Extensions of Demand and Supply Analysis

1. 18 Extensions of Demand and Supply Analysis

2. Chapter Objectives • Price Elasticity of Demand and How It Can Be Applied • The Usefulness of the Total Revenue Test for Price Elasticity of Demand • Price Elasticity of Supply and How It Can Be Applied • Cross Elasticity of Demand and Income Elasticity of Demand • Consumer Surplus, Producer Surplus, and Efficiency Losses

3. O 18.1 Price Elasticity of Demand • Measuring Responsiveness to Price Changes • Relatively Elastic or Inelastic • Price-Elasticity Coefficient and Formula Percentage Change in Quantity Demanded of Product X Ed = Percentage Change in Price of Product X

4. W 18.1 Change in Quantity Change in Price Ed = ÷ Sum of Quantities/2 Sum of Prices/2 Price Elasticity of Demand • Formula Restated Change in Quantity Demanded of X Ed = Original Quantity Demanded of X Change in Price of X ÷ Original Price of X • Using Averages • Midpoint Formula

5. .04 Ed = = 2 .02 .01 Ed = = .5 .02 .02 Ed = = 1 .02 Price Elasticity of Demand • Why Use Percentages? • Elimination of the Minus Sign • Interpretations of Ed Elastic Demand Inelastic Demand Unit Elasticity

6. P 0 Q P 0 Q Price Elasticity of Demand Extreme Cases Perfectly Inelastic Demand D1 Perfectly Inelastic Demand (Ed = 0) Perfectly Elastic Demand D2 Perfectly Elastic Demand (Ed = ∞)

7. W 18.2 P $3 2 1 Q 0 10 20 30 40 The Total Revenue Test • Total Revenue (TR) TR = P x Q Elastic Demand a b D1

8. W 18.2 P $4 3 2 1 Q 0 10 20 The Total Revenue Test • Total Revenue (TR) TR = P x Q Inelastic Demand c d D2

9. W 18.2 P $3 2 1 Q 0 10 20 30 The Total Revenue Test • Total Revenue (TR) TR = P x Q Unit-Elastic e f D3

10. G 18.1 ] ] ] ] ] ] ] ] ] ] ] ] ] ] Elasticity on a Linear Demand Curve Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total-Revenue Test (1) Total Quantity of Tickets Demanded Per Week, Thousands (3) Elasticity Coefficient (Ed) (4) Total Revenue (1) X (2) (5) Total-Revenue Test (2) Price Per Ticket 1 2 3 4 5 6 7 8 8 7 6 5 4 3 2 1 $8,000 14,000 18,000 20,000 20,000 18,000 14,000 8,000 5.00 2.60 1.57 1.00 0.64 0.38 0.20 Elastic Elastic Elastic Unit Elastic Inelastic Inelastic Inelastic Graphically…

11. $8 7 6 5 4 3 2 1 a b c Price d e f g h 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 Quantity Demanded $20 18 16 14 12 10 8 6 4 2 Total Revenue (Thousands of Dollars) Quantity Demanded Price Elasticity and the Total-Revenue Curve Elastic Ed > 1 Unit Elastic Ed = 1 Inelastic Ed < 1 D Elastic Ed > 1 Unit Elastic Ed = 1 TR Inelastic Ed < 1

12. Determinants of Price Elasticity of Demand • Substitutability • Proportion of Income • Luxuries versus Necessities • Time • Applications: • Large Crop Yields • Excise Taxes • Decriminalization of Illegal Drugs

13. O 18.2 P Q Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Unit Elastic Supply Es = 1 Market Period: Not Enough Time to Shift Resources Sm Pm Greatest Price Impact P0 D1 D2 Q0

14. O 18.2 P Q Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Inelastic Supply Es < 1 Short Run: Resources Not Easily Shifted to Alternative Uses Ss Lower Price Impact Ps P0 D1 D2 Q0 Qs

15. O 18.2 P Q Price Elasticity of Supply Percentage Change in Quantity Supplied of Product X Es = Percentage Change in Price of Product X Elastic Supply Es > 1 Long Run: Resources Easily Shifted to Alternative Uses Sl Least Price Impact Pl P0 D1 D2 Q0 Ql

16. Price Elasticity of Supply • Applications • Antiques and Reproductions • Volatile Gold Prices

17. Cross Elasticity of Demand Percentage Change in Quantity Demanded of Product X • Substitute Goods – Positive Sign • Complementary Goods- Negative Sign • Independent Goods – Zero or Near-Zero Value Exy = Percentage Change in Price of Product Y

18. Income Elasticity of Demand • Normal Goods – Positive Sign • Inferior Goods- Negative Sign • Insights into the Economy Percentage Change in Quantity Demanded Ei = Percentage Change in Income

19. O 18.3 Consumer and Producer Surplus Consumer Surplus Consumer Surplus Equilibrium Price = $8 P1 Price (Per Bag) D Q1 Quantity (Bags)

20. Consumer and Producer Surplus Producer Surplus S Equilibrium Price = $8 P1 Price (Per Bag) Producer Surplus Q1 Quantity (Bags)

21. W 18.3 Consumer and Producer Surplus Efficiency Revisited S Consumer Surplus Equilibrium Price = $8 P1 Price (Per Bag) Producer Surplus D Q1 Quantity (Bags)

22. Consumer and Producer Surplus Efficiency Revisited Efficiency Losses (Deadweight Losses) S Efficiency Losses P1 Price (Per Bag) D Q3 Q2 Q1 Quantity (Bags)

23. Elasticity and Pricing Power: Last Word Why Different Consumers Pay Different Prices • All Buyers in a Highly Competitive Market Pay the Same Price Regardless of Their Elasticities • Difficulty in Applying Different Prices • Observe Differences in Group Elasticities • Business Travelers • Leisure Travelers • Discounting for Children • Different Net Prices for College Tuition

24. price elasticity of demand midpoint formula elastic demand inelastic demand unit elasticity perfectly inelastic demand perfectly elastic demand total revenue test (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) Key Terms

25. Next Chapter Preview… Consumer Behavior And Utility Maximization Chapter 19!