q supplied %  in price E s = Price Elasticity of Supply

54 54 $40 $30 $20 $10 10203040 Perfectly Elastic Supply = 8

55 55 $40 $30 $20 $10 10203040 Perfectly Inelastic Supply E s = 0

56 56 $40 $30 $20 $10 10203040 Unit Elastic Supply E s = 1 S.5%

57 57 Who pays the tax levied on sellers of goods such as gasoline, cigarettes, and alcoholic beverages? It all depends; the corporation pays all, some, or very little of the tax

58 58 What decides who pays what part of the tax increase? The more elastic the demand, the more the corporation pays; the less elastic the demand, the more the consumer pays

59 59 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.7 5 $2.00 2530354045 s1s1 s2s2 D Buyers Sellers Partially shifted tax to buyers

60 60 Increase in gasoline tax Decrease in supply Consumers and suppliers share burden of tax

61 61 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.75 $2.00 2530354045 s1s1 s2s2 D Buyers Fully shifted tax to buyers

62 62 Increase in gasoline tax Decrease in supply Consumers bear full burden of tax

63 63 Key Concepts

64 64 Key Concepts What is elasticity? What is price elasticity of demand? What is elastic demand? What is a unitary elastic demand curve? What is a perfectly elastic demand curve? What is a perfectly inelastic demand curve?

65 65 Key Concepts cont. What factors influence demand sensitivity? What are other elasticity measures? What is Income elasticity of demand? What is cross-elasticity of demand? What is the price elasticity of supply?

66 66 Summary

67 67 Price elasticity of demand is a measure of the responsiveness of the quantity demanded to a change in price. Specifically, price elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in price.

68 68 %  in Q demanded %  in price E d = Price Elasticity of Demand

69 69 What is the midpoint formula for the price elasticity of demand?

70 70  in quantity demanded sum of quantities/2 divided by  in price sum of prices/2 Price elasticity equals the

71 71 Elastic demand is a change of more than one percent in quantity demanded in response to a one percent change in price. Demand is elastic when the elasticity coefficient is greater than one and total revenue (price time quantity) varies inversely with the direction of the price change.

72 72 $40 $30 $20 $10 10203040 Elastic Demand

73 73 Inelastic demand is a change of less than one percent in quantity demanded in response to a one percent change in price. Demand is inelastic when the elasticity coefficient is less than one and total revenue varies directly with the direction of the price change.

74 74 $40 $30 $20 $10 10203040 Inelastic Demand

75 75 Unitary elastic demand is a one percent change in quantity demanded in response to a one percent change in price. Demand is unitary elastic when the elasticity coefficient equals one and total revenue remains constant as the price changes.

76 76 $40 $30 $20 $10 10203040 Unitary elastic Demand

77 77 Perfectly elastic demand is a decline in quantity demanded to zero for even the slightest rise or fall in price. This is an extreme case in which the demand curve is horizontal and the elasticity coefficient equals infinity.

78 78 $40 $30 $20 $10 10203040 Perfectly Elastic Supply = 8

79 79 Perfectly inelastic demand is no change quantity demanded in response to price changes. This is an extreme case in which the the demand curve is vertical and the elasticity coefficient equals zero.

80 80 $40 $30 $20 $10 10203040 Perfectly Inelastic Supply E s = 0

81 81 Determinants of price elasticity of demand include (a) the availability of substitutes, (b) the percentage of budget spent on the product, and (c) the length of time allowed for adjustment. Each of these factors is directly related to the elasticity coefficient.

82 82 Income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in income. For a normal good or service, income elasticity of demand is positive. For an inferior good or service, income elasticity of demand is negative.

83 83 Cross elasticity of demand is the percentage change in the quantity demanded of one product caused by a change in the price of another product. When the cross-elasticity of demand is negative, the two products are complements.

84 84 Price elasticity of supply is a measure of the responsiveness of the quantity demanded to a change in price. Price elasticity of supply is the ratio of the percentage change in quantity supplied to the percentage change in price.

85 85 Tax incidence is the share of a tax ultimately paid by buyers and sellers. Facing a downward- sloping demand curve and an upward-sloping supply curve, sellers cannot raise the price by the full amount of the tax. If the demand curve is vertical, sellers will raise the price by the full amount of a tax.

