economics chapter 10 price elasticity of demand and supply
TRANSCRIPT
Economics
Chapter 10
Price elasticity of
Demand and Supply
Law of demand
∆P ∆Qd , ceteris paribus* P Qd or P Qd
P ($)
Q
Given
1. When price , Qd ?
Qd of toy car Qd of doll
2. Which one shows greater effect when P by 10%?
Qd of toy car: 10 units / 10%
Qd of doll: 20 units / 100%∴ Doll reflects greater respond to ∆P
Price Toy Car Doll
Qd (unit /day) $100 100 20
Qd (unit /day) $90 110 40
Price elasticity of demand
Measures the responsiveness of quantity demanded to a change in price
Percentage change in quantity demanded over one percent change in price
% ∆ Qd Ed = ---------- % ∆ P
Price elasticity of demand
Example (p.75) When P
Price elasticity of demand
Example (p.76) When P
Price elasticity of demand
Example (p.76) Midpoint formula
Price elasticity of demand
Calculate Ed of toy car and doll when Prices drop Prices rise By using midpoint formula
Toy Car Doll
Qd (unit /day, P=$100) 100 20
Qd (unit /day, P=$90) 110 40
Price elasticity of demand
Given a straight line demand curve :Slope of demand curve = 6-0 / 0-6 = -1Slope = 1, with negative relationship between P and Qd
Price elasticity:If ∆P = $6$0,
∆ Qd = 0 unit 6 unitsEd = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)= [(6-0) / ((6+0)/2)] / [(0-6) / ((6+0)/2))]= -1
Is Ed = Slope of straight line demand curve?
Price elasticity of demand
If ∆P = $5$4, ∆ Qd = 1 unit 2 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(2-1) / ((2+1)/2)] / [(5-4) / ((4+5)/2)]
= (1/1.5) / (1/4.5) = 3
Slope of demand curve = 1 Ed ≠Slope of demand curve?
Price elasticity of demand
If ∆P = $4$3, ∆ Qd = 2 unit 3 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(3-2) / ((3+2)/2)] / [(4-3) / ((4+3)/2)]
= (1/2.5) / (1/3.5) = 1.4
Slope of demand curve = 1 Ed ≠Slope of demand curve?
Price elasticity of demand
If ∆P = $3$2, ∆ Qd = 3 unit 4 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(4-3) / ((4+3)/2)] / [(3-2) / ((3+2)/2)]
= (1/3.5) / (1/2.5) = 0.714
Slope of demand curve = 1 Ed ≠Slope of demand curve?
Price elasticity of demand
If ∆P = $2$1, ∆ Qd = 4 unit 5 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(5-4) / ((5+4)/2)] / [(2-1) / ((2+1)/2)]
= (1/4.5) / (1/1.5) = 0.33
Slope of demand curve = 1 Ed ≠Slope of demand curve?
Price elasticity of demand
P ($)
Q
Ed < 1
Ed > 1Ed = 1
0
5 Types of elasticity of demand
Elastic demand Elasticity is greater than 1 (Ed > 1) Percentage change in quantity demanded is greater than
percentage change in price (%∆ Qd > %∆P) Example
Toys
D
P ($)
Q0
5 Types of elasticity of demand
Inelastic demand Elasticity is smaller than 1 (Ed < 1) Percentage change in quantity demanded is smaller than
percentage change in price (%∆ Qd < %∆P)
Example Transportation
D
P ($)
Q0
5 Types of elasticity of demand
Unitary elastic demand Elasticity equals 1 (Ed = 1) Percentage change in quantity demanded equals the
percentage change in price (%∆ Qd = %∆P)
D (regular hyperbola)
P ($)
Q0
5 Types of elasticity of demand
Perfectly elastic demand Elasticity equals infinity (Ed = ∞) A slightly rise in price will cause quantity demanded fall to 0.
i.e. %∆P Example: Lucky draw ticket
D (horizontal)
P ($)
Q0
5 Types of elasticity of demand
Perfectly inelastic demand Elasticity equals 0 (Ed = 0) Price change has no effect on the quantity
demanded. (i.e. %∆Qd = 0) Example: HKID card
D (vertical)
P ($)
Q0
Factors affecting price elasticity of demand
SubstitutesQuantity
More substitutes Easier to be replaced Price elasticity E.g.
