USC ECON 203 - C6 (11 pages)

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C6



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C6

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Pages:
11
School:
University of Southern California
Course:
Econ 203 - Principles of Microeconomics
Principles of Microeconomics Documents
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ECON 203 Principles of Microeconomics Class 6 Price Elasticities of Demand and Supply 1 Knowledge Recap Simultaneous events that produce a shift in both the demand and supply curves have an ambiguous effect on either equilibrium price or equilibrium quantity Example the increase in both demand and supply for the Rams tickets lead to an increase in quantity but an unknown effect on prices In those cases the final effect on equilibrium price or quantity will be determined by The magnitude of the shifts of demand and supply How much will buyers and sellers respond to the demand and supply changes elasticities of demand and supply 2 Elasticity Elasticity is a measure of how much buyers and sellers respond to changes in market conditions The response of buyers and sellers to changes in prices is measured by price elasticities of demand and supply Determines the shape slope of the demand and supply curves 3 Elasticity of Demand Price elasticity of demand Measures the percent changes in quantity demanded as a response to a 1 change in the price of a good The demand for a good is said to be elastic when a change in price leads to a large change in quantity demanded The demand for a good is said to be inelastic when a change in price leads to a small change in quantity demanded 4 Elasticity of Demand Price elasticity of demand reflects buyers preferences Factors that affect the price elasticity of demand Availability of close substitutes goods with more available substitutes have more elastic demands Necessities vs luxuries necessities have more inelastic demands while luxuries have more elastic demands Definition of the market narrowly defined markets have more elastic demands while broadly defined markets have more inelastic demands Time horizon as the time horizon becomes longer demand becomes more elastic 5 Computing Elasticity of Demand Midpoint formula Solves the problem of the difference in base number depending on the direction of the change Example Price 10 8 6 4 Quantity 20 40 60 80 6 Types of Elasticity of Demand When price elasticity is greater than 1 the demand is considered elastic When price elasticity is less than 1 the demand is considered inelastic When price elasticity equals 1 the demand is considered to have unit elasticity Flatter demand curves have greater price elasticities Perfectly inelastic demand vertical line Perfectly elastic demand horizontal line 7 Total Revenue and Elasticity Total revenue the total amount paid by all buyers and received by all sellers of a good When demand is inelastic less than 1 an increase in price leads to an increase in total revenue When demand is elastic less than 1 an increase in price leads to a decrease in total revenue When demand is unit elastic equal to 1 an increase in price leads to no change in total revenue 8 Total Revenue and Elasticity Total revenue the total amount paid by all buyers and received by all sellers of a good Example elasticity along a linear demand curve Quantity Price 0 2 4 6 8 10 12 7 6 5 4 3 2 1 Q2 Q1 Q2 Q1 2 P2 P1 P2 P1 2 Elasticity 2 0 67 0 40 0 29 0 22 0 18 0 15 0 18 0 22 0 29 0 40 0 67 13 3 3 7 1 8 1 0 6 0 3 Total Revenue 0 12 20 24 24 20 12 9 Elasticity of Supply Price elasticity of supply Measures the percent changes in quantity supplied as a response to a 1 change in the price of a good Depends on the flexibility of sellers to change their production as a response to change in prices and the time horizon considered Computed using the midpoint formula 2 1 2 1 2 2 1 2 1 2 10 Elasticity of Supply Types of price elasticity of supply The supply of a good is said to be elastic when price elasticity of supply is greater than 1 The supply of a good is said to be inelastic when price elasticity of supply is less than 1 The supply of a good is said to have unit elasticity when price elasticity of supply is equal to 1 A horizontal supply is considered perfectly elastic while a vertical supply curve is considered perfectly inelastic 11


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