Managerial Economics

20
C HAPT E R
Elasticity of Demand & Supply
Price Elasticity of Demand

The law of demand tells us that consumers will respond to a price decrease by buying more of a product (other things remaining constant), but it does not tell us how much more. The degree of responsiveness or sensitivity of consumers to a change in price is measured by the concept of price elasticity of demand.
If consumers are relatively responsive to price changes, demand is said to be elastic. If consumers are relatively unresponsive to price changes, demand is said to be inelastic. Note that with both elastic and inelastic demand, consumers behave according to the law of demand; that is, they are responsive to price changes. The terms elastic or inelastic describe the degree of responsiveness.
Price elasticity formula

Quantitative measure of elasticity: Ed = % change in quantity / % change in price. Calculate the percentage change in quantity by dividing the absolute change in quantity by the original quantity. Calculate the percentage change in price by dividing the absolute change in price by the original price.
PRICE ELASTICITY OF DEMAND Measures Responsiveness to Price Changes

P
The percentage change in quantity The percentage change in price
1
P2 P1 Q2 Q1
2
D Elasticity is .5 Q
PRICE ELASTICITY OF DEMAND
Commonly Expressed as
P
The percentage change in quantity The percentage change in price
P2 P1 Q2 Q1
%(Q d %( P
D Elasticity is .5 Q

The Price-Elasticity Coefficient and Formula
Percentage change in quantity demanded of product X
Ed =
Percentage change in price of product X
Or equivalently
Ed =
Percentage change in quantity demanded of X Original quantity demanded of X
Change in price of X Original price of X
Elimination of the Minus Sign
Elastic Demand
Ed
4 2 1 2 2 2
=2
Inelastic Demand
Ed Ed
= .5 =1
Unit Elasticity
=
Percentages makes it possible to compare elasticities of demand for different products. Because of the inverse relationship between price and quantity demanded, the actual elasticity of demand will be a negative number. However, we ignore the minus sign and use the absolute value of both percentage changes.
If the coefficient of elasticity of demand is a number greater than one, we say demand is elastic; if the coefficient is less than one, we say demand is inelastic. In other words, the quantity demanded is relatively responsive when Ed is greater than 1 and relatively unresponsive when Ed is less than 1. A special case is if the coefficient equals one; this is called unit elasticity. Note: Inelastic demand does not mean that consumers are completely unresponsive. This extreme situation called perfectly inelastic demand would be very rare, and the demand curve would be vertical.
Likewise, elastic demand does not mean consumers are completely responsive to a price change. This extreme situation, in which a small price reduction would cause buyers to increase their purchases from zero to all that it is possible to obtain, is perfectly elastic demand, and the demand curve would be horizontal.
The midpoint formula for elasticity is

Ed = [(change in Q)/(sum of Qs/2)] divided by [(change in P)/(sum of Ps/2)]
Ed =
Change in quantity Sum of Quantities/2
Change in price Sum of prices/2
Summary of Price elasticitie of Demand relatively elastic Ed > 1, unitary elastic Ed = 1, relative inelastic Ed < 1, Extreme cases: perfectly elastic Ed = , perfectly inelastic Ed =0.
Extreme Cases
Perfectly Inelastic Demand
P
D1
Ed = 0
0 Q
Perfectly Elastic Demand

P
D2 Ed = g
0 Q
Elasticity varies over range of prices

Demand is more elastic in upper left portion of curve (because price is higher and quantity smaller). Demand is more inelastic in lower right portion of curve (because price is lower and quantity larger). It is impossible to judge elasticity of a single demand curve by its flatness or steepness, since demand elasticity can measure both as elastic and as inelastic at different points on the same demand curve.
Total Revenue Test

A total-revenue test is the easiest way to judge whether demand is elastic or inelastic. This test can be used in place of an elasticity formula, unless there is a need to determine the elasticity coefficient. Elastic demand and the total-revenue test: Demand is elastic if a decrease in price results in a rise in total revenue, or if an increase in price results in a decline in total revenue. (Price and revenue move in opposite directions).
Inelastic demand and the total-revenue test: Demand is inelastic if a decrease in price results in a fall in total revenue, or an increase in price results in a rise in total revenue. (Price and revenue move in same direction). Unit elasticity and the total-revenue test: Demand has unit elasticity if total revenue does not change when the price changes. The graphical representation of the relationship between total revenue and price elasticity is shown in Fig. 20-2.
PRICE ELASTICITY & TOTAL REVENUE

