economics laws of supply, demand, and elasticity
economics laws of supply, demand, and elasticity Economics 22060-002
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This 7 page Bundle was uploaded by Brendan O'Donnell on Tuesday February 2, 2016. The Bundle belongs to Economics 22060-002 at Kent State University taught by Harris, Jeremiah R. in Winter 2016. Since its upload, it has received 47 views. For similar materials see PRINCIPLES OF MICROECONOMICS in Economcs at Kent State University.
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Date Created: 02/02/16
Elasticity Elasticity: measure of responsiveness If you change something such as the price, how does the quantity respond Price Elasticity of Demand: Can we use the slope of the line? No, the slope will always be based on the unit of measurements of the quantity; i.e. Slope = $5 / 2 Will results in an invalid comparison across different goods We want a measurement that is independent of the units of measurement Units of measurement vary so we need “unitfree” measure → Use percentage changes: %∆Qd divided by %∆P Starting point→ Use percentage changes Price Elasticity of Demand = (εd) = %∆Qd %∆P Factors That Influence the Elasticity of Demand The closeness of substitutes The time elapsed since a price change Availabilities of substitutes Lots of substitutes →Demand more elastic Fewer substitutes →Demand less elastic Example: Luxuries, such as exotic vacations, generally have elastic demand (lots of substitutes). Necessities, such as food or housing, generally have inelastic demand (not as many substitutes). Small proportion of budget →Demand less elastic Large proportion of budget → Demand more elastic Example: Small proportion: consider a candy bar, a 50% increase in price does not change demand much Large proportion: consider the purchase of your first home, a 50% increase in price does change things Time Elapsed Since Price Change More time → Demand more elastic Less time → Demand less elastic The more time consumers have to adjust to a price change, the more elastic is the demand for that good. Key Rules If εd > 1 then revenue changes the same direction as the quantity εd < 1 then revenue changes the same direction as the price Managerial rule: if demand is inelastic then raise prices to increase revenue. CrossPrice Elasticity of Demand: a measure of the responsiveness of demand for a good to a change in the price of a ______________________, other things remaining the same. Income Elasticity of Demand: measures how the quantity demanded of a good responds to a change in income, other things remaining the same. Income elasticity= Elasticity of Supply: measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same. εs = >0 εs >1 elastic εs <1 inelastic εs =1 unit elastic Availability of substitute inputs Fewer substitute inputs (Van Gogh Painting) → less elastic supply More substitute inputs (Wheat/Corn) → more elastic supply Time More time → more elastic supply Less time → less elastic supply Elasticity (price, crossprice, income, supply) : intuition and how to calculate Elastic, Inelastic, Unit elastic: appropriate ranges, and location on graph compared to midpoint Extremes: Perfectly elastic or inelastic Relationship between revenue and elasticity Laws of Demand Diminishing Marginal Return: the tendency for additional units to provide less satisfaction than previous units Law of demand: Inverse relationship between price and quantity demanded; i.e. higher price, less demanded Generally we assume a linear relationship between price (P) and quantity demanded (Qd) The demand gives us the marginal benefit of the last good purchased. Imagine that the demand for snickers is represented by: P= 2 Qd + 12 At a P = 6, Qd = ___ Thus the 3 Snickers is worth $6. Likewise, we know that the addition of one more Snickers is only worth $4, Law of Diminishing Marginal Return main factors that change demand are o The prices of related goods o Expected future prices o Population o Preferences . Prices of related goods Substitutes: Goods that are related to each other, i.e. Nike and Addidas Definition: if the price increases for good 1 then the demand increases for good 2; shifts curve outward Compliments: Goods that are used together, i.e. milk and cereal Expectations Price expect price to rise → ↑ current demand expect price to fall → ↓ current demand Income expect income to rise → ↑ D for normal goods and ↓ D for inferior goods Expectations Price expect price to rise → ↑ current demand expect price to fall → ↓ current demand Income expect income to rise → ↑ D for normal goods and ↓ D for inferior goods Expectations Price expect price to rise → ↑ current demand expect price to fall → ↓ current demand Income expect income to rise → ↑ D for normal goods and ↓ D for inferior goods Laws of Supply Supply: maximum quantity a seller is willing and able to sell at various prices Law of Supply: positive relationship between price and quantity supplied; i.e. higher prices result in more goods supplied Similar to the demand side, we usually assume a linear relationship between price and quantity supplied (Qs) Supply: maximum quantity a seller is willing and able to sell at various prices Law of Supply: positive relationship between price and quantity supplied; i.e. higher prices result in more goods supplied Similar to the demand side, we usually assume a linear relationship between price and quantity supplied (Qs) main factors that change supply are o The prices of factors of production (input prices) o The prices of related goods produced o The number of suppliers o State of Nature Input prices: ▪ ↑ wages paid to labor → ↓ Supply (shift to left) ▪ ↓ wages paid to labor → ↑ Supply (shift to right) Expectations ▪ Price expect price to rise expect price to fall → ↑ current supply Input prices: o ▪ ↑ wages paid to labor → ↓ Supply (shift to left) o ▪ ↓ wages paid to labor → ↑ Supply (shift to right) Expectations ▪ Price expect price to rise expect price to fall → ↑ current supply Complements in Production: Example: beef and leather o ▪↑ P of beef then ↑ S of leather o Number of Suppliers more sellers → ↑ S fewer sellers → ↓ S Technology o Advances in technology create new products and lower the cost of producing existing products. o Changes in the marginal cost of production o ↓ costs → ↑ supply State of Nature: o Production influenced by weather events Combining Supply and Demand Equilibrium: a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers. Equilibrium Price: Equilibrium Quantity: the quantity bought and sold at the equilibrium price. Shortage: not enough supply to meet needs Qs < Qd P < P* Price will serve as the regulator and price will rise until P = P* Surplus: more supply then demand Qs > Qd P > P* Price will fall until P = P* If only a movement of supply or demand you can draw picture and see how price and quantity change. If both supply and demand change at the same time, you cannot definitively say what happens to both price and quantity—only one or the other. In this case, separate into two cases (1 for supply and 1 for demand) and see what is consistent for both.
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