When MTR started operation Ed of bus service
(MTR South Island Line)When 3DTV launched Ed of TV sets Technology of recycled energy Ed of traditional energy sources
Factors affecting price elasticity of demand
SubstitutesSubstitutability
Similar goods have high substitutabilityHigher substitutability Price elasticityE.g.
Snacks and soft drinks: Many brands Ed Laptop (similar function): Many brands Ed Bank services: Many banks in the market Ed MTR service: Less choice EdUniversity programmes: A few choice only Ed
Factors affecting price elasticity of demand
What one has higher price elasticity of demand, hamburger or water? Why?
Hamburger is more elasticas a kind of food more substitutes Ed as a brand many other brands Ed
Water is not elasticas a kind of element (functional): no close substitutes Edas a brand comparatively less brands Ed is not high
Factors affecting price elasticity of demand
The way of determining a good1. Salt
As an element (NaCl) : No close substitute Very inelastic
As different brands, e.g. Taikoo Salt, First choice, No frills:Many brands Very elastic
2. Water As an element(H2O) :
No close substitute Very inelastic As different brands, e.g. Watsons, Bonaqua, Vita
Many brands Very elastic As different packages, e.g. 500mL, 1L, 2L, 5L, 10L, 1Lx6
Many packages Very elastic
Factors affecting price elasticity of demand
TypesNecessities
Lower price elasticity, Price Less change in QdE.g. electricity, tap water, public transports
LuxuriesHigher price elasticity, Price Greater response in Qd E.g. visiting Disneyland, travelling overseas
Think about: Go to schoolDatingWedding
Wedding banquet Fish fin
Factors affecting price elasticity of demand
TimeLonger time after ∆P
Easier to find substitutes Ed Less change in Qd
E.g. 1. Price of oil People take time to develop new technology More substitutes Less relying on oil Ed 2. Price of washing powder Shortly, no close substitutes Low Ed People take time to develop new technology: washing ball No need to use washing powder Ed of washing powder
Factors affecting price elasticity of demand
Exceptional casesCase of Cross-Harbour Tunnel (1984, Dr. T.D.Hau)
Toll
Usage 15% , shift to vehicle ferry
Inconvenient, and no way to find substitutes
Go back to 98% of normal usage before PCase of Cross-Harbour Tunnel (Now)
Toll
Usage , shift to Eastern and Western Harbour Tunnels
Time cost (Inconvenient) + higher tolls (EHT & WHT)
Go back to similar usage before P
Factors affecting price elasticity of demand
Proportion of income spent on goodSmall proportion More inelasticLarge proportion More elastic
Soy sauce Travelling
Monthly expenditure $10 $600
Expenditure after P by 10% (Qd unchanged) $11 $660
Additional expenditure $1 $60
Incentive to find substitute Low High
Therefore, price elasticity is… Low High
Factors affecting price elasticity of demand Question (p.84)
Suppose the cost of finding substitutes for soy sauce and bus service are both $5. Explain whether you would find substitute for them.
Answer:The benefit of finding substitutes for soy sauce is low relative to the cost. Therefore, consumers may not find substitutes for it.However, for bus service, the benefit is relatively high when compared to the cost, consumers may search for its substitutes.
