ECO2030 1nd Edition Lecture 12 Outline of Last Lecture I Elasticity Outline of Current Lecture II Elasticity of Supply III Examples of price elasticity of supply Current Lecture Quiz next monday exam friday Elasticity in the real world chart Revenue Price x Quantity Continuing our scenario from the previous lecture if you raise your price of websites from 200 to 250 would your revenue rise or fall Revenue P x Q a price increase can have two effects on revenue a higher price means more revenue on each website you sell but you will sell less because of the law of demand However which effect is greater depends on the price elasticity of demand of your product Recall that if price is elastic price elasticity of demand will be 1 change in Q change in P because the fall in revenue from the lower demand Q is greater than the increase in revenue from the higher price P overall there is a fall in revenue steeper demand curve more inelastic less steep more elastic Elastic Demand elasticity 1 8 If P 200 and Q 12 then Revenue P x Q 200 12 2400 If P 250 and Q 8 then Revenue P x Q 200 8 2000 When D is elastic a price increase causes revenue to fall If P is raised by 50 again but demand Q only falls to 10 instead of 8 it is because the demand curve is steeper and therefore If P 200 and Q 12 Revenue 2400 just like before However if P 250 and Q 10 then Revenue 2500 This is 100 more because when the demand curve is steeper gains in P can outweigh losses in Q Remember this is because the demand curve is steeper Conclusion when D is inelastic a price increase causes revenue to rise Example Questions likely on the exam when you see a question like this you need to determine if the demand is elastic A Pharmacies raise the price of insulin by 10 Does total expenditure on insulin rise or fall a Recall that insulin is a necessity and therefore demand is inelastic Since the demand will not fall much for necessities a 10 increase in price will not decrease demand as much as 10 so the revenue expenditure rises B As a result of a price war the price of luxury cruise falls 20 does the total revenue for luxury cruises rise or fall a although the fall in P reduces revenue the demand increase outweighs it This is because demand is elastic meaning Q will increase more than 20 so total revenue will rise Example A Does drug interdiction increase or decrease drug related crime a a side effect of drug use is crime in order to pay for the addiction b For simplicity we say that drug related crime is equal to the money spent on drugs dollar value c Also since demand for drugs is similar to insulin because addiction is similar to a necessity the demand curve is inelastic Interdiction reduces the supply of drugs However since demand for drugs is inelastic P rises more than Q falls Remember that we assume that drug related crime is equal to the money spent on drugs therefore if the price of drugs goes up more than the demand falls there is an increase in spending on drugs and therefore an increase in spending on drug related crime The other alternative Education Education reduces the demand for drugs therefore both P and Q fall The result sounds good because this effectively reduces the price of drugs which reduces drug related crime expenditures The problem is that cheap drugs are an incentive to try them so in reality law officials use both methods shown here When a demand is inelastic a price increase causes revenue to rise When a demand is elastic a price increase causes revenue to fall Price elasticity of Supply very similar to demand Measures price elasticity of supply how much Q responds to change in P Remember that when price increases so does quantity the Law of Supply Price elasticity of Supply Percent change in Q Percent change in P So P elasticity of Supply 16 8 2 steeper more inelastic less steep more elastic One thing that differs from the elasticity of demand and the elasticity of supply is that when price increases do does quantity Perfectly inelastic supply Q P 0 10 0 S curve is steep vertical No Price sensitivity Inelastic Q P 10 10 1 The S curve is relatively steep the Price sensitivity is relatively low Unit Elasticity Q P 10 10 1 Just like elasticity of demand Elastic flatter stretchier P rises 10 and Q rises 10 so Elasticity 10 10 1 Relatively flat curve price sensitivity relatively high Perfectly Elastic something that is not dependent on resources e g copying software Determinants of supply elasticity The more easily sellers can change the quantity they produce the greater the price elasticity of supply Example Supply of beachfront property is harder to vary and thus less elastic than supply of new cars 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 may be able to enter the market