ECON 101 Introduction to Economics1

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1 ECON 101 Introduction to Economics1 Session 7 The Concept of Elasticity II Lecturer: Mrs. Hellen A. Seshie-Nasser, Department of Economics Contact Information: haseshie@ug.edu.gh College of Education School of Continuing and Distance Education 2014/ /2017

2 Session Overview Some producers respond more to changes in price than others. This session provides explanations to the extent of change in quantity offered for sale when there are changes in the prices of goods and services. Slide 2

3 Session Objectives At the end of the session, the student should be able to: Understand Price Elasticity of Supply and its measurement Know how to measure own price elasticity using Point and Arc methods and the interpretation of the results. Understand elasticity along a straight line demand curve. Appreciate the relationship between Elasticity and Total Revenue. Enumerate and explain the determinants of elasticity. Understand Cross-price Elasticity of Demand. Understand Income Elasticity of Demand. Slide 3

4 Session Outline The key topics to be covered in the session are as follows: Elasticity of Supply Price elasticity of supply Computation of price elasticity of supply Determinants of elasticity of supply Application of elasticity of supply Hellen A. Seshie-Nasser, Dept of Economics Slide 4

5 Reading List Lipsey R. G. and K. A. Chrystal. (2007). Economics. 11 th Edition. Oxford University Press. Bade R. and M. Parkin. (2009). Foundations of Microeconomics. 4 th Edition. Boston: Pearson Education Inc., Begg. D. Fischer S. and R. Dornbusch. (2003). Economics. 7 th Edition. McGraw-Hill Slide 5

6 The 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 percent change in price. Slide 6

7 Figure 1: The Price Elasticity of Supply (a) Perfectly Inelastic Supply: Elasticity Equals 0 Price Supply 1. An increase in price... $ Quantity leaves the quantity supplied unchanged. Slide 7

8 Figure 2: The Price Elasticity of Supply Price (b) Inelastic Supply: Elasticity Is Less Than 1 $5 Supply 4 1. A 22% increase in price Quantity leads to a 10% increase in quantity supplied. Slide 8

9 Figure 3: The Price Elasticity of Supply Price (c) Unit Elastic Supply: Elasticity Equals 1 $5 Supply 4 1. A 22% increase in price Quantity leads to a 22% increase in quantity supplied. Slide 9

10 Figure 4: The Price Elasticity of Supply (d) Elastic Supply: Elasticity Is Greater Than 1 Price Supply $5 1. A 22% increase in price Quantity leads to a 67% increase in quantity supplied. Slide 10

11 Figure 5: The Price Elasticity of Supply Price (e) Perfectly Elastic Supply: Elasticity Equals Infinity 1. At any price above $4, quantity supplied is infinite. $4 Supply 2. At exactly $4, producers will supply any quantity At a price below $4, quantity supplied is zero. Quantity Slide 11

12 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. Price elasticity of supply = Percentage change in quantity supplied Percentage change in price Slide 12

13 Determinants of Elasticity of Supply Supply elasticity increases with ability to hold stocks. It increases with ability of sellers to change the amount of the good they produce. Beach-front land is inelastic. Books, cars, or manufactured goods are elastic. Excess capacity increases the elasticity of supply Time period. Supply is more elastic in the long run. Slide 13

14 Determinants of Elasticity of Supply Time period: The time it takes to increase production. There are three periods of determining a change a) Market period: Supply is perfectly inelastic b) Short-run: Supply is relatively inelastic c) Long run: Supply is relatively elastic Price short run Long run 0 Market period Qty Slide 14

15 Applications Slide 15

16 Effects of Taxation on the Equilibrium An imposition of Per unit (specific) Tax, t. This leads to a decrease in supply resulting in a rise in equilibrium price and a decline in equilibrium quantity. However, the extent of change in equilibrium price and equilibrium quantity depends on elasticity of demand. Slide 16

17 Effects of Taxation on Equilibrium P 1 P 2 P SSt SSo e Q Q 1 Q DD in DD el 2 e Equilibrium price will rise higher in the case of inelastic demand (DD in ) and equilibrium quantity will decrease more in the case of elastic demand (DD el ). E.g. Tax on cigarette, jewelry, cars etc Slide 17

18 Incidence of Taxation P t P e P p If a tax is imposed, who pays it? The producer or the consumer? E.g. Increase in import tariffs. c f d SSt t Q 2 Q e SSo DD el The per unit tax is t, the vertical distance between the two supply curves, which is equivalent to cd. The portion of the tax born by the consumer is given by cf, while the proportion born by the producer is fd. Slide 18

19 Incidence of Taxation If demand is elastic, producers bear greater proportion of the tax, while consumers bear greater proportion of the tax if demand is inelastic. SSt SSo P 1 P e P p f d c Q 1 Q e DD in Conclusion: the higher the elasticity of demand the greater the proportion of tax born by producers, and the lesser the portion of tax born by consumers Slide 19

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