1. Chapter 5 Part 2 notes

2. 0 2 6 4 10 8 12 14 2 1 4 3 5 6 $7 Demand is elastic; demand is responsive to changes in price. Demand is inelastic; demand is not very responsive to changes in price. When price increases from $4 to $5, TR declines from $24 to $20. When price increases from $2 to $3, TR increases from $20 to $24. Elasticity is > 1 in this range. Elasticity is < 1 in this range. Price Quantity Figure 4 Elasticity of a Linear Demand Curve

3. Income Elasticity of Demand ▫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.

4. Other Demand Elasticities Computing Income Elasticity Remember, all elasticities are measured by dividing one percentage change by another

5. INCOME ELASTICITY ▫Types of Goods  Normal Goods  Inferior Goods ▫Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. ▫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.

6. Rule about income elasticity If you calculate the income elasticity and the answer is positive, it is a normal good. If you calculate the income elasticity and the answer is negative, it is an inferior good.

7. Cross-Price Elasticity ▫A measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good

8. Rule about CPE > 0 = subs < 0 = comps

9. Elasticity of Supply 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 resulting from a percentage change in price.

10. The Price Elasticity of Supply and Its Determinants 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.

11. Computing the Price Elasticity of Supply The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

12. Figure 5 The Price Elasticity of Supply (a) Perfectly Inelastic Supply: Elasticity Equals 0 $5 4 Supply Quantity100 0 1. An increase in price... 2.... leaves the quantity supplied unchanged. Price

13. Figure 5 The Price Elasticity of Supply (b) Inelastic Supply: Elasticity Is Less Than 1 110 $5 100 4 Quantity 0 1. A 22% increase in price... Price 2.... leads to a 10% increase in quantity supplied. Supply

14. Figure 5 The Price Elasticity of Supply (c) Unit Elastic Supply: Elasticity Equals 1 125 $5 100 4 Quantity 0 Price 2.... leads to a 22% increase in quantity supplied. 1. A 22% increase in price... Supply (If SUPPLY is unit elastic and linear, it will begin at the origin.)

15. Figure 5 The Price Elasticity of Supply (d) Elastic Supply: Elasticity Is Greater Than 1 Quantity 0 Price 1. A 22% increase in price... 2.... leads to a 67% increase in quantity supplied. 4 100 $5 200 Supply

16. Figure 5 The Price Elasticity of Supply (e) Perfectly Elastic Supply: Elasticity Equals Infinity Quantity 0 Price $4 Supply 3. At a price below $4, quantity supplied is zero. 2. At exactly $4, producers will supply any quantity. 1. At any price above $4, quantity supplied is infinite.

17. Applications Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?

18. Quantity of Wheat 0 Price of Wheat 3.... and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220. Demand S1S1 S2S2 2.... leads to a large fall in price... 1. When demand is inelastic, an increase in supply... 2 110 $3 100

19. Compute the Price Elasticity of Demand When There Is a Change in Supply Demand is inelastic.

20. Does Drug Interdiction Increase or Decrease Drug-Related Crime? Drug interdiction impacts sellers rather than buyers. ▫Demand is unchanged. ▫Equilibrium price rises although quantity falls. Drug education impacts the buyers rather than sellers. ▫Demand is shifted. ▫Equilibrium price and quantity are lowered.

21. Price of Drugs Quantity of Drugs Price of Drugs Quantity of Drugs Drug Interdiction Drug Education D2D2 D1D1 D1D1 S2S2 S1S1 S1S1 The demand for illegal drugs is inelastic. Interdiction shifts the supply, while education shifts the demand. In each case, the change in price is the same. But in one market the price goes up. And in the other it goes down. The changes in quantities (and TR) are remarkable. It is amazing how useful knowledge of elasticities can be! Policies to Reduce the Use of Illegal Drugs

22. Homework for tonight P. 109/110 Probs/Apps: 4, 8, 10, 11