Lecture 2: Demand Supply and Market

• Part 1: Demand, Supply and Market

• Part 2: Elasticity

• Part 3: Price control

ELASTICITY
• Part 4: Tax

• Part 5: International trade

In this chapter, You will learn
• Elasticity
• Price elasticity of demand
How is it related to the demand curve?
How is it related to the total revenue?
• Price elasticity of supply
How is it related to the supply curve?
• Income elasticity
• Cross-price elasticity
 ELASTICITY
Elasticity: the responsiveness of demand/supply due to the
change in market conditions

Price elasticity of demand is a measure of how much the

quantity demanded of a good responds to a change in the
price of that good.

Percentage change in quantity demanded

Price elasticity of demand =
Percentage change in price
 Price Elasticity and its Determinants
• Necessities vs. luxuries
• necessities : Some goods are so critical, Demand for necessities is relatively
inelastic.
• A luxury good is something we’d like to have but aren’t likely to buy unless
our income jumps or the price declines sharply.
• Availability of substitutes: The greater the availability of substitutes, the
higher the price elasticity of demand.
• Definition of the market
• Narrowly defined markets: more elastic demand
• Time horizon
• Demand is more elastic over longer time horizons
Computing Percentage Changes
Demand for Airpod Going from A to B:
• the % change in P = ($250–$200)/$200 = 25%
P
• the % change in Q = (8-12)/12 = - 33%
• Price elasticity = 33/25 = -1.33
B
$250 Going from B to A:
A • the % change in P (200-250)/250 = - 20%
$200 • the % change in Q (12-8)/8 = 50%
• Price elasticity = 50/20 = -2.5
D
The PROBLEM is…
Q The elasticity from A to B is different from the
8 12 elasticity from B to A

6
 MID-POINT Method
Using the midpoint method of computing % changes:

Demand for Airpod (𝑄2 −𝑄1 )/((𝑄2 +𝑄1 )/2)

𝑒=
P (𝑃2 −𝑃)/((𝑃2 +𝑃1 )/2)
B $250 − $200
$250 % change in P =  100% = 22.2%
A $225
$200 12 − 8
% change in Q =  100% = 40%
D 10
40%
8 12
Q Price elasticity = = 1.8
22.2%
7
 Elasticity of Demand
• Variety of demand curves • Variety of demand curves
• Demand is elastic • Demand is perfectly inelastic
ε>1 • ε=0
• Demand is inelastic • Demand curve is vertical
ε<1 • Demand is perfectly elastic
• Demand has unit elasticity • ε = ∞ (infinity)
ε=1 • Demand curve is horizontal

• The flatter the demand curve, the

greater the price elasticity of
demand
Perfectly inelastic demand
Price elasticity % change in Q 0%
= = =0
of demand % change in P 10%

P
D • D curve : Vertical

P1 • Consumers’ price sensitivity: None

P2 • Elasticity: 0

P falls Q• Examples?
by 10% Q1
Q changes
by 0%
9
Inelastic demand
Price elasticity % change in Q <10%
= = <1
of demand % change in P 10%
P
• D curve: relatively steep
P1
• Consumers’ price sensitivity:
P2 relatively low
D
• Elasticity:<1
P falls Q
by 10% Q1 Q2
• Examples?
Q rises less
than 10%
10
Unit elastic demand
Price elasticity % change in Q 10%
= = =1
of demand % change in P 10%

P • D curve: intermediate slope

• Consumers’ price sensitivity:

P1
intermediate
P2
D • Elasticity: =1
P falls Q
by 10% Q1 Q2
Q rises
by 10%
11
Elastic demand
Price elasticity % change in Q >10%
= = >1
of demand % change in P 10%
P
• D curve: relatively flat
P1
• Consumers’ price sensitivity:
P2 D relatively high

• Elasticity: >1
P falls Q
by 10% Q1 Q2
Q rises more
than 10%
12
Perfectly elastic demand
Price elasticity % change in Q any %
= = = infinity
of demand % change in P 0%
P
• D curve: horizontal
P2 = P1 D • Consumers’ price
P changes sensitivity: extreme
by 0%
• Elasticity: ∞
Q
Q1 Q2

Q changes • Rice
by any % Cho Ben thanh?
13
p.s. Elasticity along a Linear Demand Curve