Relationship between Ed and total revenue
Total revenue (R)= Total expenditure = Total market value = Price x Quantity transacted
= P x Q E.g. PA = $10 per unit, Q = 50 units
Total revenue of Good A = $10 x 50 = $500
Elasticity and change of total revenue
1. Elastic demand and revenueRise in price
At P1 and Q1: R = P1xQ1 = Area (A+B) When P (from P1 to P2), Q (from Q1 to Q2) R = P2xQ2 = Area (A+C) Loss (Area B) > Gain (Area C) R
Elastic (Ed>1): %∆Qd > %∆P R () = P() x Q()
D
P ($)
Q0
Cgain
BLossA
P2
P1
Q1Q2
more
Elasticity and change of total revenue
1. Elastic demand and revenueFall in price
At P1 and Q1: R = P1xQ1 = Area (A+C) When P (from P1 to P2), Q (from Q1 to Q2) R = P2xQ2 = Area (A+B) Gain (Area B) > Loss (Area C) R
Elastic (Ed>1): %∆Qd > %∆P R () = P () x Q()
D
P ($)
Q0
CLoss
BGainA
P2
P1
Q2Q1
more
Elasticity and change of total revenue
2. Inelastic demand and revenueRise in price
At P1 and Q1: R = P1xQ1 = Area (A+B) When P (from P1 to P2), Q (from Q1 to Q2) R = P2x Q2 = Area (A+C) Loss (Area B) < Gain (Area C) R
Elastic (Ed<1): %∆Qd < %∆P R () = P() x Q()
D
P ($)
Q0
Cgain
BLossA
P2
P1
Q1Q2
more
Elasticity and change of total revenue
2. Inelastic demand and revenueFall in price
At P1 and Q1: R = P1xQ1 = Area (A+C) When P (from P1 to P2), Q (from Q1 to Q2) R = P2 x Q2 = Area (A+B) Gain (Area B) < Loss (Area C) R
Elastic (Ed<1): %∆Qd < %∆P R () = P () x Q()
more
D
P ($)
Q0
CLoss
BGainA
P1
P2
Q2Q1
Elasticity and change of total revenue
3. Unitary elastic demand and revenueRise in price
At P1 and Q1: R = P1xQ1 = Area (A+B) When P (from P1 to P2), Q (from Q1 to Q2) R = P2x Q2 = Area (A+C) Loss (Area B) = Gain (Area C) R remains unchanged
Elastic (Ed=1): %∆Qd = %∆P R (remains unchanged) = P() x Q()
0
Cgain
BLossA
P2
P1
Q1Q2
more
P ($)
Q
Summary
Question (p.90)Pam’s monthly expenditure on apples remains unchanged after a rise in price. What is the elasticity of demand of apples? Explain. (3)Answer:Unitary elastic. Expenditure = Price x Quantity. Since her expenditure on apples remains unchanged, the percentage increase in price equals the percentage decrease in quantity demanded. So it is unitary elastic demand.
MC questionWhat can the elasticity of demand of Good X be if its revenue drops by 10% when its price rises by 5%?A. 0.5 B. 1 C. 5 D. Infinity
∆P vs. ∆Revenue Reason
Elastic demandP R P R
%∆Qd > %∆P
Inelastic demandP R P R
%∆Qd < %∆P
Unitary elastic demandP
R remains unchanged%∆Qd = %∆P
Effects on change in supply
Supply curve shifts1. Increase in supply P & Q
a. Elastic demand (Ed>1): P Rb. Unitary elastic demand (Ed=1): PR unchangedc. Inelastic demand (Ed<1): PR
D
P ($)
Q0
CLoss
BGainA
P1
P2
Q2Q1
S2
S1
Effects on change in supply
Supply curve shifts2. Decrease in supply P & Q
a. Elastic demand (Ed>1): P Rb. Unitary elastic demand (Ed=1): P R unchangedc. Inelastic demand (Ed<1): P R
D
P ($)
Q0
Cgain
BLossA
P2
P1
Q1Q2
S1
S2
Effects on change in demand
Demand curve shifts3. Increase in demand P & Q
a. Elastic demand (Ed>1): R b. Unitary elastic demand (Ed=1): R dc. Inelastic demand (Ed<1): R
4. Decrease in demand P & Q a. Elastic demand (Ed>1): R b. Unitary elastic demand (Ed=1): R c. Inelastic demand (Ed<1): R
D1
P ($)
Q0
Cgain
P2
P1
Q1 Q2
D2
S
Price elasticity of supply
Measures the responsiveness of quantity supplied to a change in price
Percentage change in quantity supplied over one percent change in price
% ∆ QS Ed = ---------- % ∆ P
Price elasticity of supply
Example (p.95) Midpoint formula
%40%100125
50%100
2/)100150(
100150%
xxQs
%18.18%10011$
2$%100
2/)10$12($
10$12$%
xxP
2.2%18.18
%40Ed
Price elasticity of supply
Example (p.95) Midpoint formula
%52.9%100105
10%100
