DEMAND AND SUPPLY

(APPLICATIONS )
ELASTICITY
1 Chapter 4 and 5
 Price Rationing The process by which the
market system allocates goods and services to
consumers when quantity demanded exceeds
quantity supplied.
 The lower total supply is rationed to those who
are willing to pay higher for it.
 Price Ceiling : Maximum price that seller may
charge for a good

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Market for rare painting

25 l

Quantity
1

3
DISCUSSED

 The direction in which the quantity demanded

moves, but not the size of the change.

 To measure how much demand responds

to changes in its determinants, economists use
the concept of elasticity.

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 Elasticity a measure of the responsiveness of
quantity demanded or quantity supplied to one of
its determinants

 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, computed as
the percentage change in quantity demanded
divided by the percentage change in price

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COMPUTING THE PRICE
ELASTICITY OF DEMAND

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VARIETY OF DEMAND CURVES
D0

Quantity

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ELASTICITY OF DEMAND
Product %Change % change Elasticity Type
in Price in Qd

Insulin +10% 0% 0 Perfectly

Inelastic

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Perfectly Inelastic Demand

D0

Quantity

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ELASTICITY OF DEMAND
Product %Change % change Elasticity Type
in Price in Qd
Insulin +10% 0% 0 Perfectly
Inelastic
Cooking +10% -1% -0.1 Inelastic
Gas

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Perfectly Inelastic Demand

D0

Quantity

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ELASTICITY OF DEMAND
Product %Change % change Elasticity Type
in Price in Qd
Insulin +10% 0% 0 Perfectly
Inelastic
Cooking +10% -1% -0.1 Inelastic
Gas
Potatoes +10% -10% -1.0 Unitarily
Elastic

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 Unitarily elastic Demand

D0

Quantity

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Note : steeper curve has the lower elasticity
ELASTICITY OF DEMAND
Product %Change % change Elasticity Type
in Price in Qd
Insulin +10% 0% 0 Perfectly
Inelastic
Cooking +10% -1% -0.1 Inelastic
Gas
Potatoes +10% -10% -1.0 Unitarily
Elastic
Fruits +10% -30% -3.0 Elastic

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Elastic Demand

D0

Quantity

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Perfectly elastic Demand

p0 D0

Quantity

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 Alternative Coefficient (E)
Perfectly Elastic E=∞
Relatively Elastic 1<E<∞
Unitarily Elastic E=1
Relatively Inelastic 0<E<1
Perfectly Inelastic E=0

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DETERMINANTS

Necessities versus Luxuries

Availability of Close Substitutes

Definition of the Market

Time Horizon
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TOTAL REVENUE AND THE PRICE
ELASTICITY OF DEMAND
The amount paid by
D buyers and received by
sellers of a good,
computed as the price
of the good times the
A
quantity sold

p
TR = P X Q

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0 q
Quantity
EFFECT OF PRICE RAISE

Effects of price increase on

a product with inelastic demand: P x QD TR

Effects of price increase on

a product with elastic demand: P x QD TR

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EFFECT OF PRICE CUT

effect of price cut on a product

with elastic demand: P x QD TR

effect of price cut on a product

with inelastic demand: P x QD TR

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INCOME ELASTICITY OF DEMAND

income elasticity of demand Measures the

responsiveness of demand to changes in
income.

% change in quantity demanded

income elasticity of demand
% change in income

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The Relation Between Quantity Demanded and Income
Quantity

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0
Income
 The Relation Between Quantity Demanded and Income

qm
Quantity

Zero income
elasticity

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0 y1 y2
Income
 The Relation Between Quantity Demanded and Income

qm

Positive income elasticity

Quantity

Zero income
elasticity

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0 y1 y2
Income
THE CROSS-PRICE ELASTICITY OF
DEMAND

cross-price elasticity of demand A measure

of the response of the quantity of one good
demanded to a change in the price of another
good.

% change in quantity of Y demanded

cross - price elasticity of demand
% change in price of X

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ELASTICITY OF SUPPLY

elasticity of supply A measure of the

response of quantity of a good supplied to a
change in price of that good. Likely to be
positive in output markets.

% change in quantity supplied

elasticity of supply
% change in price

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ELASTICITY OF LABOR SUPPLY

elasticity of labor supply A measure of the

response of labor supplied to a change in the
price of labor.

% change in quantity of labor supplied

elasticity of labor supply
% change in the wage rate

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 Three Constant-elasticity Supply Curves
S1

p1 S2

Quantity
q1 Quantity [ii]. Infinite Elasticity

[i]. Zero Elasticity

S3

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Quantity
[iii]. Unit Elasticity
IF COST OF COFFEE GOES UP CAN THE
SUPPLIERS PASS THE COST TO CONSUMERS?

 If coffee is inelastic then – yes

 If coffee is elastic the – no

 Demand is inelastic then costs incurred can be

charged to consumers.
 Demand is elastic then costs incurred cannot be
charged to consumers.

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 CAN GOOD NEWS(Technology) FOR FARMING
BE BAD NEWS FOR FARMERS?

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ELASTICITY ALONG A LINEAR
DEMAND CURVE

 The slope of a linear

demand curve is
constant, but its
elasticity is not.

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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
consumer surplus The difference between the
maximum amount a person is willing to pay for a
good and its current market price.

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SUPPLY AND DEMAND AND
MARKET EFFICIENCY

producer surplus The difference between the current

market price and the full cost of production for the firm.

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DEAD WEIGHT LOSS

deadweight loss The net loss of producer and consumer

surplus from underproduction or overproduction.

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THE MIDPOINT METHOD
 Calculate Percentage Change in Quantity
Demanded (% QD):
Q2 - Q1
x 100%
(Q1 Q2 ) / 2

 Calculate Percentage Change in Price (% P):

P2 - P1
x 100%
( P1 P2 ) / 2

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1. market equilibrium price per gardenburger is $12
2. If the price per gardenburger is $14, there is an excess supply
of 150 units in the market.
3. If the price per gardenburger is $6, there is an excess demand
of 450 gardenburgers.
4. In this market there will be an excess demand of 150
gardenburgers at a price of $10
5. In this market there will be an excess supply of 150
gardenburgers at a price of $14.
6. When there is an excess supply of a product in an unregulated
market, the Price tends to fall 37
PROBLEMS WITH GOVT. POLICIES
 Rent Control in India
 Minimum wages

 Burden of tax on Buyers or Sellers

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