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Economics

Economics. Chapter 10 Price elasticity of Demand and Supply. Law of demand. ∆P  ∆Q d , ceteris paribus* P   Q d  or P   Q d . P ($). Q. Given. 1. When price , Q d ? Q d of toy car  Q d of doll  2. Which one shows greater effect when P  by 10%?

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Economics

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  1. Economics Chapter 10 Price elasticity of Demand and Supply

  2. Law of demand • ∆P  ∆Qd , ceteris paribus* • P  Qd  or P   Qd  P ($) Q

  3. 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

  4. 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

  5. Price elasticity of demand • Example (p.75) • When P

  6. Price elasticity of demand • Example (p.76) • When P

  7. Price elasticity of demand • Example (p.76) • Midpoint formula

  8. Price elasticity of demand • Calculate Ed of toy car and doll when • Prices drop • Prices rise • By using midpoint formula

  9. Price elasticity of demand • Given a straight line demand curve : Slope of demand curve = 6-0 / 0-6 = -1 Slope = 1, with negative relationship between P and Qd • Price elasticity: If ∆P = $6$0, ∆ Qd = 0 unit 6 units Ed = %∆ 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?

  10. 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?

  11. 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?

  12. 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?

  13. 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?

  14. Price elasticity of demand P ($) Ed > 1 Ed = 1 Ed < 1 Q 0

  15. 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 P ($) D 0 Q

  16. 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 P ($) D 0 Q

  17. 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) P ($) D (regular hyperbola) 0 Q

  18. 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 P ($) D (horizontal) 0 Q

  19. 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 P ($) D (vertical) 0 Q

  20. Factors affecting price elasticity of demand • Substitutes • Quantity • 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 

  21. Factors affecting price elasticity of demand • Substitutes • Substitutability • Similar goods have high substitutability • Higher substitutability  Price elasticity • E.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  Ed • University programmes: A few choice only  Ed

  22. Factors affecting price elasticity of demand • What one has higher price elasticity of demand, hamburger or water? Why? • Hamburger is more elastic • as a kind of food more substitutes  Ed  • as a brand  many other brands  Ed  • Water is not elastic • as a kind of element (functional): no close substitutes  Ed • as a brand  comparatively less brands  Ed is not high

  23. Factors affecting price elasticity of demand • The way of determining a good 1. 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

  24. Factors affecting price elasticity of demand • Types • Necessities • Lower price elasticity, Price  Less change in Qd • E.g. electricity, tap water, public transports • Luxuries • Higher price elasticity, Price  Greater response in Qd • E.g. visiting Disneyland, travelling overseas • Think about: • Go to school • Dating • Wedding • Wedding banquet • Fish fin

  25. Factors affecting price elasticity of demand • Time • Longer 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

  26. Factors affecting price elasticity of demand • Exceptional cases • Case 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 P • Case 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

  27. Factors affecting price elasticity of demand • Proportion of income spent on good • Small proportion  More inelastic • Large proportion  More elastic

  28. 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.

  29. 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

  30. P ($) P2 C gain P1 D B Loss A 0 Q Q2 Q1 Elasticity and change of total revenue 1. Elastic demand and revenue Rise 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() more

  31. Elasticity and change of total revenue 1. Elastic demand and revenue Fall 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() P ($) P1 C Loss D P2 B Gain more A 0 Q Q1 Q2

  32. Elasticity and change of total revenue 2. Inelastic demand and revenue Rise 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() P ($) P2 C gain P1 more B Loss A D 0 Q Q2 Q1

  33. Elasticity and change of total revenue 2. Inelastic demand and revenue Fall 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() P ($) P1 C Loss P2 more B Gain A D 0 Q Q1 Q2

  34. Elasticity and change of total revenue 3. Unitary elastic demand and revenue Rise 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() P ($) P2 C gain P1 more A B Loss Q Q2 Q1 0

  35. 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 question What 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

  36. Effects on change in supply Supply curve shifts 1. Increase in supply  P & Q • Elastic demand (Ed>1): P R • Unitary elastic demand (Ed=1): PR unchanged • Inelastic demand (Ed<1): PR S1 P ($) S2 P1 C Loss P2 D B Gain A 0 Q Q1 Q2

  37. Effects on change in supply Supply curve shifts 2. Decrease in supply  P & Q  • Elastic demand (Ed>1): P  R • Unitary elastic demand (Ed=1): P R unchanged • Inelastic demand (Ed<1): P R  S2 P ($) S1 P2 C gain P1 D B Loss A 0 Q Q2 Q1

  38. Effects on change in demand Demand curve shifts 3. Increase in demand  P & Q  • Elastic demand (Ed>1): R  • Unitary elastic demand (Ed=1): Rd • Inelastic demand (Ed<1): R  4. Decrease in demand  P & Q  • Elastic demand (Ed>1): R  • Unitary elastic demand (Ed=1): R  • Inelastic demand (Ed<1): R  P ($) S P2 D2 C gain P1 D1 0 Q Q1 Q2

  39. 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

  40. Price elasticity of supply • Example (p.95) • Midpoint formula

  41. Price elasticity of supply • Example (p.95) • Midpoint formula

  42. Price elasticity of supply • Example (p.95) • Taking the case of P

  43. Price elasticity of supply • Example (p.95) • Midpoint formula

  44. 5 Types of elasticity of supply P ($) • Elastic supply • Elasticity is greater than 1 (Es > 1) • %∆ Qs > %∆P • Inelastic supply • Elasticity is smaller than 1 (Es < 1) • %∆ Qs < %∆P S Q 0 P ($) S Q 0

  45. 5 Types of elasticity of supply • Unitary elastic supply • Elasticity equals 1 (Ed = 1) • %∆ Qs = %∆P P ($) S 0 Q

  46. 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 P ($) S (horizontal) 0 Q

  47. 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) P ($) S (vertical) 0 Q

  48. Factors affecting price elasticity of supply 1. Factors of production a. Values of factors of production different uses • Products required non-specialized factors  Price elasticity  • E.g. • Garment • P   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 change Or Demand   P   Existing equipment can’t be used for other purposes  Change of Qs has less response

  49. Factors affecting price elasticity of supply 1. Factors of production b. 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

  50. Factors affecting price elasticity of supply • Factors of production • Availability of information • More information  Es  • Reserve capacity of equipment • More reserve  Es  • Idle resources in the economy • More resources  Es  • Occupational/Geographical Mobility • Higher mobility  Es 

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