2/)100110(
100110%100
.%
xxxQsAvg
QsQs
%88.4%1005.512$
25$%100
2/)500$525($
500$525$%100
.%
xxxPAvg
PP
95.1%88.4
%52.9Ed
Price elasticity of supply
Example (p.95) Taking the case of P
%50%100100
50%100
100
100150%
xxQs
%20%10010$
2$%100
10$
10$12$%
xxP
5.2%20
%50Ed
Price elasticity of supply
Example (p.95) Midpoint formula
%40%100125
50%100
2/)100150(
100150%
xxQs
%18.18%10011$
2$%100
2/)10$12($
10$12$%
xxP
2.2%18.18
%40Ed
5 Types of elasticity of supply
Elastic supply Elasticity is greater than 1 (Es > 1) %∆ Qs > %∆P
Inelastic supply Elasticity is smaller than 1 (Es < 1) %∆ Qs < %∆P
S
P ($)
Q0
S
P ($)
Q0
5 Types of elasticity of supply
Unitary elastic supply Elasticity equals 1 (Ed = 1) %∆ Qs = %∆P
SP ($)
Q0
5 Types of elasticity of supply
Perfectly elastic supply Elasticity equals infinity (Ed = ∞) A slightly rise in price will cause quantity supplied fall to 0.
i.e. %∆P
S (horizontal)
P ($)
Q0
5 Types of elasticity of supply
Perfectly inelastic supply Elasticity equals 0 (Ed = 0) Price change has no effect on the quantity
supplied. (i.e. %∆Qs = 0)
S (vertical)
P ($)
Q0
Factors affecting price elasticity of supply
1. Factors of productiona. Values of factors of production different uses
Products required non-specialized factors Price elasticity E.g.
GarmentP Qs no need to hire many factors non-specialized factors (e.g. low-skilled workers) leave the product and go to another industry Greater fall in Qs
Products required specialized factors Price elasticity Medical service (factor: equipment) P temporary, no increase in equipment because too specialized Qs has less effect on price changeOr Demand
P Existing equipment can’t be used for other purposes Change of Qs has less response
Factors affecting price elasticity of supply
1. Factors of productionb. Adjustment cost of the cost of production
Production with non-specialized factors Es E.g. Clerk, easier to hire when needed
Production with specialized factors Es University principal, need to go through many procedures
Factors affecting price elasticity of supply
1. Factors of productionc. Availability of information
More information Es
d. Reserve capacity of equipment More reserve Es
e. Idle resources in the economy More resources Es
f. Occupational/Geographical Mobility Higher mobility Es
Factors affecting price elasticity of supply
2. Nature of products Easily perishable Es
E.g. flowers at flower market: worthless if unsold
3. Market structure and entry barrier Restriction on output Es How to restrict?
Entry barrier (e.g. registration is needed to become a doctor) Monopoly (e.g. water supply) Quota on imported goods
Factors affecting price elasticity of supply
4. Time Long the time Es
More time to hire/release factors of production When P
High cost to increase output shortly Longer the time, more firms join the market, output
S1P ($)
Q0
S2
Cases of perfectly inelastic supply
1. Output limitation Qs cannot be increases shortly
E.g. Cross Harbour Tunnel at peak hours Public Hospital (esp. maternity services) in HK Application of China Visa
Q0
Cases of perfectly inelastic supply
1. Output limitation Qs cannot be increases shortly
E.g. Cross Harbour Tunnel at peak hours Public Hospital (esp. maternity services) in HK Application of China Visa
2. Goods or services of non-profit making bodies Qs cannot be changed in accordance to price change
E.g. Public housing (gov’t policy) Police service Social welfare service by NGO
Cases of perfectly inelastic supply
3. Government control Quotas
E.g. Taxi license Broadcasting license
4. Land supply Qs is fixed In terms of natural resources, but not the ownership of
a piece of land by the gov’t