Chapter 5

Terms:

In/elastic
perfectly (in)elastic
total revenue
own price (S and D) elasticity
cross price (substitutes/complements) elasticity
income (normal/inferior goods) elasticity
ceiling/floor
shortage/surplus

How much do consumers/producers react to changes in prices?  How steep/flat are the D and S curves? What is the price elasticity of each curve?
What factors will impact this?

necessity/luxury (where does addiction fit in?)
close substitutes
time horizon (long and short run)
what 'market' is being considered?

% change in Q demanded/% change in P = (DQ/Q)/(Dp/p) = 1/slope * p/Q

inelastic – large change in price leads to small change in quantity – elasticity <1
elastic – small change in price leads to large change in quantity – elasticity >1
unit elastic (unitary elasticity) – 1 unit change in price leads to 1 unit change in quantity
zero elasticity (perfectly inelastic) – no matter how great the change in price, quantity will remain unchanged
infinite elasticity (perfectly elastic) – no matter how small the change in price, quantity will drop to zero.

Can we graph each of these?

Demand elasticity is generally negative, while supply elasticity is positive.

How does elasticity impact revenues?

Will raising the price always increase revenues?

First, what is revenue?

P*Q=TR (or R)

For inelastic demand, increases in price lead to an increase revenue.

Example:

P=$4, Q=1000
50% increase in price
25% decrease in quantity
P=$6, Q= 750
Calculate TR and elasticity.
$4000, $4500

Demand elasticity is -.5. This is an inelastic demand.

What if demand elasticity had been 2?

P=4, Q=1000
25% increase in price
50% decrease in quantity
P=3, Q=500
TR = 4000, 1500

Economists also calculate:

income elasticity of demand

% change in Q/% change in income

Normal goods have an income elasticity greater than 0, inferior goods less than 0.

cross-price elasticity of demand:

% change in quantity demanded of good 1/% change in price of good 2

What sign will complements have? -

How about substitutes? +

price elasticity of supply:

% change in quantity supplied/% change in price

Supply can also be in(elastic). Inelastic means steep, elastic means flatter.

The steepness of the curves depends on the length of time also.

In the short run both supply and demand may be steeper than they are in the long run.

What happens when government intervenes - ex: price floor (minimum wage)

Standard supply and demand analysis suggests that this will cause a surplus of workers - unemployment.

Impact of the minimum wage depends on elasticity.
If labor supply and demand are inelastic, unemployment effect will be minimal.
If on the other hand, supply and/or demand is elastic, unemployment effect may be large.

A price ceiling or price floor – the former will likely cause a shortage, while the latter causes a surplus.

What goods in the US are subject to either price ceilings or floors?

Rent, wages, certain agricultural commodities