• The slope of a linear

demand curve is constant,
but its elasticity is not.
• At points with a low price
and high quantity, the
demand curve is inelastic.
• At points with a high price
and low quantity, the
demand curve is elastic.
1. The price elasticity of demand measures
a. buyers’ responsiveness to a change in the price of a good.
b. the extent to which demand increases as additional buyers enter the market.
c. how much more of a good consumers will demand when incomes rise.
d. the movement along a supply curve when there is a change in demand.
2. Economists compute the price elasticity of demand as the
a. percentage change in price divided by the percentage change in quantity demanded.
b. change in quantity demanded divided by the change in the price.
c. percentage change in quantity demanded divided by the percentage change in price.
d. percentage change in quantity demanded divided by the percentage change in income.
3. If the price elasticity of demand for a good is 0.2, then a 3 percent decrease in price results in a
a. 0.6 percent increase in the quantity demanded.
b. 1.5 percent increase in the quantity demanded.
c. 2 percent increase in the quantity demanded.
d. 6 percent increase in the quantity demanded.
4. Elasticity of demand is closely related to the slope of the demand curve. The less responsive buyers are to a
change in price, the
a. steeper the demand curve will be.
b. flatter the demand curve will be.
c. further to the right the demand curve will sit.
d. closer to the vertical axis the demand curve will sit.
5. The smaller the price elasticity of demand, the 7. Demand is said to be inelastic if
a. steeper the demand curve will be through a a. buyers respond substantially to changes in
given point. the price of the good.
b. flatter the demand curve will be through a b. demand shifts only slightly when the price of
given point. the good changes.
c. more strongly buyers respond to a change in c. the quantity demanded changes only slightly
price between any two prices P1 and P2. when the price of the good changes.
d. smaller the decrease in equilibrium price d. the price of the good responds only slightly to
when the supply curve shifts rightward from changes in demand.
S1 to S2. 8. When the price of bubble gum is $0.50, the
6. As we move downward and to the right along a quantity demanded is 400 packs per day.
linear, downward-sloping demand curve, When the price falls to $0.40, the quantity
a. both slope and elasticity remain constant. demanded increases to 600. Given this
b. slope changes but elasticity remains constant. information and using the midpoint method,
c. both slope and elasticity change. we know that the demand for bubble gum is
d. slope remains constant but elasticity changes. a. inelastic.
b. elastic.
c. unit elastic.
d. perfectly inelastic.
9. For a good that is a necessity, 11. A person who takes a prescription drug
a. quantity demanded tends to respond to control high cholesterol most likely
substantially to a change in price. has a demand for that drug that is
b. demand tends to be inelastic. a. inelastic.
c. the law of demand does not apply. b. unit elastic.
d. All of the above are correct. c. elastic.
d. highly responsive to changes in income.

10. Suppose the price of potato chips 12. Studies indicate that the price elasticity
decreases from $1.45 to $1.25 and, as a of demand for cigarettes is about 0.4. A
result, the quantity of potato chips government policy aimed at reducing
demanded increases from 2,000 to smoking changed the price of a pack of
2,200. Using the midpoint method, the cigarettes from $2 to $6. According to
price elasticity of demand for pota-to the midpoint meth-od, the government
chips in the given price range is policy should have reduced smoking by
a. 2.00. a. 30%.
b. 1.55. b. 40%.
c. 1.00. c. 80%.
d. 0.64. d. 250%.
 Price Elasticity and Total Revenue

• Total revenue is the amount paid by buyers and

received by sellers of a good.
• Computed as the price of the good times the quantity
sold.

TR = P x Q
 Price Elasticity and Total Revenue
Price

$4

P × Q = $400
P
(revenue) Demand

0 100 Quantity

Q
 Price Elasticity and Total Revenue

• For a price increase, if demand is elastic

▪ E > 1: % change in Q > % change in P
▪ TR decreases: the fall in revenue from lower Q > the
increase in revenue from higher P
• For a price increase, if demand is inelastic
▪ E < 1: % change in Q < % change in P
▪ TR increases: the fall in revenue from lower Q < the
increase in revenue from higher P
 Price Elasticity and Total Revenue
Demand for your Airpod • Elastic demand
(elasticity = 1.8)
increased
P revenue
due to lost
• If P = $200, Q = 12, and revenue
higher P revenue = $2400
$250 due to
$200
lower Q • If P = $250, Q = 8, and
D revenue = $2000

• When D is elastic, a price

Q increase causes revenue to fall.
8 12
21
 Price Elasticity and Total Revenue
Demand for your Cigarettes • Inelastic demand
(elasticity = 0.82)
increased
P revenue • If P = $2, Q = 1200, and
due to lost revenue = $2400
higher P revenue
$2.5 due to
lower Q
• If P = $2.5, Q = 1000, and
$2 revenue = $2500
D
• When D is inelastic,
a price increase causes
Q revenue to rise.
1000 1200
22
APPLICATION of ELASTICITY
: Does Drug Interdiction Increase or Decrease Drug-Related Crime?

