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CHAPTER 5

ELASTICITY AND I T S A P P L I C A T I O N

INSTRUCTOR
NGUYEN TAI VUONG

GROUP 6 :
1. Nguyen Nhat
Linh
2. Hoang Thi Le
3. Nguyen Ngoc
Mai
4. Pham Thuy
Linh
MAIN PARTS

Three
The Applications
The
Elasticity of Supply,
Elasticity
of Demand,
of Supply and
Demand
Elasticity
THE ELASTICITY OF DEMAND
Price elasticity of demand : A measure of how much
the quantity demanded of a good responds to a change in the
price of that good.
Factors affecting Elasticity

Necessities versus Luxuries Availability of Close Substitutes


if the good the larger the
is a luxury. number of close
substitutes.
DETERMINANTS

Definition of the Market Time Horizon


the more narrowly defined the longer the time
the market. period.
COMPUTING THE PRICE ELASTICITY OF DEMAND

How the price elasticity is measured :


THE MIDPOINT METHOD: A BETTER WAY TO
CALCULATE PERCENTAGE CHANGES AND ELASTICITIES

The Midpoint formula


is preferable when
calculating the price
elasticity of demand
because it gives the same
answer regardless of the
direction of the change.
THE VARIETY OF DEMAND CURVES

Demand is elastic when the elasticity


is greater than 1, so that quantity
moves proportionately more than the
price. Rule of thumb :
Demand is inelastic when the The flatter the curve,
elasticity is less than 1, so that
the bigger the
quantity moves proportionately
less than the price. elasticity.

The steeper the


If the elasticity is exactly 1, so
that quantity moves the same curve, the smaller
amount proportionately as price, the elasticity.
demand is said to have unit
elasticity.
TOTAL REVENUE AND THE PRICE ELASTICITY OF DEMAND

Total Revenue : the amount paid by buyers and received by


sellers of a good.

TR = P x Q
Inelastic
Demand

Elastic
Demand
General Rule

When a demand
When a demand In the special case
curve is elastic (a
curve is inelastic (a of unit elastic
price elasticity
price elasticity less demand (a price
greater than 1), a
than 1), a price elasticity exactly
price increase
increase raises equal to 1), a
reduces total
total revenue, and change in the
revenue, and a
a price decrease price does not
price decrease
reduces total affect total
raises total
revenue. revenue.
revenue.
ELASTICITY AND TOTAL REVENUE ALONG
A LINEAR DEMAND CURVE
OTHER DEMAND ELASTICITIES

A measure of how much the quantity


The Income demanded of a good responds to a change
Elasticity of in consumers income .
Demand

The Cross-
A measure of how much the quantity
Price
demanded of one good responds to a
Elasticity of
change in the price of another good.
Demand
THE ELASTICITY OF SUPPLY

Price elasticity of supply : A measure of how much the


quantity supplied of a good responds to a change in the price
of that good.
Factors affecting
Elasticity

Seller

DETERMINANTS

Time
TIME
New buiding
COMPUTING THE PRICE
ELASTICITY OF SUPPLY

How the price elasticity is


measured :
THE VARIETY OF SUPPLY CURVES

In the extreme case of a


zero elasticity, supply is
perfectly inelastic, and
the supply curve is
vertical.

At the opposite extreme,


supply is perfectly elastic.
This occurs as the price
elasticity of supply
approaches infinity and the
supply curve becomes
horizontal.
THREE APPLICATIONS OF SUPPLY, DEMAND, AND
ELASTICITY

DOES DRUG
CAN GOOD
WHY DID INTERDICTION
NEWS FOR
OPEC FAIL TO INCREASE OR
FARMING BE
KEEP THE DECREASE
BAD NEWS
PRICE OF OIL DRUG-
FOR
HIGH? RELATED
FARMERS?
CRIME?
CAN GOOD NEWS FOR FARMING BE BAD NEWS FOR FARMERS ?

First, we examine whether


the supply curve or demand
curve shifts

Second, we consider which


direction the curve shifts.

Third, we use the supply-


and-demand diagram to
see how the market
equilibrium changes.
bushel of
produce more
wheat sells for
wheat
less
(Q rises)
(P falls)
Each Farmer All Farmers

produce and sell more the price falls, and


wheat farmers are worse off
FARMERS CONSUMERS

TECHNOLOGY

POLICY
WHY DID OPEC FAIL TO KEEP THE PRICE OF OIL HIGH?
In the short run In the long run
DOES DRUG INTERDICTION INCREASE
OR DECREASE DRUG-RELATED CRIME?
summa
ry
Price elasticity of
demand measures how The income elasticity
In most markets,
much the quantity of demand measures
supply is more elastic
demanded responds to how much the quantity
in the long run than in
changes in the price. demanded responds to
the short run.
Price elasticity of changes in consumers'
The price elasticity of
demand is calculated as income.
supply is calculated as
the percentage change in The cross-price
the percentage change
quantity demanded elasticity of demand
in quantity supplied
divided by the measures how much the
divided by the
percentage change in quantity demanded of
percentage change in
price. in good responds to the
price.
If a demand curve is price of another good.
The tools of supply
elastic, total revenue The price elasticity of
and demand can be
falls when the price supply measures how
applied in many
rises. much the quantity
different types of
If it is inelastic, total supplied responds to
markets.
revenue rises as the changes in the price
price rises.