Class 6 - Elasticity

On the second exam, there will be 2 supply & demand graphs - one from the broad chapter 4 and one from ch 5 elasticity, externalities of private and public goods.

See pg 87 - problems and applications

#3 - 5 different shocks to the system

start with original equilibrium - S1 and D1 curves
use table 1 and/or table 2, then proceed to process described in table 3

a. people decide to have more children - demand change - table 1: number of buyers, shifts the demand curve, to the RIGHT. at p1, we no longer have equilibrium, we have a shortage. this signals to the sellers to raise the prices, to p2.

however, it also signals to the manufacturers to increase the quantity supply, moving us up the supply curve (not moving the curve itself). movement which is only motivated by price is a move along the curve, not a move of the curve.

at the same time, the quantity demand is decreasing due to the increase in price. this continues until the supply and demand meet at equilibirium.

b. a strike by steelworkers raises steel prices - supply-side change - a change of the input prices, shifting the supply curve, to the LEFT. at p1, we again do not have equilibrium, we have a shortage. price goes up. quantity demanded decreases and the quantity supply increases.

e. a stock-market crash lowers people's wealth - a demand-side change - a change of income, shifting the demand curve to the LEFT. at p1, we have a surplus, which leads to a lowering of prices (to p2) by salesmen. this signals to manufacturers to produce fewer - quantity supply drops. it also signals to buys to buy more - quantity demand increases.

4. identify the flaw in the analysis. change in taste, shifts the demand curve to the LEFT. leads to a surplus at P1. excess bread on the shelf. this signals sellers to lower the price. this leads to lower quantity supply and an increase in the quantity demand.

Elasticity

See figure 1 - the price elasticity of demand. pg. 93.

a - perfectly inelastic demand curve - demand is unaffected by price at all. approximates demand for Starbucks coffee.

graph e is the opposite - purchasers are absolutely affected by price. they will pay only one price.

In the real world, demand curves always have negative slopes, like those in graphs b, c or d - most likely like b or d.

Pe = %ΔQuantity / %ΔPrice

elasticity coeffient:
>1 price elastic
<1 price inelastic

What makes demand curves elastic or inelastic?

Determinants of Price Elasticity of Demand: (see pp 90-91)
1. Substitutes
2. Necessity vs. Luxury
3. Definition of the Market - the narrower the market, the more elastic it is
4. Time Horizon - the longer the time horizon, the more elastic it is (Perot proposed a 10 cent excise tax on gasoline each year, allowing people to adjust to it.)
5. % of Total Budget - a smaller percentage make the response to price changes more inelastic

Total revenue test (see figure 2 pg 95).
multiply price x quantity
you need a second p2 and q2 to compare to
multiply p2 x q2

Yield Management - started with hotels, went to airlines, concerts and other industries where there's fixed capacity.

Impact of Drug Interdiction

See figure 9 pg 107
Demand curve is inelastic. It's a necessity for those who use the drugs.

If there's a drug bust, the supply goes down - shift the supply curve to LEFT. Price goes up. This makes the drug lords richer.

If you use drug education to try to decrease the demand and shift the demand curve to the LEFT, that would reduce total revenue.

Supply of Wheat

Farmers want their own output to increase, but not everyone else's.
See figure 7, pg 103.
If the supply increases, total farm income goes down due to inelastic demand (people don't eat that much more just because prices go down).