Embed Size (px)
Citation preview
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
1
Market Behaviour:Markets in action
2012 version
Learning Objectives1. Define the price elasticity of demand and
understand how to calculate it.
2. Understand the determinants of the price elasticity of demand.
3. Understand the relationship between the price elasticity of demand and total revenue.
4. Define the cross-price elasticity of demand and the income elasticity of demand, and understand their determinants and how they are calculated.
Learning Objectives
5. Use price elasticity and income elasticity to analyse economic issues.
6. Define the elasticity of supply, and understand its main determinants and how it is calculated.
7. To investigate the effects on markets of government intervention, i.e. price ceilings, price floors and taxes.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
4
Price Elasticity of Demand
• The price elasticity of demand is the measure of the responsiveness of the quantity demanded to a change in price of a product
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
5
Price Elasticity is...
Q
P
P1
P2
Q1Q2
D
As price increases fromP1 to P2, quantity decreases
from Q1 to Q2
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
6
Price Elasticity is... (cont.)
Q
P
P2
P1
Q2Q1
D
As price decreases fromP1 to P2, quantity increases
from Q1 to Q2
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
7
Price Elasticity is... (cont.)
Q
P
P1
P2
Q1Q2
D
But what percentage did price change and what percentage did quantity
change?
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
8
Formula for Elasticity
The percentage change in price
The percentage change in quantityEd =
PED cannot be equated with the slope of the demand curve, it is really easy to change the slope of a demand curve by changing the units of the vertical or horizontal axis, but changing the units will change the under lying demand conditions.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
9
Price Elasticity of Demand (cont.)
• Elastic Demand– a given percentage change in price results
in a larger percentage change in quantity demanded
• Ed > 1
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
10
Price Elasticity of Demand (cont.)
• Inelastic Demand– a given percentage change in price results
in a relatively smaller percentage change in quantity demanded
• Ed < 1
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
11
Price Elasticity of Demand (cont.)
• Unit elasticity– a given percentage change in price results
in an equal percentage change in quantity demanded
• Ed = 1
• Total revenue is maximised
Inelastic and Elastic Demand
6
12
Pri
ce
Quantity
D1
Elasticity = 0
Perfectly Inelastic
Figure 4.3(a)
Inelastic and Elastic Demand
6
12
Pri
ce
Quantity
D2
1 2 3
Elasticity = 1
Unit Elasticity
Figure 4.3(b)
PED = 1 curve is a rectangular hyperbola, i.e. P x Q equals a constant.
Inelastic and Elastic Demand
6
12
Pri
ce
Quantity
D3
Elasticity =
Perfectly Elastic
Figure 4.3(c)
Elastic
Inelastic
Elasticity Along a Linear Demand Curve
Elasticity = 1
0 5 10 12.5 15 20 25
2.50
1.00
2.00
3.00
4.00
5.00
Pri
ce (
dolla
rs p
er s
moo
thie
)
Quantity (smoothies per hour)
Elasticity 1/4
Elasticity =4 Figure 4.4
When demandis inelastic, aprice cut decreasestotal revenue
Inelastic demand
When demandis elastic, aprice cut increasestotal revenue
Elastic demand
31.250 6 12
1.00
2.00
3.00
4.00
5.00
Pri
ce (
doll
ars
per
smoo
thie
)
0 12.5 25
Tot
al R
even
ue (
doll
ars)
Quantity (smoothies per hour)
Unitelastic
Maximum total revenue
2.50
Elasticity and Total Revenue
16
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
17
Total Revenue Test
• Elastic demand– a change in price will cause total revenue to
change in the opposite direction
• Inelastic demand– a change in price will cause total revenue to
change in the same direction
• Unit elasticity– a change in price leaves total revenue unchanged– total revenue is maximised
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
18
Determinants of Price Elasticity of Demand• Substitutability
• Proportion of income
• Luxuries versus necessities
• Time
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
19
Price Elasticity of Supply
Es=
Percentage change in quantitysupplied of product X
Percentage change in the price of product X
This time slope is directly related to PES
Elasticity of Supply• The time frame for supply decisions
– The more time that passes after a price change, the greater is the elasticity of supply.
– Momentary supply is perfectly inelastic. The quantity supplied immediately following a price change is constant.
– Short-run supply is somewhat elastic.– Long-run supply is the most elastic.
• Resource substitution possibilities– The easier it is to substitute among the
resources used to produce a good or service, the greater is its elasticity of supply.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
21
Price Elasticity of Supply (cont.)
Immediate market Period No Quantity
response just a price response
PPoo
PP
QQDD11
SSmm
PPmm
DD11
DD22
DD22
Qo
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
22
DD22
Price Elasticity of Supply (cont.)
PPoo
PPss
PP
DD11
Qo
SSss Short run Large
increase in D leads to a
small increase in
Q.
