2012.09.29Lecture Four Welcome to the Microeconomics World!1Chapter 4 Supply and Demand: Elasticity and Applications2Overview3As we have already known, properly framed, the essence of most economic questions can be approached using the basic market analysis you learned in Chapter 3. Properly interpreted, the answer to almost any question concerning resource allocation can be explained in terms of supply-demand intuition.Overview4In Chapter 3, we have learned the law of demand and supply. And, we know there are some factors other than the own price of the good will affect consumers or firms behavior, shifting the demand or supply curve. Income increase demand curve shifts to the right other things equal, both price and quantity exchanged increase Technology progress supply curve shifts to the right held other things constant, price goes down and quantity exchanged increasesOverview5This leads naturally to the following questions:“By how much?”“By how much?”How large are the responses to the changes, and upon what does this responsiveness depend ? This chapter will provide you with the tools you need to answer this question and with the opportunity to apply your tools in the arena of policy-making.4.1 Price Elasticity of Demand and supply4.1.1 Price Elasticity of Demand Calculating Elasticities Price Elasticity Diagrams A Shortcut for Calculating Elasticities The Algebra of Elasticities Elasticity is Not the Same as Slope4.1.2 Elasticity and Revenue4.1.3 Price Elasticity of SupplyOutline64.2 Applications to Major Economic Issues4.2.1 The Economics of Agriculture Long-run Relative Decline of Farming Crop Restrictions4.2.2 Impact of a Tax on Price and Quantity4.2.3 Minimum Floors and Maximum Ceilings The Minimum-Wage Controversy Energy Price Controls Rationing by the Queue, by Coupons, or by the Purse? SummaryOutline74.1 Price Elasticity of Demand and supply8 To solve the “How much” question, we need to introduce a new and key economic conceptElasticityElasticity All elasticities are designed to answer this question. For example, we know from the law of demand that as price falls, quantity demanded increases. 4.1.1 Price Elasticity of Demand 9 Price elasticity of demand Price elasticity of demand describes the percentage percentage changechange in quantity demanded of a product caused by some percentage change percentage change in its price.4.1.1 Price Elasticity of Demand 10 When the price elasticity of a good is highhigh, we say that the good has “elasticelastic” demand, which means that it quantity demanded responds greatlygreatly to price changes. When the price elasticity of a good is lowlow, we say that the good has “inelasticinelastic” demand, which means that it quantity demanded responds littlelittle to price changes.4.1.1 Price Elasticity of Demand 11 Goods that have available substitutes tend to have more elastic demand than those that have no substitutes. (page 66) Why? Considering apples and banana, suppose they are substitutes. If the price of apples goes up, consumers will reduce the consumption on apples, and consume more banana. Which means that for a given percentage change in price, the percentage change in quantity demanded will be large. (you have other alternative choices)4.1.1 Price Elasticity of Demand 12 considering footwear, it has little substitutes. you can not go around barefoot. If you dont ware a pair of shoes, what do you plan to ware? Which means that for a given percentage change in price, the percentage change in quantity demanded will be small. (you barely have any choice)4.1.1 Price Elasticity of Demand 13 The price of elasticities of demand for individual goods are determined by the economic characteristics of demand. Price elasticities tend to be higherhigher when the goods are luxuries, when substitutes are available, and when consumers have more time to adjust their behavior.4.1.1 Price Elasticity of Demand 14 Demand for most goods will be more elastic in the long run than in the short run, since a longer time frame allows consumers to search more carefully for substitutes. By contrast, elasticities are lowerlower for necessities, for goods with few substitutes, and for the short run.4.1.1 Price Elasticity of Demand 15 Calculating Elasticities Notice that the sign of E ED D will always be negativenegative. That is, as long as the demand curve is downward- sloping, there will be an inverse relationship between P P and Q Qd d. Therefore when you interpret E ED D, just look at its absolute size, or absolute valueabsolute size, or absolute value. Ignore the Ignore the negative signnegative sign. 4.1.1 Price Elasticity of Demand 16 Then we can do the following analyses. Demand is defined as elasticelastic when the percentage change in quantity demanded is greater than greater than the percentage change in price. (E ED D 1 1) D