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themeaningoftheelasticityofsupply.

whatdeterminestheelasticityofsupply.

theconceptofelasticityinthreeverydifferentmarkets（themarketforwheat,themarketforoil,andthemarketforillegaldrugs）.

CONTEXTANDPURPOSE:

Chapter5isthesecondchapterofathree-chaptersequencethatdealswithsupplyanddemandandhowmarketswork.Chapter4introducedsupplyanddemand.Chapter5showshowmuchbuyersandsellersrespondtochangesinmarketconditions.Chapter6willaddresstheimpactofgovernmentpolicesoncompetitivemarkets.

ThepurposeofChapter5istoaddprecisiontothesupply-and-demandmodel.Weintroducetheconceptofelasticity,whichmeasurestheresponsivenessofbuyersandsellerstochangesineconomicvariablessuchaspricesandincome.Theconceptofelasticityallowsustomakequantitativeobservationsabouttheimpactofchangesinsupplyanddemandonequilibriumpricesandquantities.

KEYPOINTS:

1.Thepriceelasticityofdemandmeasureshowmuchthequantitydemandedrespondstochangesintheprice.Demandtendstobemoreelasticifclosesubstitutesareavailable,ifthegoodisaluxuryratherthananecessity,ifthemarketisnarrowlydefined,orifbuyershavesubstantialtimetoreacttoapricechange.

2.Thepriceelasticityofdemandiscalculatedasthepercentagechangeinquantitydemandeddividedbythepercentagechangeinprice.Iftheelasticityislessthanone,sothatquantitydemandedmovesproportionatelylessthantheprice,demandissaidtobeinelastic.Iftheelasticityisgreaterthanone,sothatquantitydemandedmovesproportionatelymorethantheprice,demandissaidtobeelastic.

3.Totalrevenue,thetotalamountpaidforagood,equalsthepriceofthegoodtimesthequantitysold.Forinelasticdemandcurves,totalrevenuerisesaspricerises.Forelasticdemandcurves,totalrevenuefallsaspricerises.

4.Theincomeelasticityofdemandmeasureshowmuchthequantitydemandedrespondstochangesinconsumers’income.Thecross-priceelasticityofdemandmeasureshowmuchthequantitydemandedofonegoodrespondstothepriceofanothergood.

5.Thepriceelasticityofsupplymeasureshowmuchthequantitysuppliedrespondstochangesintheprice.Thiselasticityoftendependsonthetimehorizonunderconsideration.Inmostmarkets,supplyismoreelasticinthelongrunthanintheshortrun.

6.Thepriceelasticityofsupplyiscalculatedasthepercentagechangeinquantitysupplieddividedbythepercentagechangeinprice.Iftheelasticityislessthanone,sothatquantitysuppliedmovesproportionatelylessthantheprice,supplyissaidtobeinelastic.Iftheelasticityisgreaterthanone,sothatquantitysuppliedmovesproportionatelymorethantheprice,supplyissaidtobeelastic.

7.Thetoolsofsupplyanddemandcanbeappliedinmanydifferentkindsofmarkets.Thischapterusesthemtoanalyzethemarketforwheat,themarketforoil,andthemarketforillegaldrugs.

CHAPTEROUTLINE:

I.TheElasticityofDemand

A.Definitionofelasticity:

ameasureoftheresponsivenessofquantitydemandedorquantitysuppliedtooneofitsdeterminants.

B.ThePriceElasticityofDemandandItsDeterminants

1.Definitionofpriceelasticityofdemand:

ameasureofhowmuchthequantitydemandedofagoodrespondstoachangeinthepriceofthatgood,computedasthepercentagechangeinquantitydemandeddividedbythepercentagechangeinprice.

2.DeterminantsofPriceElasticityofDemand

a.AvailabilityofCloseSubstitutes:

themoresubstitutesagoodhas,themoreelasticitsdemand.

b.NecessitiesversusLuxuries:

necessitiesaremorepriceinelastic.

c.Definitionofthemarket:

narrowlydefinedmarkets（icecream）havemoreelasticdemandthanbroadlydefinedmarkets（food）.

d.TimeHorizon:

goodstendtohavemoreelasticdemandoverlongertimehorizons.

C.ComputingthePriceElasticityofDemand

1.Formula

Workthroughacoupleofelasticitycalculations,startingwiththeexampleinthebook.Forprinciplesofeconomicscourseswherethereisnomathematicalprerequisite,thismaybedifficultforsomestudents.Doingacoupleofsimpleexampleswillhelptoalleviatesomeofthestudents’anxiety.Showeverystepofthealgebrainvolved.

2.Example:

thepriceoficecreamrisesby10%andquantitydemandedfallsby20%.

Priceelasticityofdemand=（20%）/（10%）=2

3.Becausethereisaninverserelationshipbetweenpriceandquantitydemanded（thepriceoficecreamroseby10%andthequantitydemandedfellby20%）,thepriceelasticityofdemandissometimesreportedasanegativenumber.Wewillignoretheminussignandconcentrateontheabsolutevalueoftheelasticity.

