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7/23/2019 ch04chapter 4 of dEMAND cUREVE Elasticity of Demand chapter 4 of dEMAND cUREVE Elasticity of Demand chapter 4 of dEMAND cUREVE Elasticity of Demand chapter 4 of dE…
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Law of Demand
Law of DemandPeople do less of what they want to do as
the cost of doing it risesRecall the Cost-Benefit PrinciplePursue an action if and only if its benefits
are at least as great as its costs
Recall the Reservation PriceThe highest price we’d be willing to pay
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Total Expenditure
Total !penditure e"uals
The number of units sold multiplied by
the price of the good
Total !penditure # Total Revenue
The dollar amount that consumers spend
on a product is e"ual to the dollar amountthat sellers receive
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The Law of Demand and Total
Expenditure$%ill consumers spend more on my product
if & sell more units at a lower price or fewer
units at a higher price'(Depends upon price elasticity of demand
%hen price rises) total e!penditure mayincrease) decrease) or stay the same
This is due to the Law of Demand*s price rises) "uantity demanded falls
*s price falls) "uantity demanded rises
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Fig. 5.7
The Demand Curve for Movie Ticket
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Fig. 5.! The Demand Curve for Movie Ticket
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Fig. 5."# Total Expenditure a a Function of $rice
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$rice Elaticit% of Demand
&n order to predict what will happen to
total e!penditures)
%e must +now how much "uantity will
change when the price changes
Price elasticity of demand is
the percentage change in the "uantity
demanded that results from a one-percentchange in its price
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$rice Elaticit% of Demand
P Q
D
D
P ∆
∆=%
%ε
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$rice Elaticit%lastic , "uantity changes by a lot when price
changes even a littleprice elasticity is greater than one
&nelastic , "uantity changes by a little whenprice changes even a lotprice elasticity is less than one
nit elastic , "uantity change # price changeprice elasticity e"uals one
%hen calculating price elasticity of demand)you will always get a negative- %./'0or convenience we will ta+e the absolute value
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Fig. 5.""Elatic and &nelatic Demand
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$rice Elaticit% and
Expenditure0or an elastic product1uantity demanded is highly responsive
Percentage change in "uantity dominates
*n increase in price will reduce total e!penditure
* decrease in price will increase total e!penditure
0or an inelastic product1uantity demanded is not responsive
Percentage change in price dominates
*n increase in price will increase total e!penditure
* decrease in price will decrease total e!penditure
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Determinant of Elaticit%
2ubstitution possibilitiesPrice elasticity of demand will be relatively high if
it is easy to substitute between products , %hy'
Budget shareThe larger the share of the budget the good uses
tends to have higher price elasticities of demand ,%hy'
TimeBecause substitution ta+es time) price elasticity
will be higher in the long run than in the shortrun
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Example
%hat are some goods that will have
very elastic demand'
%hat are some goods that will have
very inelastic demand'
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Calculating $rice Elaticit%
Proportion by which "uantity demanded
changes divided by the proportion by which
price changes
slope
Q P
P P
Q
Q
P
Q1
%
%==
∆
∆=
∆
∆
ε
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Fig. 5."'(raphical &nterpretation of $rice Elaticit%
of Demand
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)ther Elaticitie of Demand
&ncome lasticity of Demand
The amount by which the "uantity
demanded changes in response to a one-percent change in income
Positive for normal goods
3egative for inferior goods
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)ther Elaticitie of Demand
Cross Price lasticity of Demand
The amount by which the "uantity
demanded of one good changes in responseto a one-percent change in the price of
another good
Positive for substitutes
3egative for complements
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$erfect Elaticit%
Perfectly lastic demand
Price elasticity of demand is infinite
ven the slightest change in price leads
consumers to find substitutes
Perfectly &nelastic demand
Price elasticity of demand is 4ero
Consumers do not switch to substitutes
even when price increases dramatically
Do goods li+e these e!ist'
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Fig. 5."*$erfectl% Elatic and $erfectl% &nelatic
Demand Curve
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$rice Elaticit% of +uppl%
The percentage change in the "uantity
supplied that will occur in response to a
one-percent change in its price
slope
Q P
P P
Q
QS
S
P P
Q1%
%
==∆
∆
= ∆
∆
ε
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Determinant of +uppl%
Elaticit%The more easily additional units of
inputs can be ac"uired) the higher the
price elasticity 5more elastic60le!ibility of &nputs
7obility of &nputs
*bility to Produce 2ubstitute &nputsTime
ni"ue and ssential &nputs
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$erfect Elaticit%
Perfectly &nelasticlasticity of supply is 4ero
%hether the price is high or low) the same
amount is available
Perfectly lasticlasticity of supply is infinite
%hen additional units can be producedusing the same combination of inputspurchased at the same prices
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Fig. ,."#- $erfectl% &nelatic +uppl% Curve
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Fig. ,.""- $erfectl% Elatic +uppl% Curve
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Elaticit% of +uppl%
%hat determines whether the supply ofa particular good will be elastic orinelastic'*vailability of resources used to produce
the good , how "uic+ly and easily canproducers respond to a price change'
g of good with inelastic supply'
g of good with elastic supply'
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aturalit /uetion
%hy do you pay 89 for a beer in theairport when you can buy the same
beer for less than 8: outside theairport'
%hy do you get a discounted airfarewhen you stay over a 2aturday night'
%hy are there so many personali4edlicense plates in ;irginia vs< 3C'