Elasticity of Demand and Supply © 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.

Price Elasticity of Demand 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.

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

Price Elasticity of Demand Price elasticity of demand, ED Law of demand Price and quantity demanded are inversely related ED negative Absolute value of ED 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.

Exhibit 1 Demand Curve for Tacos 0.90 Price per taco $1.10 D a b 105 95 Thousands per day 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.

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

Categories of ED If %∆q > %∆p A change in price has a relatively large effect on quantity demanded ED greater than 1 Elastic 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.

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 © 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.

Price Elasticity and Linear D 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 © 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.

(a) Demand and price elasticity Exhibit 2 Demand, Price Elasticity, and Total Revenue (a) Demand and price elasticity 90 60 10 70 Price per unit $100 80 50 40 30 20 D b a 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. Elastic, ED >1 Unit elastic, ED =1 c Inelastic, ED <1 d e 800 500 200 100 Quantity per period 1,000 900 (b) Total revenue Total revenue $25,000 Where the demand curve is inelastic, further decreases in price reduce total revenue. Total revenue 500 Quantity per period 1,000 © 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.

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

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

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 ED = 1 Constant-elasticity demand curve Price elasticity is the same everywhere along the curve Elasticity value is unchanged © 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.

Exhibit 3 Constant-Elasticity Demand Curves (a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic Price per unit p Price per unit D’ Price per unit $10 6 ED’’ = 1 D’’ ED’ = 0 ED = ∞ a D b Quantity per period Quantity per period Q Quantity per period 60 100 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.

Exhibit 4 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.

Determinants of Price Elasticity of D ED 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) © 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.

Exhibit 5 Demand Becomes More Elastic Over Time Price per unit $1.25 1.00 Dw Dm Dy e Quantity per day 95 100 75 50 Dw 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 Dm. One year after the price increase, quantity demanded has fallen to 50 along Dy. At any given price, Dy is more elastic than Dm, which is more elastic than Dw. © 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.

Elasticity Estimates Short run Long 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 © 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.

Exhibit 6 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.

Deterring Young Smokers Health hazard Kills 440,000 Americans a year 10 times more than traffic accidents Lung cancer Heart disease Emphysema Stroke © 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.

Deterring Young Smokers Cost to society More than $7 per pack sold in Higher health cost Lost worker productivity Total: more than $150 billion a year More than $3,400 per smoker per 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.

Deterring Young Smokers About 80% of adult smokers Began before the age of 18 Each day 3,500 U.S. teens under 18 try smoking for the first time One third become regular smokers © 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.

Deterring Young Smokers Discouraging smoking Prohibit the sale of cigarettes to minors Higher cigarette tax ED is higher for teens Big share of budget Less peer pressure Not an addiction yet Reduces teen smoking Change consumer tastes Health warnings © 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.

Price Elasticity of Supply Responsiveness Price elasticity of supply Responsiveness of quantity supplied to a price change Percentage change in quantity supplied 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.

Price Elasticity of Supply Law of supply ES 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.

Exhibit 7 Price Elasticity of Supply Price per unit p p’ S Quantity per period q q’ 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. © 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.

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

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

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

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

Exhibit 8 Constant-Elasticity Supply Curves (a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic Price per unit p Price per unit S’ Price per unit $10 5 S’’ ES’’ = 1 ES’ = 0 ES = ∞ S Quantity per period Quantity per period Q Quantity per period 10 20 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. © 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.

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

Exhibit 9 Supply Becomes More Elastic Over Time Sm Sw Price per unit 1.00 $1.25 Sy Quantity per day 110 200 100 140 The supply curve one week after a price increase, Sw, is less elastic, at a given price, than the supply curve one month later, Sm, which is less elastic than the supply curve one year later, Sy. 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.

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 © 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.

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 © 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.

Exhibit 10 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.

Market for Food & the “Farm Problem” 1950: 10 millions family farms Today: less than 3 millions Demand Price inelastic Total revenue falls when P falls Income inelastic: D increases Supply Technological improvements: S increases © 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.

Exhibit 11 The Demand for Grain Price per bushel $5 4 3 2 1 D 5 10 11 Billions of bushels per year The demand for grain tends to be price inelastic. As the market price falls, so does 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.

Exhibit 12 The Effect of Increases in Demand and Supply on Farm Revenue Price per bushel $8 4 S Over time, technological advances in farming have sharply increased the supply of grain. In addition, increases in consumer income over time have increased the demand for farm products. But because increases in the supply of grain exceed increases in demand, the combined effect is a drop in the market price and a fall in total farm revenue. D D’ S’ 5 10 14 Billions of bushels per 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.

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 © 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.

Price Elasticity and Tax Incidence Decrease in supply by the amount of tax Tax incidence Consumers : high price Producers: 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.

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 © 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.

Exhibit 13 Effects of Price Elasticity of Demand on Tax Incidence (a) Less elastic demand (b) More elastic demand Price per ounce $1.15 1.00 0.95 St D Price per ounce $1.05 1.00 0.85 St $0.20 Tax $0.20 Tax S D’ S Millions of ounces per day 10 9 10 7 Millions of ounces per day The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. 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.

Exhibit 14 Effects of Price Elasticity of Supply on Tax Incidence (a) More elastic supply (b) Less elastic supply Price per ounce $1.15 1.00 0.95 St’ $0.20 Tax Price per ounce $1.05 1.00 0.85 St” S” D’’ D’’ $0.20 Tax S’ Millions of ounces per day 10 8 10 9 The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. 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.