ECON 1 1st Edition Lecture 8Outline of Last Lecture 1. Chapter 5: Elasticity and its ApplicationsOutline of Current Lecture 2. Finish Chapter 5: Elasticity Current LectureElasticity of Demand and Total Revenue- A firm’s revenues are equal to price per unit times quantity sold.o Revenue (R)= Price (P) x Quantity (Q)- The elasticity of demand directly influences revenues when the price of the good changes.Ex. If you raise your price from $200 to $250, would your revenue rise or fall?- A price increase has two effects on revenueo Higher P means more revenue on each unit you sell.o But you sell fewer units due to the law of demand (lower Q).- If demand is elastic, then price elasticity of demand > 1. o The fall in revenue from lower Q is greater than the increase in revenue from higher P, so revenue falls. - If demand in INELASTIC, the price elasticity of demand is < 1.o The fall in revenue from lower Q is smaller that the increase in revenue from higher P, so revenue rises. Case Study: Does Drug Interdiction Increase of Decrease Drug-Related Crime? - One side effect of illegal drug use=crime to finance their habit.- Assume that total dollar value of drug-related crime equals total expenditure on drugs.- Demand for illegal drugs is inelastic, due to addiction issues.- Policy 1: Interdiction reduces the supply of drugs and sine the demand for drugs is inelastic, P rises proportionally more than Q falls. o The result is an increase in total spending on drugs, and in drug-related crime. - Policy 2: Education reduces the demand for drugs so P and Q falls.o The result is a decrease in total spending on drugs, and in drug-related crime. Summary of Determinants of Elasticity of DemandAbsolute Value of Elasticity Name Price and RevenueEd<1 Inelastic P and R move togetherEd>1 Elastic P and R move oppositeEd=1 Unit elastic P moves but T stays the sameElasticity of SUPPLY:- The law of supply indicates a direct relationship between price and quantity supplied.- Elastic: A supply curve is elastic when an increase in price increases the Qs a lot and viceversa. o Causes a big increase in Qs- Inelastic: A supply curve is inelastic when the same increase in price increases quantity supplied just a little. o Causes a small increase in QsDeterminants of the Elasticity of Supply1. Change in Per-Unit Costs with Increased Productiona. The more easily sellers can change the Q they produce, the greater the price elastic of supply.b. For many goods, price elasticity of supply is greater in the long run than in the short run because firms can build new factories or new firms can enter the market. 2. Time Horizona. Immediately following a price increase, producers can expand output only using their current capacity (makes supply inelastic).b. Over time, producers can expand their capacity (makes supply elastic).3. Share of Market for Inputsa. Supply is elastic when the industry can be expanded without causing a big increase in the demand (and P) for the industry’s inputs.b. Supply is inelastic when industry expansion causes a significant increase in the demand/price for inputs.4. Geographic Scopea. The wider the scope of the market of a good, the less elastic its supply.b. The narrower the scope, the more elastic. Summary of Determinants of Elasticity of SupplyLess Elastic More ElasticDifficult to Increase Easy to IncreaseProduction at Constant Unit Costs Production at Constant Unit CostsRaw Materials Manufactured GoodsShort Run Long RunLarge Share of Market for Inputs Small share of Market for InputsGlobal Supply Local Supply**The midpoint formula for supply is the same as the demand one.Variety of Supply Curves - The slope of the supply curve is closely related to price elasticity of supply. - Rule of thumb:o The flatter the curve, the bigger the elasticity.o The steeper, the smaller the