Chapter 3 Elasticity.notebook. February 03, Chapter 3: Competitive Dynamics and Government (Elasticity and Related Concepts)

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1 Chapter 3: Competitive Dynamics and Government (Elasticity and Related Concepts) price elasticity of demand the responsiveness of a product's quantity demanded to a change in its price. Degree of Elasticity 1) Perfectly Inelastic 2) Inelastic 3) Unit Elasticity 4) Elastic 5) Perfectly Elastic Description Example Graph The same amount will be bought regardless of the change in price. in price leads to a smaller percentage demanded. in price leads to the same percentage demanded. in price leads to a greater percentage demanded. in price leads to an infinitely large percentage change in quantity demanded. Page 61 Page 62 1

2 prıce elastıcıty and total revenue: Total Revenue = Price x Quantity Demanded TR = P x Q d Page 63 Elastic Demand (%ΔQ > %ΔP): -> price falls, quantity will rise by a greater proportion, therefore increasing revenue. ->price rises, quantity demanded will fall by a greater proportion, therefore, decreasing revenue P x Q d = TR P x Q d = TR Inelastic Demand (%ΔP > %ΔQ): Page 64 -> price falls, quantity will rise by a smaller proportion, therefore decreasing revenue. P x Q d = TR ->price rises, quantity demanded will fall by a smaller proportion, therefore, increasing revenue P x Q d = TR 2

3 Unit Elastic Demand (%ΔP = %ΔQ): -> price changes leave total revenue unchanged Page 64 factors that affect prıce elastıcıty of demand: 1) Portion of Consumer Incomes the smaller the portion of income spent, the more inelastic the demand. 2)Access to Substitutes the greater the number of substitutes, the more elastic the demand. the more narrowly defined a product is, the more elastic its demand. Ex: running shoes 3) Nature of the Product necessities have inelastic demand compared to luxuries which have elastic demand. 4) Time the greater the time frame, the more elastic the demand. Ex: oil calculatıng prıce elastıcıty of demand: A numerical value for price elasticity of demand (e d) is found by taking the ratio of the changes in quantity demanded and in price, each divided by its average value. Example: If a product falls in price from \$10 to \$8 and the quantity demanded increases from 1200 units to 1800 units, determine the elasticity coefficient. In mathematical terms: 3

4 Complete the following chart: Price(\$) Qd (Millions) Ed Degree of Elasticity ** NOTE: slope elasticity coefficient 0 5 other types of elastıcıty of demand: Income Elasticity Income elasticity (e i) is the responsiveness of a product s quantity demanded to changes in consumer income. Cross Price Elasticity Cross price elasticity (e xy) is the responsiveness of the quantity demanded of one product (x) to a change in price of another (y). In mathematical terms: In mathematical terms: Substitutes e xy is positive Normal Goods e i is positive Inferior Goods e i is negative Complements e xy is negative 4

5 Degree of Elasticity Description Example Graph price elasticity of supply the responsiveness of a product's quantity supplied to a change in its price. 1) Perfectly Inelastic 2) Inelastic 3) Unit Elasticity 4) Elastic 5) Perfectly Elastic The same amount will be supplied regardless of the change in price. in price leads to a smaller percentage supplied. in price leads to the same percentage supplied. in price leads to a greater percentage supplied. in price leads to an infinitely large percentage change in quantity supplied. tıme and prıce elastıcıty of supply: Page 70 Price elasticity of supply changes over three production periods: 1) immediate run perfectly inelastic 2) short run either elastic or inelastic. 3) long run perfectly elastic for a constant cost industry. very elastic for a increasing cost industry. constant cost industry an industry that is not a major user any single resource; increases in quantity supplied does not effect resource prices. Prices in the market remain unchanged. increasing cost industry an industry that is a major user of at least one resource; increases in quantity supplied leads to an increase in price of that major resource. Prices in the market rise to cover the higher per unit cost. 5

6 Page 71 calculatıng prıce elastıcıty of supply: A numerical value for price elasticity of supply (e s) is found by taking the ratio of the changes in quantity supplied and in price, each divided by its average value. In mathematical terms: applıcatıons of elastıcıty: Page 74 1) Excise Tax is a tax on a particular product expressed as a dollar amount per unit of quantity. Such a tax creates a new supply curve (S 1) seen by consumers. It is vertically above the initial supply curve (S 0) seen by producers. The after tax price for consumers is found where S 1 crosses the demand curve. The after tax equilibrium price for producers is the corresponding price on S 0. 6

7 For a given supply curve, the more elastic the demand curve the greater the proportion of an excise tax paid by producers. For a given demand curve, the more elastic the supply curve the greater the proportion of an excise tax paid by consumers. Page 75 Page 76 2) Price Control price floor is a minimum price set above the equilibrium price. It results in a surplus in the market. Example: Agricultural Supports They help overcome unstable agricultural prices. Farmers win from these supports. Consumers and taxpayers lose from these supports. Page 79 7

8 price ceiling is a maximum price set below the equilibrium price. It results in a shortage in the market. Example: Rent Controls They keep down prices of controlled rental accommodation. Some (especially middle class) tenants win from these controls. Other (especially poorer) tenants lose from these controls. Page 80 9a) page 84 8