1. The Price System, Supply and Demand, and Elasticity By: Kathleen Ba ñaga

2. PRICE SYSTEM ▰ The market system, also called the price system, performs two important and closely related functions :  Price Rationing  Resource Allocation

3. Price Rationing Price rationing is the process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied.

4.  The lower total supply is rationed to those who are willing and able to pay the higher price. Price Rationing  A decrease in supply creates a shortage at P 0. Quantity demanded is greater than quantity supplied. Price will begin to rise.

5. Alternative Rationing Mechanism ▰ Price ceiling ▰ Price ceiling is a maximum price that sellers may charge for a good, usually set by government. ▰ Queuing is a non-price rationing system that uses waiting in line as a means of distributing goods and services. ▰ Favored customers are those who receive special treatment from dealers during situations when there is excess demand.

6. Alternative Rationing Mechanism ▰ Ration coupons are tickets or coupons that entitle individuals to purchase a certain amount of a given product per month. ▰ A black market is a market in which illegal trading takes place at market-determined prices.

7. Price Floor A price floor is a minimum price below which exchange is not permitted. The most common example of a price floor is the minimum wage, which is a floor set under the price of labor. The result of setting a price floor will be excess supply, or higher quantity supplied than quantity demanded.

8. Consumer Surplus Consumer surplus is the difference between the maximum amount a person is willing to pay for a good and its current market price.

9. Consumer Surplus ▰ Some consumers are willing to pay as much as Php.50 each for hamburgers. ▰ Since the price is only Php.25, they receive a consumer surplus of Php.25.

10. Consumer Surplus ▰ Others are willing to pay something less than Php.50 but more than Php.25. ▰ Consumer surplus is the area below the demand curve and above the price level.

11. Producer Surplus Producer surplus is the difference between the maximum amount a producer is willing to accept to supply a good and its current market price.

12. Producer Surplus ▰ Some producers are willing to accept as little as Php.10 each for hamburgers. ▰ Since the price is Php.25, they receive a producer surplus of Php.15 per hamburger.

13. Producer Surplus ▰ Others producers are willing to receive something less than Php.50 but higher than Php.10. ▰ Producer surplus is the area above the supply curve and below the price level.

14. Elasticity Elasticity is a general concept that can be used to quantify the response in one variable when another variable changes.

15. Price Elasticity of Demand A popular measure of elasticity is price elasticity of demand measures how responsive consumers are to changes in the price of a product. The value of demand elasticity is always negative, but it is stated in absolute terms.

16. Perfectly Elastic & Perfectly Inelastic Demand Curve  When demand does not respond at all to a change in price, demand is perfectly inelastic.

17. Perfectly Elastic & Perfectly Inelastic Demand Curve  Demand is perfectly elastic when quantity demanded drops to zero at the slightest increase in price.

18. Slope of Elasticity Hypothetical Demand Elasticities for Four Products PRODUCT % CHANGE IN PRICE (%  P) % CHANGE IN QUANTITY DEMANDED (%  Q D ) ELASTICITY (%  Q D d %  P) Insulin+10%0%0.0Perfectly inelastic Basic telephone service+10%-1%-0.1Inelastic Beef+10%-10%Unitarily elastic Bananas+10%-30%-3.0Elastic

19. Calculating Elasticities  Elasticity is a ratio of percentages, and it involves computing percentage changes.

20.  We can say that an increase in quantity demanded from

21. Slope Elasticity P1= 300 P2= 200 Q1= 25 Q1= 50Q P

22. Calculating Elasticities  Using the values on the graph to compute elasticity, using percentage changes yields the following result:

23. Calculating Elasticities  A more accurate way of computing elasticity than percentage changes is the midpoint formula:

24. Interpreting the Value of Elasticity Here is how to interpret two different values of elasticity:  When  = 0.2, a 10% increase in price leads to a 2% decrease in quantity demanded.  When  = 2.0, a 10% increase in price leads to a 20% decrease in quantity demanded.

25. Interpreting the Value of Elasticity  Price elasticity of demand decreases as we move downward along a straight line demand curve.  Demand is elastic in the upper range and inelastic in the lower range of the line.

26. Interpreting the Value of Elasticity  Along the elastic range, elasticity values are greater than one.  Along the inelastic range, elasticity values are less than one.  6.4 .29

27. Elasticity and Total Revenue Type of demandValue of E d Change in quantity versus change in price Effect of an increase in price on total revenue Effect of a decrease in price on total revenue ElasticGreater than 1.0 Larger percentage change in quantity Total revenue decreases Total revenue increases InelasticLess than 1.0Smaller percentage change in quantity Total revenue increases Total revenue decreases Unitary elastic Equal to 1.0Same percentage change in quantity and price Total revenue does not change  When demand is inelastic, price and total revenues are directly related. Price increases generate higher revenues.  When demand is elastic, price and total revenues are indirectly related. Price increases generate lower revenues.

28. Determinants of Demand Elasticity  Availability of substitutes  Importance of the item in the budget  Time frame

29. Other Important Elasticities Income elasticity of demand – measures the responsiveness of demand to changes in income.

30. Other Important Elasticities Cross-price elasticity of demand: A measure of the response of the quantity of one good demanded to a change in the price of another good.

31. Other Important Elasticities Elasticity of supply: A measure of the response of quantity of a good supplied to a change in price of that good. Likely to be positive in output markets.

32. Other Important Elasticities Elasticity of labor supply: A measure of the response of labor supplied to a change in the price of labor.

33. THANK YOU ! End of presentation..