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Chapter Objectives
Price elasticity of demand The total revenue test Price elasticity of supply Cross elasticity of demand Income elasticity of demand Consumer & producer surplus Efficiency losses
6-2
Inelastic demand
Small change in quantity purchased for given price change
6-3
Ed =
6-4
Ed =
Sum of Prices/2
Change in Price
6-6
Interpretations of Elasticity
Elastic Demand
.04 .02
Ed =
Inelastic Demand
=2
Ed =
Unit Elasticity
.01 .02
= .5
Ed =
.02 .02
=1
6-7
Elastic demand
P and TR change in opposite direction
6-9
b
1
D1
10
20
30
40
Q
6-10
d
1
D2 0 10 20 Q
6-11
f
1
D3
10
20
30
Q
6-12
1 2 3 4 5 6
$8
7
8
] 7 ] 6 ] 5 ] 4 ] 3 ] 2 ] 1
$8,000
0.20
Inelastic
6-13
Price
0 1 2 3 4 5 6 7 8
Quantity Demanded
$20 18 16 14 12 10 8 6 4 2
TR
0 1 2 3 4 5 6 7 8
Quantity Demanded
6-14
Determinants of Elasticity
Substitutability
More substitutes, more elastic demand
Proportion of income
Price relative to income
Time
More elastic in the long run
6-15
Applications of Elasticity
Large crop yields
Inelastic demand
Excise taxes
Inelastic demand
6-16
Es =
Short run
Fixed plant size
Long run
Adjustable plant size Supply more elastic
6-18
Sm
Pm P0
D1 D2
Q0
Q
6-19
Ss
Ps P0
D1 D2
Q0 Qs
Q
6-20
P
Sl
Pl P0
D1 D2
Q0 Ql
Q
6-21
Exy =
Complementary goods
Negative sign
Independent goods
Zero
6-24
Responsiveness of sales to change in income Normal goods positive sign Inferior goods negative sign
6-25
Consumer Surplus
Benefit surplus Maximum willingness to pay (WTP) less than actual price paid
Person Bob Barb Bill Bart Brent Betty Max WTP Actual Price $13 $8 $12 $8 $11 $8 $10 $8 $9 $8 $8 $8 CS $5 $4 $3 $2 $1 $0
6-26
Consumer Surplus
D
Q1
Quantity (Bags)
6-27
Producer Surplus
Benefit surplus Actual price received more than minimum acceptable price (AP)
Person Carlos Courtney Chuck Cindy Craig Chad Min AP $3 $4 $5 $6 $7 $8 Actual Price $8 $8 $8 $8 $8 $8 PS $5 $4 $3 $2 $1 $0
6-28
Producer Surplus
Producer Surplus
P1
Equilibrium Price = $8
Q1
Quantity (Bags)
6-29
Efficiency Revisited
Productive and allocative efficiency
Consumer Surplus Price (Per Bag)
S
Equilibrium Price = $8
P1
Producer Surplus
D
Q1
Quantity (Bags)
6-30
Efficiency Loss
Deadweight loss
Efficiency Losses Price (Per Bag)
S
P1
D
Q2 Q1 Q3
6-31
Quantity (Bags)
Key Terms
price elasticity of demand midpoint formula elastic demand inelastic demand unit elasticity perfectly inelastic demand perfectly elastic demand total revenue (TR) total-revenue test price elasticity of supply market period short run long run cross elasticity of demand income elasticity of demand consumer surplus producer surplus efficiency losses (deadweight losses)
6-33
Consumer Behavior
6-34