You are on page 1of 22

Applications of

Supply & Demand


Chapter 4
Samuelson, Nordhaus 18e

Applications of Supply &


Demand
Basics
How

to Calculate Elasticity

Applications

to Major Economic Issues

Syed Arshad Hussain


Jr. Lecturer

Basics
Restaurant

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

Syed Arshad Hussain


Jr. Lecturer

Basics
Gasoline

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

Syed Arshad Hussain


Jr. Lecturer

Basics
Several factors that affect the
price elasticity of a good:
1. Availability of substitutes
2. The degree of necessity
3. The proportion of a purchaser's
budget consumed by the item
4. The time period involved
5. Raising productivity
Syed Arshad Hussain
Jr. Lecturer

Applications of Supply &


Demand
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 B

% change in A
Syed Arshad Hussain
Jr. Lecturer

Applications of Supply &


Demand
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.
% change in quantity demanded
price elasticity of demand
% change in price

Syed Arshad Hussain


Jr. Lecturer

Elastic Demand Shows Large


Quantity Response to Price
Change

Chapter 4
Figure 4-1

Syed Arshad Hussain


Jr. Lecturer

Price Elasticity of Demand


Types of Elasticity

TABLE 5.1 Hypothetical Demand Elasticities for Four Products


% Change In
Price
(% P)

% Change
In Quantity
Demanded
(% QD)

Insulin

+10%

0%

.0

Basic telephone service

+10%

-1%

-.1

Beef

+10%

-10%

-1.0

Unitarily elastic

Bananas

+10%

-30%

-3.0

Elastic

Product

Elasticity
(% QD %P)
Perfectly inelastic
Inelastic

perfectly inelastic demand Demand in which


quantity demanded does not respond at all to a
change in price.
Syed Arshad Hussain
Jr. Lecturer

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
Syed Arshad Hussain
higher price.
Jr. Lecturer

Chapter 4
Figure 4-2

Price Elasticity of Demand Falls


into Three Categories

Syed Arshad Hussain


Jr. Lecturer

Price Elasticity of Demand


Types of Elasticity
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.

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.

Syed Arshad Hussain


Jr. Lecturer

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.
Syed Arshad Hussain
Jr. Lecturer

Price Elasticity of Demand


Types of Elasticity

A good way to remember the difference between


the two perfect elasticities is:

Syed Arshad Hussain


Jr. Lecturer

Calculating Elasticities
Calculating Percentage Changes

To calculate percentage change in quantity


demanded using the initial value as the base, the
following formula is used:

% changeinquantitydemanded

changeinquantitydemanded
x100%
Q
1

Q Q
x100%
Q
2

Syed Arshad Hussain


Jr. Lecturer

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 Pthat is, P1as the base for calculating
the percentage. By using P1 as the base, the
formula for calculating the percentage of change in
P is

changeinprice
%changeinprice
x100%
P
1

P P

x100%
P
2

Syed Arshad Hussain


Jr. Lecturer

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:

priceelasticityofdemand

%changeinquantitydemanded
%changeinprice

Syed Arshad Hussain


Jr. Lecturer

Basics
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 shortrun
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
Syed Arshad Hussain
Jr. Lecturer

Basics

Estimated Price Elasticities of Demand for


Various Goods and Services
Approximately Unitary Elasticity:
Movies, Shellfish, consumed at home, Tires short-run
~ 0.9
Oysters consumed at home, Private education
~
1.1
Housing, owner occupied long-run, Tires long-run,
Radio and television receivers
~ 1.2

Syed Arshad Hussain


Jr. Lecturer

Basics

Estimated Price Elasticities of Demand for


Various Goods and Services
Elastic Demand:
Automobiles- short-run
Restaurant meals
Airline travel- long-run
Fresh green peas
Chevrolet automobiles
tomatoes

1.2 - 1.5
~2.3
~2.4
~2.8
~4.0 Fresh
~4.6
Syed Arshad Hussain
Jr. Lecturer

How to calculate
Numerical calculation:

ED =

Q
(Q1+Q2)/2

P
(P1+P2)/2

Syed Arshad Hussain


Jr. Lecturer

Applications of Supply &


Demand

Read Chapter 5

Syed Arshad Hussain


Jr. Lecturer