Qs
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
23
Price Elasticity of Supply (cont.)
PPoo
PPLL
PP
DD11Qo
SSLL
Long run: Large increase in D leads to a large quantity
response
DD22
SS′′LLSS′′LL
Qo QLQ′L
Elasticity of Supply
• Supply is perfectly inelastic if the supply curve is vertical and the elasticity of supply is 0.
• Supply is unit elastic if the supply curve is linear and passes through the origin. (Note that slope is irrelevant.)
• Supply is perfectly elastic if the supply curve is horizontal and the elasticity of supply is infinite.
Perfectly Inelastic Supply
Pri
ceP
rice
QuantityQuantity
SS11
Elasticity of Elasticity of supply = 0supply = 0
00
Figure 4.10 (a)
Unit Elastic Supply
Pri
ceP
rice
QuantityQuantity
SS22AA
00
SS22BB
Elasticity of supply Elasticity of supply = 1 = 1
Figure 4.10 (b)
Elastic Supply
Pri
ceP
rice
QuantityQuantity
SS22AA
00
SS22BB
Inelastic Supply
Pri
ceP
rice
QuantityQuantity
SS22AA
00
SS22BB
Perfectly Elastic Supply
Pri
ceP
rice
QuantityQuantity
SS33
00
Elasticity of Elasticity of supply = supply =
Figure 4.10 (c)
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
30
Exy =
Percentage change in quantitydemanded of good X
Percentage change in the price of good Y
•Substitute goods—Positive sign
•Complementary goods—Negative sign
•Independent goods—Zero value
Cross Price Elasticity of Demand
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
31
Income Elasticity of Demand
Ei =
Percentage change inquantity demanded
Percentage changein income
Normal goods 0>1Inferior goods <0Superior goods Superior goods > 1> 1
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
32
Price Ceilings
DD
DD SS
SS
Legal Price CeilingLegal Price CeilingPPPPcc
PP
Shortage
Qe QdQs
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
33
Price Ceilings and Shortages• Price ceiling is the maximum legal price a
seller may charge for a product or service. Price ceilings result in shortages.– Wartime price controls– Rent controls
• Over time both PED and PES increase so the shortage gets bigger.
• Designed to help poor people, but they end up hurting them, eg overcrowding or black markets.
Rent ceiling
A Price (Rent) Ceiling
Quantity (thousands of units per month)
Ren
t (do
llar
s pe
r un
it p
er m
onth
)
0 20 300 20 30 4040
500500
700700
900900
DD
SSSSAA
Housingshortage
Maximum black market rent
Figure 6.2
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
35
Price floors• Price support or ‘price floor’ is a minimum
price fixed by government, above equilibrium prices– Minimum wage legislation– Agricultural support prices
• Price support results in surpluses• Over time both PED and PES increase so
the surplus gets bigger.• In SR they may increase income, but in the
long run as DD gets flatter incomes falls.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
36
Price Support and Surpluses
DD
DD SS
SS
PPeeLegal Price Support
PPss
PP
Surplus
QsQd
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
37
Tax Incidence• Price elasticity of demand and
supply determines who bears the burden of sales or excise tax, called the incidence of a tax.
• Slopes of SS and DD reflect relative elasticity.
• The relatively less elastic side of the market bears the burden of the tax.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
38
Incidence of a Sales TaxP
Q0
5
4
3
2
1
5 10 15 20 25 30 35 40
Pri
ce (
$ p
er b
ott
le)
Quantity demanded (thousands of bottles/month)
SSDD
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
39
Incidence of a Sales Tax (cont.)P
Q0
5
4
3
2
1
5 10 15 20 25 30 35 40
Pri
ce (
$ p
er b
ott
le)
Quantity demanded (thousands of bottles/month)
Tax $1
SS11
SSDD
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
40
Incidence of a Sales TaxP
Q0
5
4
3
2
1
5 10 15 20 25 30 35 40
Pri
ce (
$ p
er b
ott
le)
Quantity demanded (thousands of bottles/month)
Tax $1
SS11
SSDD
Consumer’s tax incidence
Producer’s tax incidence
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
41
Elastic Demand and IncidenceP
Q0
5
4
3
2
1
5 10 15 20 25 30 35 40
Pri
ce (
$ p
er b
ott
le)
Quantity demanded (thousands of bottles/month)
Tax $1
SS11
SS
DD
Consumer’s tax incidence
Producer’s tax incidence
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
42
Inelastic Demand and IncidenceP
Q0
5
4
3
2
1
5 10 15 20 25 30 35 40
Pri
ce (
$ p
er b
ott
le)
Quantity demanded (thousands of bottles/month)
Tax $1
SS11
SS
DD
Consumer’s tax incidence
Producer’s tax incidence
