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Chapter 5Chapter 5Chapter 5Chapter 5
Elasticity and itsApplicationsElasticity and itsApplications
2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited
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Learn the meaning of the elasticity ofdemand
E!amine "hat determines the elasticity ofdemand
Learn the meaning of the elasticity ofs#pply
E!amine "hat determines the elasticity ofs#pply
Apply the concept of elasticity in threedifferent mar$ets
Learn the meaning of the elasticity ofdemand
E!amine "hat determines the elasticity ofdemand
Learn the meaning of the elasticity ofs#pply
E!amine "hat determines the elasticity ofs#pply
Apply the concept of elasticity in threedifferent mar$ets
%n this chapter yo# "ill&%n this chapter yo# "ill&
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& allo"s #s to analy'e s#pply anddemand "ith greater precision
& is a meas#re of ho" m#ch b#yers andsellers respond to changes in mar$etconditions
& allo"s #s to analy'e s#pply anddemand "ith greater precision
& is a meas#re of ho" m#ch b#yers andsellers respond to changes in mar$etconditions
T(E ELA)T%C%T* + -E.AN-T(E ELA)T%C%T* + -E.AN-
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Price elasticity of demandis a meas#re ofho" m#ch the /#antity demanded of agood responds to a change in the price ofthat good
rice elasticity of demand is thepercentage change in /#antity demandedgiven a percent change in the price
Price elasticity of demandis a meas#re ofho" m#ch the /#antity demanded of agood responds to a change in the price ofthat good
rice elasticity of demand is thepercentage change in /#antity demandedgiven a percent change in the price
rice Elasticity of -emandrice Elasticity of -emand
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Availability of Close )#bstit#tes Necessities versusL#!#ries
-efinition of the .ar$et
Time (ori'on
Availability of Close )#bstit#tes Necessities versusL#!#ries
-efinition of the .ar$et
Time (ori'on
The rice Elasticity of -emand and %tsThe rice Elasticity of -emand and %ts
-eterminants-eterminants
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-emand tends to be more elastic1! the larger the n#mber of close
s#bstit#tes
! if the good is a l#!#ry! the more narro"ly defined the mar$et
! the longer the time period
-emand tends to be more elastic1! the larger the n#mber of close
s#bstit#tes
!if the good is a l#!#ry! the more narro"ly defined the mar$et
! the longer the time period
The rice Elasticity of -emand and %tsThe rice Elasticity of -emand and %ts
-eterminants-eterminants
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The price elasticity of demand iscomp#ted as the percentage change in the/#antity demanded divided by thepercentage change in price
The price elasticity of demand iscomp#ted as the percentage change in the/#antity demanded divided by thepercentage change in price
Comp#ting the rice Elasticity of -emandComp#ting the rice Elasticity of -emand
rice elasticity of demand
ercentage change in /#antity demanded
ercentage change in price
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The midpoint form#la is preferable "hencalc#lating the price elasticity of demandbeca#se it gives the same ans"erregardless of the direction of the change
point .ethod1 A 3etter 4ay to Calc#late ercentageChanges and Elasticities
The midpoint form#la is preferable "hencalc#lating the price elasticity of demandbeca#se it gives the same ans"erregardless of the direction of the change
point .ethod1 A 3etter 4ay to Calc#late ercentageChanges and Elasticities
The .idpoint .ethod1 A 3etter 4ay toThe .idpoint .ethod1 A 3etter 4ay to
Calc#late ercentage Changes and ElasticitiesCalc#late ercentage Changes and Elasticities
62 7 689: ;62 < 689: 2=
2 7 89: ;2 < 89: 2=rice elasticity of demand
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rom oint A to oint 31 rice rise 50> and 6#antity fall ??>
rom oint 3 to oint A1 rice fall ??> and 6#antity rise 50>
rom oint A to oint 31 rice rise 50> and 6#antity fall ??>
rom oint 3 to oint A1 rice fall ??> and 6#antity rise 50>
The .idpoint .ethod1 A 3etter 4ay toThe .idpoint .ethod1 A 3etter 4ay to
Calc#late ercentage Changes and ElasticitiesCalc#late ercentage Changes and Elasticities
@0 7 8209 :;@0 < 8209: 2=
