Elasticity Supply and Demand

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Chapter 20

• Elasticity Supply and Demand

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How do demand and supply change in response to
changes in price and quantity?Elasticity

• Elasticity of Demand and Elasticity of Supply

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Bottom Line on Elasticity of Supply

• If producers are relatively responsive to price
  changes supply is elastic
• If producers are relatively insensitive to price
  changes supply is inelastic

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• If producers are responsive to price changes,
  supply is elastic.
• If they are relatively insensitive to price
  changes, supply is inelastic

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• When a large percentage change in price brings
  about a small percentage change in quantity
  supplied inelastic.
• (examples Rise in costs of computers takes
  time to shift resources)
• Over Time more plants built, more engineers
  trained, and more computers supplied

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Elasticity and Inelasticity Supply
B
70 60 50 40 30 20
A
A
B
0 10 20 30 40 50 60 70 80 90 100 120
140 160
Supply Elasticity (small percentage increase in
price large percentage increase in quantity
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• Antiques. Supply elastic or inelastic?
• Inelastic. Only a few authentic pieces,
  reproductions would be elastic
• GoldSupply elastic or inelastic
• Gold is perfectly inelastic(supply fixed)

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• When a small percentage change in price brings
  about a large percentage change in quantity
  supplied elastic
• Example Cowboys beat Philadelphia Eagles for
  wildcard playoff T-shirt producer can raise his
  price just a tad and sell a ton more shirts

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MAIN DETERMINATION OF ELASTICY OF SUPPLY?

• TIME
• Many times this only has to do with the producers
  ability to shift resources
• If resources are not shiftable, then new mix of
  inputs has to be determined.

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Ability to Respond to Price varies

• Often the ability of an individual firm to
  respond to an increase in price is limited or
  constrained by its existing scale of operations,
  or capacity, or ability to obtain resources.. IN
  SHORT RUN
• Examples
• IN LONG RUN can adjust. The greater the amount
  of time producers have to adjust, the greater
  their output response.

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TIME AND ELASTICITY OF SUPPLY
Ss

• Sm

SL
D2
D2
D2
D1
D1
D1
Note perfectly inelastic. (price)(quantity)
Inelastic (price) (quantity)
Elastic (price) (quantity) See relationship
between small percentage increase in P and Q that
follows.
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Terms to remember

• Market Period period that occurs when the time
  immediately after a price change is too short for
  producers to respond with a change in quantity
  supplied.
• SR in Micro period of time too short to change
  plant capacity, but long enough to use current
  capacity more or less intensively.

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• Examples of adjusting to the market period.
• truck farmer (farmers market)
• limited growing season
• accepts price as it is brought to market
• cant hold back on what is sold because of
  spoilage.
• has to take price even if cost of production not
  met.

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• Perfectly elastic supply curve
• Relatively elastic supply curve
• Perfectly inelastic supply curve
• Relatively inelastic supply curve

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Supply tends to be inelastic in SR

• Example
• After WWII cars impossible to get at any price.
• Resources needed to be converted back from
  tanks, jeeps and plane production.
• Even if you had the 1,000 it took to buy a car
  had to put name on year waiting list.

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Remember

• Supplier is looking at revenue
• Revenue Test P x Q TR
• What is profit?
• TR-TC
• Question is If I decrease the price of steak 1
  what will happen to my revenue?

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Math for Measuring Price Elasticity

• Problem Sirloin steak drops 4.00 to 3.00
• Butcher sales increase from 500 lbs to 1,000 lbs
• Formula Pe Change in Q
• Change in P

Let's Work The Math!
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• 500 lbs to 1000 lbs 500 / 500 1 (Q change
  100)
• 4.00 to 3.00 1/ 4 .25
• 1 / .25 4
• The steak at this price is very elastic.
• Anything over 1 is elastic.

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Helpful Hints

• To find coefficient of price elasticity supply
  or demand simply
• Find change in quantity and change in price,
  then divide Q/P
• Hint former-current/former
• Price increase 1 to 2, quantity decrease 10 to
  8
• 1/1 x 100 100 P
• 2/10 x 100 20 Q
• 20/100 .2 inelastic

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Another Helpful Hint!

• What is the first movement for variables?
• i.e.. When a producer wants to check if he can
  get more for increasing or decreasing, what is
  the first thing he does?
• Price OR Price
• Then the quantity adjusts accordingly
• P trigger
• Q response

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Elasticity of Demand

• Logic Dictates that
• Firms contemplating a price hike want to know how
  consumers will respond
• GM advertises 0 financing for 60 months huge
  reductions on Suburban's, Tahoes,Trucks) What do
  they expect consumers to do?
• What do the dealers expect to receive?

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Bottom Line for Elasticity of Demand

• The responsiveness or (sensitivity) of consumers
  to a price change is measured by a products
  price elasticity of demand

Inelastic demand perfectly inelastic
totally elastic
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Explanation of Perfectly Inelastic Demand

• Unit Elasticity (Percentage change in price and
  resulting change in quantity demanded are the
  same.
• Where a price change results in no change in
  quantity demanded, it Perfectly Inelastic or
  Unit Elastic
• Example Insulin for Diabetes
• What else? (certain medicines.. BP Heart
  problems etc.)
• In these cases price-elasticity coefficient is
  zero (because no response to change in price)

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What is elasticity of demand?

