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ELASTICITY OF DEMAND - 1

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6 views

ELASTICITY OF DEMAND - 1

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pss931623
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© © All Rights Reserved
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DEMAND AND SUPPLY FUNCTIONS

DEMAND FUNCTION
• Suppose that (keeping everything else constant) the demand function of a commodity is given by:
• 𝑸𝒅 = 𝟔𝟎𝟎𝟎 − 𝟏𝟎𝟎𝟎𝑷
• where Qd stands for the market quantity demanded of the commodity per time period and P for the price of
the commodity.
• (a) Derive the market demand schedule for this commodity.
• (b) Draw the market demand curve for this commodity.
Solution
SUPPLY FUNCTION
• Suppose that (keeping everything else constant) the supply function for the commodity is given by:
• 𝑸𝒔 = 𝟏𝟎𝟎𝟎𝑷 where Qs stands for the market quantity supplied of the commodity per time period and P for
the price of the commodity.
• (a) Derive the market supply schedule for this commodity
• (b) draw the market supply curve for this commodity.
Solution
ELASTICITY OF DEMAND
Elasticity
• Elasticity:
• Percentage change in one variable resulting from a 1-percent increase in another.

• Price Elasticity of Demand:


• The price elasticity of demand (sometimes simply called price elasticity ) measures how
much the quantity demanded of a good changes when its price changes.
• The precise definition of price elasticity is the percentage change in quantity demanded
divided by the percentage change in price.
ELASTICITY OF DEMAND

• Price elasticity of demand:


• Percentage change in quantity demanded of a good resulting from a 1-percent increase in
its price.
Calculating Elasticities
• When a 1 percent change in price calls forth more than a 1 percent change in quantity demanded, the
good has price-elastic demand.

• For example, if a 1 percent increase in price yields a 5 percent decrease in quantity demanded, the
commodity has a highly price-elastic demand.

• When a 1 percent change in price produces less than a 1 percent change in quantity demanded, the
good has price-inelastic demand.

• This case occurs, for instance, when a 1 percent increase in price yields only a 0.2 percent decrease in
demand.

• One important special case is unit-elastic demand, which occurs when the percentage change in
quantity is exactly the same as the percentage change in price.

• In this case, a 1 percent increase in price yields a 1 percent decrease in demand.


Elasticity
INFINITELY ELASTIC DEMAND
• (a) For a horizontal demand curve, ΔQ/ΔP
is infinite. Because a tiny change in price
leads to an enormous change in demand,
the elasticity of demand is infinite.

● Infinitely elastic demand:


● Principle that consumers will buy as much of a
good as they can get at a single price, but for any
higher price the quantity demanded drops to zero,
while for any lower price the quantity demanded
increases without limit.
COMPLETELY INELASTIC DEMAND
• (b) For a vertical demand curve, ΔQ/ΔP is
zero. Because the quantity demanded is
the same no matter what the price, the
elasticity of demand is zero.

● completely inelastic demand Principle that


consumers will buy a fixed quantity of a good
regardless of its price.
Price elasticity of demand and its
determinants
• Availability of close substitutes: Goods with close substitutes tend to have more elastic demand
because it is easier for consumers to switch from that good to others.
• Necessities versus luxuries: Necessities tend to have inelastic demands, whereas luxuries have
elastic demands.
• Definition of the market: Narrowly defined markets tend to have more elastic demand than
broadly defined markets because it is easier to find close substitutes for narrowly defined goods.
For example, food, a broad category, has a fairly inelastic demand because there are no good
substitutes for food. Ice cream, a narrower category, has a more elastic demand because it is easy to
substitute other desserts for ice cream.
• Time Horizon: Goods tend to have more elastic demand over longer time horizons. When the price
of gasoline rises, the quantity of gasoline demanded falls only slightly in the first few months. Over
time, however, people buy more fuel-efficient cars, switch to public transportation, and move closer
to where they work.
Point versus Arc Elasticities
● Point elasticity of demand Price elasticity at a particular point on the demand curve.

● Arc elasticity of demand Price elasticity calculated over a range of prices.


● Also called the midpoint method.
LINEAR DEMAND CURVE
• Demand curve that is a straight line.

The price elasticity of demand depends not only


on the slope of the demand curve but also on the
price and quantity.

The elasticity, therefore, varies along the curve as


price and quantity change. Slope is constant for
this linear demand curve.

Near the top, because price is high and quantity is


small, the elasticity is large in magnitude.

The elasticity becomes smaller as we move down


the curve.
Elasticity of a Straight Line
• A simple rule for calculating the demand
elasticity

• We can calculate the elasticity as the ratio


of the lower segment to the upper
segment at the demand point.

• For example, at point B, the lower


segment is 3 times as long as the upper
segment, so the price elasticity is 3.
Calculating elasticities
• Calculate price elasticity of demand for an
increase in price from A to B.
• Calculate price elasticity of demand for an
increase in price from G to H.
• Has the elasticity increased or decreased?
• Use midpoint formula to calculate
elasticity.
Solution:
• Elasticity between A and B: • Elasticity between G and H:

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