7 B9: ; < B9: 2=rice elasticity of demand
oint A1 rice B 6#antity 820 oint 31 rice 6#antity @0
oint A1 rice B 6#antity 820 oint 31 rice 6#antity @0
8.id point method
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%nelastic -emand! 6#antity demanded does not respond
strongly to price changes
! rice elasticity of demand is less thanone
Elastic -emand
! 6#antity demanded responds stronglyto changes in price
! rice elasticity of demand is greaterthan one
%nelastic -emand! 6#antity demanded does not respond
strongly to price changes
!rice elasticity of demand is less thanone
Elastic -emand
! 6#antity demanded responds strongly
to changes in price
! rice elasticity of demand is greaterthan one
A Dariety of -emand C#rvesA Dariety of -emand C#rves
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erfectly %nelastic! 6#antity demanded does not respond to
price changes
erfectly Elastic! 6#antity demanded changes infinitely
"ith any change in price
nit Elastic
! 6#antity demanded changes by thesame percentage as the price
erfectly %nelastic! 6#antity demanded does not respond to
price changes
erfectly Elastic! 6#antity demanded changes infinitely
"ith any change in price
nit Elastic
! 6#antity demanded changes by thesame percentage as the price
A Dariety of -emand C#rvesA Dariety of -emand C#rves
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3eca#se the price elasticity of demandmeas#res ho" m#ch /#antity demandedresponds to the price, it is closely relatedto the slope of the demand c#rve
3eca#se the price elasticity of demandmeas#res ho" m#ch /#antity demandedresponds to the price, it is closely relatedto the slope of the demand c#rve
A Dariety of -emand C#rvesA Dariety of -emand C#rves
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E 0
& 6#antity
rice -emand
%&&
%. 'n increasein price(
)4.&&
)5.&&
2. (lea*es the +antit- demanded nchanged.
ig#re 578 a91 erfectly %nelastic -emandig#re 578 a91 erfectly %nelastic -emand
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E F 8
& 6#antity
rice
%&&
%. ' 22increase inprice(
)5.&&
2. ( /eads to a %% decrease in +antit- demanded.
0emand
)4.&&
$&
ig#re 578 b91 %nelastic -emandig#re 578 b91 %nelastic -emand
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E 8
& 6#antity
rice
%&&
%. ' 22increase inprice(
)5.&&
2. ( /eads to a 22 decrease in +antit- demanded.
0emand
)4.&&
#&
ig#re 578 c91 nit Elastic -emandig#re 578 c91 nit Elastic -emand
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E G 8
& 6#antity
rice
%&&
%. ' 22increase inprice(
)5.&&
2. ( /eads to a " decrease in +antit- demanded.
0emand
)4.&&
5&
ig#re 578 d91 Elastic -emandig#re 578 d91 Elastic -emand
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E
&6#antity
rice
2. 't e1actl- )4, consmers will - an- +antit-.
)4.&& 0emand
%. 't an- price ao*e )4, +antit-
demanded is ero.
3. 't an- price elow )4, +antit- demanded is infinite.
ig#re 578 e91 erfectly Elastic -emandig#re 578 e91 erfectly Elastic -emand
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Total revenueis the amo#nt paid byb#yers and received by sellers of a good
Comp#ted as the price of the good timesthe /#antity sold
TH ! 6
Total revenueis the amo#nt paid byb#yers and received by sellers of a good
Comp#ted as the price of the good timesthe /#antity sold
TH ! 6
Total Heven#e and the rice Elasticity ofTotal Heven#e and the rice Elasticity of
-emand-emand
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rice
6#antity& %&&
0emand
P 1 Q = )4&&
re*ene
)4.&&
ig#re 5721 Total Heven#eig#re 5721 Total Heven#e
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rice
6#antity& #&
0emand
)3.&&
P 1 Q = )4&&re*ene
P 1 Q = )%&& re*ene
)%.&&
%&&
ig#re 57?1 (o" Total Heven#e Changesig#re 57?1 (o" Total Heven#e Changes
4hen rices Changes1 %nelastic -emand4hen rices Changes1 %nelastic -emand
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rice
6#antity
Change in Total Heven#e "hen rice Changes
& 5&
0emand
)4.&&
)5.&&
2&
6e*ene 7 )%&&
6e*ene 7 )2&&
ig#re 57B1 (o" Total Heven#e Changesig#re 57B1 (o" Total Heven#e Changes
4hen rices Changes1 Elastic -emand4hen rices Changes1 Elastic -emand
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4ith an elastic demand c#rve, an increasein the price leads to a decrease in /#antitydemanded that is proportionately largerTh#s, total revenue decreases.