• One side effect of illegal drug use is crime: Users often turn to crime to
finance their habit.
• We examine two policies designed to reduce illegal drug use: 1. Drug
interdiction, 2. Education campaign.
• For simplicity, we assume the total dollar value of drug-related crime
equals total expenditure on drugs.

Which policy is better?

Policy 1: Interdiction
Interdiction reduces the
supply of drugs. new value of drug-
Price of related crime
Drugs S2
D1
S1
Since demand for drugs is P2
inelastic,
P rises proportionately
more than Q falls. P1 initial value
of drug-
related
crime
Result: an increase in
total spending on drugs, and in Q2 Q 1 Quantity
drug-related crime of Drugs
Policy 2: Education
new value of drug-
Education reduces the Price of related crime
demand for drugs. Drugs
D2 D1
S

P and Q fall.
P1 initial value
Result: of drug-
A decrease in total spending P2 related
on drugs, and in drug-related crime
crime.
Q2 Q 1 Quantity
of Drugs
 Income Elasticity
measures the response of Qd to a change in consumer income
Income elasticity of Percent change in Qd
=
demand Percent change in income

• Normal goods: Positive income elasticity

• Necessities tend to be income inelastic
• i.e.) food, fuel, clothing, utilities, and medical services.
• Luxuries tend to be income elastic.
• i.e.) sports cars, furs, and expensive foods.
• Inferior goods: Negative income elasticities
 Cross Price elasticity of demand
measures the response of demand for one good to changes in the price
of another good

Cross-price elast. % change in Qd for good 1

=
of demand % change in price of good 2
▪ For substitutes, cross-price elasticity > 0
(e.g., an increase in price of beef causes an increase in demand for
chicken)
▪ For complements, cross-price elasticity < 0
(e.g., an increase in price of computers causes decrease in demand for
software)
 Price elasticity of supply
• Price elasticity of supply measures how much Qs
responds to a change in P.
Price elasticity of Percentage change in Qs
supply =
Percentage change in P

▪ Loosely speaking, it measures sellers’ price-sensitivity.

▪ Again, use the midpoint method to compute the percentage changes.
 The Elasticity of Supply
• Elastic supply
• Quantity supplied responds substantially to changes in the price
• Inelastic supply
• Quantity supplied responds only slightly to changes in the price
• Determinant of price elasticity of supply
• Time period: Supply is more elastic in the long run
• Variety of supply curves:
• Supply is unit elastic: Es = 1
• Supply is elastic: Es > 1
• Supply is inelastic: Es < 1
• Supply is perfectly inelastic: Es = 0 Supply curve is vertical
• Supply is perfectly elastic: Es = infinity Supply curve is horizontal
29
 The Elasticity of Supply
• Computing price elasticity of supply
• Percentage change in quantity supplied divided by
percentage change in price
• Always positive
• Midpoint method
• Two points: (Q1, P1) and (Q2, P2)

(Q2 − Q1 ) / [(Q2 + Q1 ) / 2 ]
Price elasticity of supply =
(P2 − P1 ) / [(P2 + P1 ) / 2 ]

30
 The Price Elasticity of Supply (a, b)
(a) Perfectly Inelastic Supply: (b) Inelastic Supply:
Elasticity Equals 0 Elasticity Is Less Than 1

•The price elasticity of supply determines whether the supply curve is steep or flat.
•Note that all percentage changes are calculated using the midpoint method.
31
The Price Elasticity of Supply (c, d)

(c) Elastic Supply: Elasticity (D) Perfectly Elastic Supply:

Is Greater Than 1 Elasticity Equals Infinity

The price elasticity of supply determines whether the supply curve is steep or flat.
Note that all percentage changes are calculated using the midpoint method.
32
Elasticity of Supply
P
Si
SS

b
P2
c SL
P3
d
P4
P1
a

D2
D1
O Q1 Q3 Q4 Q
13. Which of the following statements is valid when the market supply curve is vertical?
a. Market quantity supplied does not change when the price changes.
b. Supply is perfectly elastic.
c. An increase in market demand will increase the equilibrium quantity.
d. An increase in market demand will not increase the equilibrium price.

