Chapter 4 Samuelson 18e Final

Applications of Applications of Supply & DemandSupply & Demand

Chapter 4Samuelson, Nordhaus 18e

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►Basics

►How to Calculate Elasticity

►Applications to Major Economic Issues

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► Restaurant meals prices, are very elastic (meaning price changes greatly affect our purchase of them).

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► Gasoline is considered inelastic (meaning price changes have little effect on the quantity we buy).

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Several factors that affect the price elasticity of a good:

1. Availability of substitutes 2. The degree of necessity3. The proportion of a purchaser's

budget consumed by the item 4. The time period involved5. Raising productivity

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►Elasticity A general concept used to quantify the response in one variable when another variable changes.

►If some variable, A, changes in response to a change in another variable, B, then:

Elasticity of A with respect B = % change in A % change in B

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► Price elasticity of demand The ratio of the percentage of change in quantity demanded to the percentage of change in price; measures the responsiveness of quantity demanded to changes in price.

pricein change %

demandedquantity in change % demand of elasticity price

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Elastic Demand Shows Large Elastic Demand Shows Large Quantity Response to Price Quantity Response to Price

ChangeChange

Chapter 4 Figure 4-1

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Price Elasticity of Demand

Types of Elasticity

perfectly inelastic demand Demand in which quantity demanded does not respond at all to a change in price.

TABLE 5.1 Hypothetical Demand Elasticities for Four Products

Product

% Change In Price(% P)

% ChangeIn Quantity Demanded

(% QD)Elasticity

(% QD ÷ %P)

Insulin +10% 0% .0 Perfectly inelastic

Basic telephone service +10% -1% -.1 Inelastic

Beef +10% -10% -1.0 Unitarily elastic

Bananas +10% -30% -3.0 Elastic

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Price Elasticity of Demand

Types of Elasticity

FIGURE 5.2 Perfectly Inelastic and Perfectly Elastic Demand Curves

Figure 5.2(a) shows a perfectly inelastic demand curve for insulin. Price elasticity of demand is zero. Quantity demanded is fixed; it does not change at all when price changes.Figure 5.2(b) shows a perfectly elastic demand curve facing a wheat farmer. A tiny price increase drives the quantity demanded to zero. In essence, perfectly elastic demand implies that individual producers can sell all they want at the going market price but cannot charge a higher price.

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Price Elasticity of Demand Falls Price Elasticity of Demand Falls into Three Categoriesinto Three Categories

Chapter 4 Figure 4-2

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Price Elasticity of Demand

inelastic demand Demand that responds somewhat, but not a great deal, to changes in price. Inelastic demand always has a numerical value between zero and -1.

Types of Elasticity

A warning: You must be very careful about signs. Because it is generally understood that demand elasticities are negative (demand curves have a negative slope), they are often reported and discussed without the negative sign.

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Price Elasticity of Demand

Types of Elasticity

unitary elasticity A demand relationship in which the percentage change in quantity of a product demanded is the same as the percentage change in price in absolute value (a demand elasticity of -1).

elastic demand A demand relationship in which the percentage change in quantity demanded is larger than the percentage change in price in absolute value (a demand elasticity with an absolute value greater than 1).

perfectly elastic demand Demand in which quantity drops to zero at the slightest increase in price.

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Price Elasticity of Demand

Types of Elasticity

A good way to remember the difference between the two “perfect” elasticities is:

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Calculating Elasticities

%1

change in quantity demanded change in quantity demanded x 100%

Q

1

2 1 -

x 100%Q Q

Q

To calculate percentage change in quantity demanded using the initial value as the base, the following formula is used:

Calculating Percentage Changes

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Calculating Elasticities

Calculating Percentage Changes

We can calculate the percentage change in price in a similar way. Once again, let us use the initial value of P—that is, P1—as the base for calculating the percentage. By using P1 as the base, the formula for calculating the percentage of change in P is

1

change in price% change in price x 100%

P

2 1

1

- x 100%P P

P

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Calculating Elasticities

Elasticity Is a Ratio of Percentages

Once all the changes in quantity demanded and price have been converted to percentages, calculating elasticity is a matter of simple division. Recall the formal definition of elasticity:

% change in quantity demandedprice elasticity of demand

% change in price

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►Estimated Price Elasticities of Demand for Various Goods and Services

Inelastic-Demand:

Salt, Matches, Toothpicks, Airline travel short-run Residential natural gas, short-run ~0.1

Gasoline short-run, Automobiles long-run, Coffee ~0.2 Tobacco products short-run Legal services short-run ~0.4 Residential natural gas long-run ~0.5 Fish (cod) consumed at home ~0.5 Physician services, Taxi short-run

~0.6 Gasoline long-run ~0.7

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► Estimated Price Elasticities of Demand for Various Goods and Services

Approximately Unitary Elasticity:

Movies, Shellfish, consumed at home, Tires short-run ~ 0.9Oysters consumed at home, Private education ~ 1.1Housing, owner occupied long-run, Tires long-run,

Radio and television receivers ~ 1.2

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► Estimated Price Elasticities of Demand for Various Goods and Services

Elastic Demand:

Automobiles- short-run 1.2 - 1.5

Restaurant meals ~2.3Airline travel- long-run ~2.4Fresh green peas ~2.8Chevrolet automobiles ~4.0 Fresh tomatoes ~4.6

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How to calculateHow to calculate

Numerical calculation:

Δ Q Δ PED = (Q1+Q2)/2 (P1+P2)/2

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