Total revenue rises then declines with price to a P TR point...
D Q
Quantity Demanded

Inelastic Demand
D Q
Inelastic Demand
Quantity Demanded

Elastic Demand Inelastic Demand
D Q
Elastic Inelastic Demand Demand

Quantity Demanded

Elastic Demand Inelastic Demand
Unit Elastic
D Q
Elastic Inelastic Demand Demand

Quantity Demanded
Determinants of Price Elasticity:

1. Substitutes for the product: Generally, the more substitutes, the more elastic the demand. 2. The proportion of price relative to income: Generally, the larger the expenditure relative to someones budget, the more elastic the demand, because buyers notice the change in price more. 3. Luxury versus necessary Products: Generally, the less necessary the item, the more elastic the demand. 4. Time: Generally, the longer the time period involved, the more elastic the demand becomes.
The practical applications of the price elasticity of demand 1. Inelastic demand for agricultural products helps to explain why good crops depress the prices and total revenues for farmers. 2. Governments look at elasticity of demand when levying excise taxes. Excise taxes on products with inelastic demand will raise the most revenue and have the least impact on quantity demanded for those products. 3. Demand for drugs is highly inelastic and presents problems for law enforcement. Stricter enforcement reduces supply, raises prices and revenues for sellers, and provides more incentives for sellers to remain in business. Crime may also increase as buyers have to find more money to buy their drugs.
Price Elasticity of Supply

The concept of price elasticity also applies to supply. The elasticity formula is the same as that for demand, but we must substitute the word supplied for the word demanded everywhere in the formula. Es = percentage change in quantity supplied/percentage change in price As with price elasticity of demand, the midpoints formula is more accurate.
PRICE ELASTICITY OF SUPPLY

Percentage change in quantity supplied of good X
Es=
Percentage change in the price of good X
Now, compare the immediate market period, the short-run, and long run...
The ease of shifting resources between alternative uses is very important in price elasticity of supply because it will determine how much flexibility a producer has to adjust his or her output to a change in the price. The degree of flexibility, and therefore the time period, will be different in different industries. (Figure 20-3) The market period is so short that elasticity of supply is inelastic; it could be almost perfectly inelastic or vertical. In this situation, it is virtually impossible for producers to adjust their resources and change the quantity supplied. (Think of adjustments on a farm once the crop has been planted.)

Immediate Market period
P Sm An increase in demand without enough time to change supply causes
Po
D1 Qo Q

Immediate Market period
P Sm An increase in demand without enough time to change supply causes an increase in price
Pm Po
D2 D1 Qo Q

Short Run
P Ss An increase in demand with less intensity supply use causes...
Po
D1 Qo Q

Short Run
P Ss An increase in demand with less intensity supply use causes...a lower increase in price D2 D1 QoQs Q
Ps Po

Long Run
P An increase in demand in the long run allows greater change causing... SL
Po
D1 Qo Q

Long Run
P An increase in demand in the long run allows greater change causing... SL
Po
D1 Qo Q
The short-run supply elasticity is more elastic than the market period and will depend on the ability of producers to respond to price change. Industrial producers are able to make some output changes by having workers work overtime or by bringing on an extra shift. The long-run supply elasticity is the most elastic, because more adjustments can be made over time and quantity can be changed more relative to a small change in price, as in Figure 20-3c. The producer has time to build a new plant.
Applications of the price elasticity of supply.

1. Antiques and other non-reproducible commodities are inelastic in supply, sometimes the supply is perfectly inelastic. This makes their prices highly susceptible to fluctuations in demand. 2. Gold prices are volatile because the supply of gold is highly inelastic, and unstable demand resulting from speculation causes prices to fluctuate significantly.
Cross and income elasticity of demand: Cross elasticity of demand refers to the effect of a change in a products price on the quantity demanded for another product. Numerically, the formula is shown for products X and Y. Exy = (percentage change in quantity of X)/(percentage change in price of Y) If cross elasticity is positive, then X and Y are substitutes. If cross elasticity is negative, then X and Y are complements. Note: if cross elasticity is zero, then X and Y are unrelated, independent products.
CROSS ELASTICITY OF DEMAND
Exy =
Percentage change in quantity demanded of good X Percentage change in the price of good y
Positive Sign
Goods are Substitutes