14. Refer to Figure, Over which range is the supply Price

curve in this figure the most elastic?

a. Between $16 and $40 430 Supply
b. Between $40 and $100
c. Between $100 and $220
d. Between $220 and $430

15. Refer to Figure, Using the midpoint method, what

220
is the price elasticity of supply between $16 and $40?
a. 0.125
b. 0.86 100
c. 1.0
d. 2.5 40
16
2 5 9 14 20 Quantity
16. The price elasticity of demand for a good will tend to increase as the:
(a) number of available substitutes increases.
(b) consumer income level increases.
(c) good is a less important budget item.
(d) time allowed for response decreases.
17. Most college students strongly oppose tuition increases. If only one student in fifty transfers
to another school following a ten percent tuition hike at your school, your economics professor
would probably conclude that most students’ demands for education at your college are:
(a) perfectly price elastic.
(b) relatively price elastic.
(c) unitarily price elastic.
(d) relatively price inelastic.

18. Scrutiny of demand curves DD and D0D0 reveals that:

(a) D0D0 is relatively more elastic at a price of P1.
(b) DD is relatively more elastic at a price of P2.
(c) D0D0 probably reflects the demand for a biological
necessity.
(d) DD probably represents the demand for a good with
more close substitutes.
19. If average income rises from $18,000 per 21. At a price of $2 per can, the quantity
year to $22,000 per year and annual of applesauce supplied daily is 1000
gasoline consumption per household rises cases; at $4, the quantity supplied is 3000
from 1000 to 1500 gallons, the income cases daily. The price elasticity of supply
elasticity of demand for gas is: is:
(a) in the inferior range. (a) 2/3.
(b) 0.5. (b) 1/3.
(c) 1.0. (c) 3/2.
(d) 2.0. (d) 1/4.
22. The income elasticity of demand is a
20 If a price hike from $15 to $20 for DVD
measure of the:
disks causes sales of DVD players to fall from
(a) relative responsiveness of quantity
100 to 50 units, the coefficient of cross-
demanded to changes in income.
elasticity of demand between these goods is
(b) absolute change in demand yielded by
roughly:
an absolute change in income.
(a) -1/10.
(c) slope of the income-consumption
(b) -10.
curve.
(c) -7/3.
(d) negative slope of a market demand
(d) -3/7.
curve.
 An Increase in Supply in the Market for Wheat

When an advance in farm technology increases the supply of wheat from S1 to S2, the price of
wheat falls. Because the demand for wheat is inelastic, the increase in the quantity sold from
100 to 110 is proportionately smaller than the decrease in the price from $3 to $2. As a
result, farmers’ total revenue falls from $300 ($3 × 100) to $220 ($2 × 110).
37
A Reduction in Supply in the World Market for Oil

• When the supply of oil falls, the response depends on the time horizon. In the short run, supply and
demand are relatively inelastic, as in panel (a). Thus, when the supply curve shifts from S1 to S2, the price
rises substantially.
• In the long run, however, supply and demand are relatively elastic, as in panel (b). In this case, the same
size shift in the supply curve (S1 to S2) causes a smaller increase in the price. 38
Summary
• Elasticity measures the responsiveness of Qd or Qs to one of its
determinants.
• Price elasticity of demand equals percentage change in Qd divided by
percentage change in P.
When it’s less than one, demand is “inelastic.” When greater than one,
demand is “elastic.”
• When demand is inelastic, total revenue rises when price rises. When
demand is elastic, total revenue falls when price rises.
Summary
• Demand is less elastic in the short run, for necessities, for broadly
defined goods, and for goods with few close substitutes.
• Price elasticity of supply equals percentage change in Qs divided by
percentage change in P.
When it’s less than one, supply is “inelastic.” When greater than one,
supply is “elastic.”
• Price elasticity of supply is greater in the long run than in the short run.
• The income elasticity of demand measures how much quantity
demanded responds to changes in buyers’ incomes.
• The cross-price elasticity of demand measures how much demand for
one good responds to changes in the price of another good.