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Lecture Economics (6/e): Chapter 18 - Stephen L. Slavin

Chapter 18 - The elasticities of demand and supply. Learning objectives of this chapter include: The elasticity of demand, the determinants of elasticity, elasticity and total revenue, the elasticity of supply, tax incidence. | Chapter 18 The Elasticities of Demand and Supply 18-1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Objectives The elasticity of demand The determinants of elasticity Elasticity and total revenue The elasticity of supply Tax incidence 18-2 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 18-3 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. The Elasticity of Demand The elasticity of demand for a good or service measures the change in quantity demanded in response to a change in price In other words, elasticity measures the sensitivity (measured in percentage change) of quantity demanded because of a change (percentage) in price When price goes up, we know that quantity demanded declines. But we don’t know by how much? Elasticity provides us a way of measuring this response Elasticity answers the “how much” question 18-4 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Measuring Elasticity Calculate the coefficient of price elasticity (Ep) Ep = Percentage change in quantity demanded Percentage change in price Ep = Q2 - Q1 P2 + P1 X Q2 + Q1 P2 - P1 P1 is the initial price; P2 is the new price Q1 is the initial quantity sold; Q2 is the new quantity sold 18-5 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. A firm has been selling 100 chairs a week. It runs a sale, charging $8 instead of the usual $10. Sales go up to 140 chairs. Ep = Q2 - Q1 P2 + P1 Q2 + Q1 P2 - P1 X Ep = 140 -100 8 + 10 140 + 100 8 - 10 X Ep = 240 40 X 18 -2 = - 1.4999994 Ep = 1.5 So the negative sign is ignored Note: the answer is always negative 18-6 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price is raised from $40 to $41, and quantity sold declines from 15 to 12 Ep = Q2 - Q1 P2 + P1 Q2 + Q1 P2 - P1 X Ep = 15 - 12 41 + 40 12 + 15 41 - 40 X Ep = 27 -3 X 81 1 = -8.9999991 Ep = 9.0 So the negative sign is ignored Note: the answer is always negative | Chapter 18 The Elasticities of Demand and Supply 18-1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Objectives The elasticity of demand The determinants of elasticity Elasticity and total revenue The elasticity of supply Tax incidence 18-2 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 18-3 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. The Elasticity of Demand The elasticity of demand for a good or service measures the change in quantity demanded in response to a change in price In other words, elasticity measures the sensitivity (measured in percentage change) of quantity demanded because of a change (percentage) in price When price goes up, we know that quantity demanded declines. But we don’t know by how much? Elasticity provides us a way of measuring this response Elasticity answers the “how much” question 18-4 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Measuring .