4ith an elastic demand c#rve, an increasein the price leads to a decrease in /#antitydemanded that is proportionately largerTh#s, total revenue decreases.
Elasticity and Total Heven#e along a LinearElasticity and Total Heven#e along a Linear
-emand C#rve-emand C#rve
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Table 578 Elasticity and Total Heven#e alongTable 578 Elasticity and Total Heven#e along
a Linear -emand C#rvea Linear -emand C#rve
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rice
6#antity2 B @ 80 820
5
B
?
2
8
I
8B
Elasticit-is largerthan %.
Elasticit-is smallerthan %.
ig#re 5751 A Linear -emand C#rveig#re 5751 A Linear -emand C#rve
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Income elasticity of demandmeas#resho" m#ch the /#antity demanded of agood responds to a change in cons#mersJincome
%t is comp#ted as the percentage changein the /#antity demanded divided by thepercentage change in income
Income elasticity of demandmeas#resho" m#ch the /#antity demanded of agood responds to a change in cons#mersJincome
%t is comp#ted as the percentage changein the /#antity demanded divided by thepercentage change in income
+ther -emand Elasticities+ther -emand Elasticities
Income elasticity of demand =
Percentage changein quantity demanded
Percentage changein income
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Types of Koods! Normal Koods
! %nferior Koods
(igher income raises the /#antitydemanded for normal goods b#t lo"ersthe /#antity demanded for inferior goods
Types of Koods! Normal Koods
! %nferior Koods
(igher income raises the /#antitydemanded for normal goods b#t lo"ersthe /#antity demanded for inferior goods
+ther -emand Elasticities+ther -emand Elasticities
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Koods cons#mers regard as necessitiestend to be income inelastic
! E!amples incl#de food, f#el, clothing,#tilities, and medical services
Koods cons#mers regard as l#!#ries tendto be income elastic
! E!amples incl#de sports cars, f#rs, and
e!pensive foods
Koods cons#mers regard as necessitiestend to be income inelastic
! E!amples incl#de food, f#el, clothing,#tilities, and medical services
Koods cons#mers regard as l#!#ries tendto be income elastic
! E!amples incl#de sports cars, f#rs, and
e!pensive foods
+ther -emand Elasticities+ther -emand Elasticities
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Cross-Price elasticity of demandmeas#resho" m#ch the /#antity demanded of agood responds to a change in the price ofanother good
%t is comp#ted as the percentage change inthe /#antity demanded divided by thepercentage change in the price of thesecond good
Cross-Price elasticity of demandmeas#res
ho" m#ch the /#antity demanded of agood responds to a change in the price ofanother good
%t is comp#ted as the percentage change in
the /#antity demanded divided by thepercentage change in the price of thesecond good
+ther -emand Elasticities+ther -emand Elasticities
Income elasticity of demand =
Percentage changein quantity demanded
Percentage changeinthe price of
good 2.