86 86 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.75 $2.00 2530354045 s1s1 s2s2 D Buyers Fully shifted tax to buyers

87 87 $1.00 $.75 $.50 $.25 5101520 $1.25 $1.50 $1.75 $2.00 2530354045 s1s1 s2s2 D Buyers Sellers Partially shifted tax to buyers

88 88 Chapter 5 Quiz ©2002 South-Western College Publishing

89 89 1. If an increase in bus fares in Charlotte, North Carolina, reduces total revenue of the public transit system, this is evidence that demand is a. price elastic. b. price inelastic c. unitary elastic A. When price increases and the total revenue decreases, by definition, this represents an elastic demand curve. The revenue lost from selling fewer units is not offset by the revenue gained by charging a higher price.

90 90 2. Which of the following results in an increase in total revenue? a. Price increases when demand is elastic. b. Price decreases when demand is elastic. c. Price increases when demand is unitary elastic. d. Price decreases when demand is inelastic. B. When price decreases and the total revenue increases, the revenue gained by the increase in sales more than offsets the revenue lost from the lower price. By definition, this represents an elastic demand curve.

91 91 3. You are on a committee that is considering ways to raise money for your city’s symphony program. You would recommend increasing the price of symphony tickets only if you thought the demand curve for these tickets was a. inelastic. b. elastic. c. unitary elastic. d. perfectly elastic. A. When the demand curve is inelastic, the revenue gained from the higher price more than offsets the revenue lost from the decline in sales.

92 92 4. The price elasticity of demand for a horizontal demand curve is a. perfectly elastic. b. perfectly inelastic. c. unitary elastic. d. inelastic. A. A perfectly elastic demand curve exists when any increase in price leads to zero sales. The only curve that would illustrate this would be a horizontal line at the beginning price.

93 93 5. Suppose the quantity of steak purchased by the Jones family is 110 pounds per year when the price is $3.90 per pound and 90 pounds per year when the price is $2.10 per pound. The price elasticity of demand coefficient for this family is a. 0.33. b. 0.50. c. 1.00. d. 2.00. A. 20/100 divided by $1.80/$3.00 =.33

94 94 6. If a 5 percent reduction in the price of a good produces a 3 percent increase in the quantity demanded, the price elasticity of demand over this range of the demand curve is a. elastic. b. perfectly elastic. c. unitary elastic. d. inelastic. e. perfectly elastic. D. Since the percentage change in quantity demanded is less than the percentage change in price, this range is defined inelastic

95 95 7. A manufacturer of Beanie Babies hires an economist to study the price elasticity of demand for this product. The economist estimates that the price elasticity of demand coefficient for a range of prices close to the selling price is greater than 1. The relationship between changes in price and quantity demanded for this segment of the demand curve is a. elastic. b. inelastic. c. perfectly elastic. d. perfectly inelastic. A. Elasticity > 1 = elastic demand

96 96 8. A downward-sloping demand curve will have a a. higher price elasticity of demand coefficient along the top of the demand curve. b. lower price elasticity coefficient along the top of the demand curve. c. constant price elasticity of demand coefficient throughout the length of the demand curve. d. positive slope. A. The quantity demanded by consumers is more sensitive to a price change at higher prices than at lower prices.

97 97 9. The price elasticity of demand coefficient for a good will be less a. if there are few or no substitutes available. b. if a small portion of the budget will be spent on it. c. in the short run than in the long run. d. all of the above cases. D. A low elasticity of demand means that there is a low sensitivity to a change in price. When the good has few substitutes, or the purchase represents a small portion of one’s budget, or they do not have much time to adjust to the price change, price elasticity of demand is inelastic.

98 98 10. The income elasticity of demand for shoes is estimated to be 1.50. We can conclude that shoes a. have a relatively steep demand curve. b. have a relatively flat demand curve. c. are a normal good. d. are an inferior good. B. A flat demand curve would illustrate that when the price changes the quantity demanded changes a lot. This would be represented by a relatively flat demand curve.

99 99 11. To determine whether two goods are substitutes or complements, an economist would estimate the a. price elasticity of demand. b. income elasticity of demand. c. cross-elasticity of demand. d. price elasticity of demand. C. Cross-elasticity of demand shows what will happen to the demand for one good if the price of a complementary good, or a good that is a substitute, changes.

100 100 12. If the government wanted to raise tax revenue and shift most of the tax burden to the sellers, it would impose a tax on a good with a a. steep (inelastic) demand curve and a steep (inelastic) supply curve. b. steep (inelastic) demand curve and a flat (elastic) supply curve. c. flat (elastic) demand curve and a steep (inelastic) supply curve. d. flat (elastic) demand curve and a flat (elastic) supply curve. C. A steep supply curve would mean that higher taxes will shift the supply curve to the left, but will have a small effect on the quantity supplied. A flat demand curve would mean that higher prices would not effect the quantity demanded very much.

101 END


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