Negative Sign
Goods are Complementary

Zero or Near-Zero Value
Goods are Independent
Income Ealsticity of Demand

Income elasticity of demand refers to thepercentage change in quantity demanded that results from some percentage change in consumer incomes. Ei = (% in quantity demanded) / (% in income) A positive income elasticity indicates a normal or superior good. A negative income elasticity indicates an inferior good. Those industries that are income elastic will expand at a higher rate as the economy grows.
3
C HAPT E R
Individual Markets:
Demand & Supply
Markets Defined
A market is an institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of particular goods, services, or resources. A market may be local, national, or international in scope. Some markets are highly personal, face-to-face exchanges; others are impersonal and remote. A product market involves goods and services. A resource market involves factors of

Demand
Demand is a schedule that shows the various amounts of a product that consumers are willing and able to buy at each specific price in a series of possible prices during a specified time period. The schedule shows how much buyers are willing and able to purchase at different prices. The market price depends on demand and supply. To be meaningful, the demand schedule must have a period of time associated with it.

DEMAND DEFINED
DEMAND SCHEDULE
P $5 4 3 2 1 QD 10 20 35 55 80
Various Amounts A Series of Possible Prices
a specified time period other things being equal
Law of demand
Law of demand other things being equal, as price increases, the corresponding quantity demanded falls. Law of demand restated, there is an inverse relationship between price and quantity demanded. Note the other-things-equal assumption refers to consumer income and tastes, prices of related goods, and other things besides the price of the product being discussed.
The demand curve

It illustrates the inverse relationship between price and quantity. The downward slope indicates lower quantity (horizontal axis) at higher price (vertical axis) and higher quantity at lower price, reflecting the Law of Demand.
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 20 35 55 80
Plot the Points
10 20 30 40 50 60 70 80 Quantity of Corn
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 20 35 55 80
Plot the Points
10 20 30 40 50 60 70 80 Quantity of Corn
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 20 35 55 80
Connect the Points
D
10 20 30 40 50 60 70 80 Quantity of Corn
Individual versus market demand

Transition from an individual to a market demand schedule is accomplished by summing individual quantities at various price levels. Market curve is horizontal sum of individual curves (see corn example, Tables 3-2, 3-3 and Figure 3-2).
Determinants of demand
There are several determinants of demand or the other things, besides price, which affect demand. Changes in determinants cause changes in demand. a. Tastes: favorable change leads to an increase in demand; unfavorable change to a decrease. b. Number of buyers: more buyers lead to an increase in demand; fewer buyers lead to a decrease. c. Income: more leads to an increase in demand; less leads to a decrease in demand for normal goods. (The rare case of goods whose demand varies inversely with income is called inferior goods).
d. i.
Prices of related goods Substitute goods (those that can be used in place of each other): The price of the substitute good and demand for the other good are directly related. If the price of Coke rises (because of a supply decrease), demand for Pepsi should increase. Complementary goods (those that are used together like tennis balls and rackets): When goods are complements, there is an inverse relationship between the price of one and the demand for the other. Expectations consumer views about future prices, product availability, and income can shift demand.
ii.
e.
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 20 35 55 80
What if Demand Increases?

D
10 20 30 40 50 60 70 80 Quantity of Corn
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 30 20 40 35 60 55 80 80 +
Increase in Quantity Demanded
Increase in Demand
10 20 30 40 50 60 70 80 Quantity of Corn
D D Q
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 30 20 40 35 60 55 80 80 +
Increase in Quantity Demanded
Increase in Demand
10 20 30 40 50 60 70 80 Quantity of Corn
D D Q
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 20 35 55 80
What if Demand Decreases?