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Price elasticity of supplyis a meas#re ofho" m#ch the /#antity s#pplied of a goodresponds to a change in the price of thatgood
rice elasticity of s#pply is the percentagechange in /#antity s#pplied given apercent change in the price
Price elasticity of supplyis a meas#re ofho" m#ch the /#antity s#pplied of a goodresponds to a change in the price of thatgood
rice elasticity of s#pply is the percentagechange in /#antity s#pplied given apercent change in the price
H%CE ELA)T%C%T* + )L*H%CE ELA)T%C%T* + )L*
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Ability of sellers to change the amo#nt ofthe good they prod#ce
! 3each7front land is inelastic
! 3oo$s, cars, or man#fact#red goods areelastic
Time period
! )#pply is more elastic in the long r#n
Ability of sellers to change the amo#nt ofthe good they prod#ce
! 3each7front land is inelastic
! 3oo$s, cars, or man#fact#red goods areelastic
Time period
! )#pply is more elastic in the long r#n
The rice Elasticity of )#pply and %tsThe rice Elasticity of )#pply and %ts
-eterminants-eterminants
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The price elasticity of s#pply is comp#tedas the percentage change in the /#antitys#pplied divided by the percentagechange in price
The price elasticity of s#pply is comp#tedas the percentage change in the /#antitys#pplied divided by the percentagechange in price
Comp#ting the rice Elasticity of )#pplyComp#ting the rice Elasticity of )#pply
Price elasticity of supply =
Percentage changein quantity supplied
Percentage change in price
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& #sing the midpoint method, "e calc#late the percent change inthe price as 280 7 809 : 200 ! 800 80>
)imilarly, "e calc#late the percent change in the /#antity s#ppliedas 88 000 7 0009 : 80 000 ! 800 20>
& #sing the midpoint method, "e calc#late the percent change inthe price as 280 7 809 : 200 ! 800 80>
)imilarly, "e calc#late the percent change in the /#antity s#ppliedas 88 000 7 0009 : 80 000 ! 800 20>
20>rice elasticity of s#pply
)#ppose an increase in the price of mil$ from 80 to 280 a litre raisesthe amo#nt that dairy farmers prod#ce from 000 to 88 000 L per month&
)#ppose an increase in the price of mil$ from 80 to 280 a litre raisesthe amo#nt that dairy farmers prod#ce from 000 to 88 000 L per month&
20
Comp#ting the rice Elasticity of )#pplyComp#ting the rice Elasticity of )#pply
80>
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E 0
& 6#antity
rice
8ppl-
%. 'n increasein price(
)5.&&
2. (lea*es the +antit- spplied nchanged.
%&&
)4.&&
ig#re 57 a91 erfectly %nelastic )#pplyig#re 57 a91 erfectly %nelastic )#pply
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E F 0
& 6#antity
rice
8ppl-
%&&
%. ' 22increase inprice(
)5.&&
2. (leads to a %& increase in +antit-spplied.
)4.&&
%%&
ig#re 57 b91 %nelastic )#pplyig#re 57 b91 %nelastic )#pply
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E 8
& 6#antity
rice
8ppl-
%&&
%. ' 22increase inprice(
)5.&&
2. (leads to a 22 increase in +antit-spplied.
)4.&&
%25
ig#re 57 c91 nit Elastic )#pplyig#re 57 c91 nit Elastic )#pply
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E G 8
& 6#antity
rice
8ppl-
%&&
%. ' 22increase inprice(
)5.&&
2. (leads to a " increase in +antit-spplied.
)4.&&
2&&
ig#re 57 d91 Elastic )#pplyig#re 57 d91 Elastic )#pply
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E
&6#antity
rice
2. 't e1actl- )4, prodcers will sppl- an- +antit-.
)4.&& 8ppl-
%. 't an- price ao*e )4, +antit-
spplied is infinite.
3. 't an- price elow )4, +antit- spplied is ero.
ig#re 57 e91 erfectly Elastic )#pplyig#re 57 e91 erfectly Elastic )#pply
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&6#antity
rice
)3
%&&
)4
2&&
)%2
5&&
)%5
525
Elasticit- isgreater than %
Elasticit- is lessthan %
ig#re 57I1ig#re 57I1 (o" the price elasticity of s#pply(o" the price elasticity of s#pply
can varycan vary
T(HEE A %CAT%+N) + ) *
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Kood ne"s bad ne"s for farmers
+EC
-r#gs and crime
Kood ne"s bad ne"s for farmers
+EC
-r#gs and crime
T(HEE AL%CAT%+N) + )L*,T(HEE AL%CAT%+N) + )L*,
-E.AN-, AN- ELA)T%C%T*-E.AN-, AN- ELA)T%C%T*
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%ncrease in )#pply
0emand
8%
)3
6#antity of 4heat
rice of
4heat
82
2. ( leadsto a fall inprice(
3. (and a proportionatel- smaller increase in +antit- sold. 's a reslt re*ene
falls from )3&& to )22&.