Studentshatethis!

Iftheypressyou,explainthatitreallymakesthingseasierandmakesmoresensebecauselargerelasticities（inabsolutevalue）implygreatersensitivityandresponsiveness.

D.TheMidpointMethod:

ABetterWaytoCalculatePercentageChangesandElasticities

1.Becauseweusepercentagechangesincalculatingthepriceelasticityofdemand,theelasticitycalculatedbygoingfrompointAtopointBonademandcurvewillbedifferentthananelasticitycalculatedbygoingfrompointBtopointA.

a.Awayaroundthisiscalledthemidpointmethod.

b.Usingthemidpointmethodinvolvescalculatingthepercentagechangeineitherpriceorquantitydemandedbydividingthechangeinthevariablebythemidpointbetweentheinitialandfinallevelsratherthanbytheinitiallevelitself.

c.Example:

thepricerisesfrom$4to$6andquantitydemandedfallsfrom120to80.

%changeinprice=（6-4）/5×

100%=40%

%changeinquantitydemanded=（120-80）/100=40%

priceelasticityofdemand=40/40=1

E.TheVarietyofDemandCurves

Figure1

1.ClassificationofElasticity

a.Whentheelasticityisgreaterthanone,thedemandisconsideredtobeelastic.

b.Whentheelasticityislessthanone,thedemandisconsideredtobeinelastic.

c.Whentheelasticityisequaltoone,thedemandissaidtohaveunitelasticity.

Toclearlyshowthedifferencesbetweenrelativelyelasticandrelativelyinelasticdemandcurves,drawagraphontheboardshowingarelativelyflatdemandcurveandoneshowingarelativelysteepdemandcurve.Showthatanygivenchangeinpricewillresultinalargerchangeinquantitydemandedifthedemandcurveisrelativelyflat.Usethesamemethodwhendiscussingtheshapeofthesupplycurvelaterinthechapter.

Activity1–HowtheBallBounces

Type:

In-Classdemonstration

Topics:

Elastic,inelastic

Materialsneeded:

Onerubberballandone“dead”ball.The“dead”ballismadeofshock-absorbingmaterialanddoesn’tbounce.Museumstoresandmagicshopscarrythem.

Time:

1minute

Classlimitations:

Worksinanysizeclass

Purpose

Thisquick,butmemorable,demonstrationcanbeusedtointroducetheconceptsofelasticandinelastic.

Instructions

Bringtwostudentstothefrontoftheclass.Giveeachofthemaballandaskthemtobounceitoffthefloorandcatchit.Thestudentwiththerubberballcandothiseasily.Thestudentwiththe“dead”ballwillnotbeabletobounceithighenoughtocatch,nomatterhowhardtheythrowit.

Explainthatoneballiselastic;

itisresponsivetochange.Theotherballisinelastic;

itrespondsverylittletochange.Thesephysicalpropertiesofelasticandinelasticareanalogoustotheeconomicconceptsofelasticandinelastic.

2.Slopeofdemandcurve:

ingeneral,theflatterthedemandcurvethatpassesthroughagivenpoint,themoreelasticthedemand.

Makesurethatyouprovideseveralexamplesofgoodswiththesetypesofdemandcurves.Youmaywanttopointoutthatstudentswillseetheperfectlyelasticdemandcurveagainwhencompetitivefirmsarediscussed.

ExtremeCases

a.Whentheelasticityisequaltozero,thedemandisperfectlyinelasticandisaverticalline.

b.Whentheelasticityisinfinite,thedemandisperfectlyelasticandisahorizontalline.

Activity2–RankingElasticities

In-Classassignment

Thedeterminantsofpriceelasticityofdemand

None

20minutes

Theintentofthisexerciseistogetstudentstothinkaboutvaryingdegreesofelasticityandthefactorsthatdeterminedemandelasticity.

Givethestudentsthefollowinglistofgoods.Askthemtorankthemfrommosttoleastelastic.

1.beef

2.salt

3.Europeanvacation

4.steak

5.HondaAccord

6.Dijonmustard

Iftheyhavedifficulty,thesehintscanbehelpful:

1.Howmuchwoulda10%priceincreaseforthegoodaffectaconsumer’stotalbudget?

2.Whatsubstitutesareavailableforthegood?

3.Doconsumersthinkofthisgoodasanecessityoraluxury?

CommonAnswersandPointsforDiscussion

Atypicalranking:

1.Europeanvacation（luxury,manyothervacationdestinations,expensive）

2.HondaAccord（expensive,manysubstitutesincludingusedcars）

3.steak（perceivedluxury,moderateexpense,othercutsofbeefareclosesubstitutes）

4.Dijonmustard（perceivedluxury,inexpensive,othertypesofmustardmaybeclosesubstitutes.）

5.beef（moderateexpense,pork&

chickenaresubstitutes）

6.salt（inexpensive,necessity,noclosesubstitutes）

F.TotalRevenue