• Elasticity of demand measures the percentage
  change in Quantity demanded in response to a
  percentage change in price.
• Law of demand states that as P increases Q
  decreases. But how much decrease?
• Measure responsiveness of QD to change in P by
  calculating the coefficient of price elasticity
  of demand (Ep)
• Ep Percentage change in QD
• Percentage Change in P
• 
  

You have already done this!!
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What does that mean?

• If elasticity is greater than 1, demand is
  elastic.
• Price change causes revenue to change in opposite
  direction Decrease in price will increase TR
• Inelastic demand is defined as an elasticity of
  less than 1 (anything from 0 to .99)
• Price changes causes TR to change in same
  direction. Decrease in price causes TR to fall
• Unit elastic is 1 No change
• Price elasticity is 0 because an increase in
  price will not decrease revenuenor will it
  increase revenue there is no change in revenue
  with unit elastic.

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• Elastic Demand A small percentage change in
  price brings about a large percentage change in
  QD
• Example cars, steak, CDs, gold jewelry
• Inelastic Demand Large percentage change in
  price brings about a small percentage change in
  QD.
• Drugs, gasoline, cigarettes, personal items,
  deodorant,

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All of the inelastic demand concepts depend on
available substitutes

• Price of steak goes too high substitute chicken
• Price of gasoline too high no substitute
• Income Effect
• Income effect simply indicates that at a lower
  price one can afford more of the good without
  giving up alternative goods.

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• Decline in the price of a product will increase
  purchasing power of ones money income
• Higher price has opposite effect.
• Substitution Effect one has the incentive to
  substitute the cheaper good for similar goods
  which are now relatively more expensive.
• Cheap products for dear products

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Determinants of Elasticity

• Necessity vs Luxuries .examples critical
  medicines, addiction, gas to drive, new car,
  boat, diamond ring.
• Availability of SubstitutesZirconia, salt
  substitute, powdered milk, tea vs coffee
• Proportion of Incomethe higher the price of a
  good relative to a consumers income, the greater
  the price elasticity of demand.
• Time.As a rule, product demand is more elastic
  the longer the time period under consideration.

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• Generally, the larger the number of substitute
  goods that are available, the greater the price
  elasticity of demand..
• (variety of beer options on the market)
• Elasticity of Demand depends on how narrowly the
  product is defined. (Coach Handbag)

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• Normal or Superior Goods
• Income goes up we buy more expensive items.
  (lobster/fish sticks)
• Inferior or Poor Mans Goods
• Income goes down take the bus rather than
  flysecond-hand clothing stores garage sales.

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How can we calculate coefficient of price
elasticities?Lets re-visit our last example

• Lets say that price is increased from 1.00 to
  2.00 for a candy bar..
• The quantity demanded decreases from 10 to 8.
• How will this producer know if the price increase
  brings in more relative to decrease in demand
  or otherwise????

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• Percent change in P
• 1-21/1 x 100 100 change in P
• Percent change in Q
• 10-8 2/10 20 change in Q
• Response/trigger..Hence
• E 20/100 .2 ( change in Q / change in P)
• Trigger was the price. Response the quantity
• Price moves(trigger) quantity change (response)
• Because change is less than 1, candy producer
  will not increase revenue by increasing price.

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Meaning of Elasticity

• Elasticity is gt than 1 means demand is elastic
• (If elasticity is greater than 1, percentage
  change in quantity must be greater than
  percentage change in price.)
• Inelasticity is anything lt than 1
• If elasticity is equal to 1 then it is unitary
  elastic

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What is Cross Elasticity?

• It is simply the response or willingness of a
  consumer to purchase product X when product Y has
  a noticeable price change.

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Lets try two more problems

• Key chains are reduced from 5 to 4
• The number of key chains purchased increases from
  80 to 82
• Was this inelastic or elastic Revenue went up or
  down?
• Bottled Water increased from 3.00 to 5.00
• The number of bottles purchased decreased from
  250 to 125.
• Elastic or inelastic?
• Key chain- .125 (inelastic)
• Bottled water 1.25 (elastic)
• Inelastic direct revenue relationshipelastic-
  indirect revenue relationship

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Advertising Purpose

• To sway the consumer. (Bayer and St. Josephs
  aspirin for children) which is better?
• Producers through advertising want to increase
  our demand curve and make it more inelastic!

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To be Discussed later

• Total Revenue and Marginal Revenue.
• If your company sold 4 computers at 3,200 each
  how much total revenue? (PxQ 12,800)
• Marginal Revenue Increase in TR when output
  sold goes up by one unit.(12,800 3,20016,000
• The additional revenue derived from selling one
  more unit. (see above)

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• THE END!

Let me out!!! I'm not elastic!