%. 9hen demand is inelastic, anincrease in sppl-(
880800
)2
ig#re 57@1ig#re 57@1 An %ncrease in )#pply in theAn %ncrease in )#pply in the
.ar$et for 4heat.ar$et for 4heat
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0emand
8%
6#antity of +il
riceof +il
82
%. n the short rn, when sppl-and demand are inelastic, a shiftin sppl-(
2. ( leadsto a largeincrease inprice(
P1
P2
0emand
8%
6#antity of +il
82
%. n the long rn, when sppl-and demand are elastic, a shift insppl-(
2. ( leadsto a smallincrease inprice(
P1
P2
riceof +il
a9 +il .ar$et in the )hort H#n b9 +il .ar$et in the Long H#n
ig#re 571ig#re 571 A Hed#ction in )#pply in theA Hed#ction in )#pply in the
4orld .ar$et for +il4orld .ar$et for +il
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0emand
8%
6#antity of -r#gs
rice of
-r#gs82
%. 0rg interdiction redces thesppl- of drgs(
2. ( whichraises theprice(
P1
P2
0%
8,ppl-
%. 0rg edcation redces thedemand for drgs(
2. ( which
redces theprice(
a9 -r#g %nterdiction b9 -r#g Ed#cation
Q1
Q2
3. ( and redces the
+antit- sold.
Q2
3. ( and redces the +antit-
sold.
6#antity of -r#gs
rice of
-r#gs
02
P1
Q1
P2
ig#re 57801ig#re 57801 olicies to Hed#ce the of %llegalolicies to Hed#ce the of %llegal
-r#gs-r#gs
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rice elasticity of demand meas#res ho" m#chthe /#antity demanded responds to changes inthe price
rice elasticity of demand is calc#lated as the
percentage change in /#antity demanded dividedby the percentage change in price
%f a demand c#rve is elastic, total reven#e falls"hen the price rises
%f it is inelastic, total reven#e rises as the pricerises
rice elasticity of demand meas#res ho" m#chthe /#antity demanded responds to changes inthe price
rice elasticity of demand is calc#lated as thepercentage change in /#antity demanded dividedby the percentage change in price
%f a demand c#rve is elastic, total reven#e falls"hen the price rises
%f it is inelastic, total reven#e rises as the pricerises
)#mmary)#mmary
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The income elasticity of demand meas#res ho"m#ch the /#antity demanded responds tochanges in cons#mersJ income
The cross7price elasticity of demand meas#res
ho" m#ch the /#antity demanded of one goodresponds to the price of another good
The price elasticity of s#pply meas#res ho"m#ch the /#antity s#pplied responds to changesin the price
The income elasticity of demand meas#res ho"m#ch the /#antity demanded responds tochanges in cons#mersJ income
The cross7price elasticity of demand meas#resho" m#ch the /#antity demanded of one goodresponds to the price of another good
The price elasticity of s#pply meas#res ho"m#ch the /#antity s#pplied responds to changesin the price
)#mmary)#mmary
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%n most mar$ets, s#pply is more elastic in thelong r#n than in the short r#n
The price elasticity of s#pply is calc#lated as thepercentage change in /#antity s#pplied divided
by the percentage change in price The tools of s#pply and demand can be applied in
many different types of mar$ets
%n most mar$ets, s#pply is more elastic in thelong r#n than in the short r#n
The price elasticity of s#pply is calc#lated as thepercentage change in /#antity s#pplied dividedby the percentage change in price
The tools of s#pply and demand can be applied inmany different types of mar$ets
)#mmary)#mmary
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The EndThe End