D
10 20 30 40 50 60 70 80 Quantity of Corn
GRAPHING DEMAND
Price of Corn
CORN
$5
P $5 4 3 2 1
QD 10 -20 10 35 20 55 40 80 60
Decrease in Quantity Demanded
Decrease in Demand
10 20 30 40 50 60 70 80 Quantity of Corn
D D Q
A summary of what can cause an increase in demand
a. Favorable change in consumer tastes. b.Increase in the number of buyers. c. Rising income if product is a normal good. d.Falling incomes if product is an inferior good. e. Increase in the price of a substitute good. f. Decrease in the price of a complementary good. g.Consumer expectation of higher prices or incomes in the future.
A summary of what can cause a decrease in demand a. Unfavorable change in consumer tastes. b. Decrease in number of buyers. c. Falling income if product is a normal good. d. Rising income if product is an inferior good. e. Decrease in price of a substitute good. f. Increase in price of a complementary good. g. Consumers expectation of lower prices or incomes in the future. G. Review the distinction between a change in quantity demanded caused by price change and a change in demand caused by change in determinants.
Supply
Supply is a schedule that shows amounts of a product a producer is willing and able to produce and sell at each specific price in a series of possible prices during a specified time period. A schedule shows what quantities will be offered at various prices or what price will be required to induce various quantities to be offered. Beyond some production quantity producers usually encounter increasing costs per added unit of output.
The supply curve

It shows a direct relationship in an upward sloping curve.
Law of supply
Law of supply producers will produce and sell more of their product at a high price than at a low price. Law of supply restated There is a direct relationship between price and quantity supplied.
Explanation: Given product costs, a higher price means greater profits and thus an incentive to increase the quantity supplied.
SUPPLY DEFINED
SUPPLY SCHEDULE
Various Amounts
CORN
P $1 2 3 4 5
QS 5 20 35 50 60
SUPPLY DEFINED
SUPPLY SCHEDULE
CORN
P Various Amounts $1 A Series of Possible Prices 2 3 4 5
QS 5 20 35 50 60
a specified time period other things being equal
GRAPHING SUPPLY
Price of Corn
Plot the Points

CORN
$5
P $5 4 3 2 1
20 30 40 50 60 70 80 Quantity of Corn
QS 60 50 35 20 5
o 5 10
GRAPHING SUPPLY
Price of Corn
Plot the Points

CORN
$5
P $5 4 3 2 1
10 20 30 40 50 60 70 80 Quantity of Corn
QS 60 50 35 20 5
GRAPHING SUPPLY
Price of Corn
$5
CORN
P QS $5 4 3 2 1 60 50 35 20 5
Connect the Points

10 20 30 40 50 60 70 80 Quantity of Corn
Determinants of supply
A change in any of the supply determinants causes a change in supply and a shift in the supply curve. An increase in supply involves a rightward shift, and a decrease in supply involves a leftward shift. a. Resource prices: a rise in resource prices will cause a decrease in supply or leftward shift in supply curve; a decrease in resource prices will cause an increase in supply or rightward shift in the supply curve. b. Technology: A technological improvement means more efficient production and lower costs, so an increase in supply or rightward shift in the curve results.
c. Taxes and subsidies A business tax is treated as a cost, so decreases supply; a subsidy lowers cost of production, so increases supply. d. Expectations Expectations about the future price of a product can cause producers to increase or decrease current supply. d. Number of sellers Generally, the larger the number of sellers the greater the supply.
GRAPHING SUPPLY
Price of Corn
$5
CORN
What if Supply Increases?

10 20 30 40 50 60 70 80 Quantity of Corn
P QS $5 4 3 2 1
Q
60 50 35 20 5
GRAPHING SUPPLY
Price of Corn
$5
Increase in Supply
S
CORN
P QS $5 4 3 Increase 2 in Quantity 1
Supplied Q
60 80 50 70 35 60 20 45 5 30
10 20 30 40 50 60 70 80 Quantity of Corn
GRAPHING SUPPLY
Price of Corn Decrease
$5
in Supply
S S
CORN
P QS $5 4 3 Decrease 2 in Quantity 1 Supplied 60 45 50 30 35 20 20 0 5 --
10 20 30 40 50 60 70 80 Quantity of Corn
Supply and Demand: Market Equilibrium

Market Equilibrium: where quantity supplied equals the quantity demanded. At prices above this equilibrium, note that there is an excess quantity or surplus. At prices below this equilibrium, note that there is an excess quantity demanded or shortage. Market clearing or market price is another name for equilibrium price. Graphically, note that the equilibrium price and quantity are where the supply and demand curves intersect. Note that it is NOT correct to say supply equals demand!
MARKET DEMAND & SUPPLY

BUSHELS OF CORN
P $5 4 3 2 1
QD 10 20 35 55 80
MARKET
BUSHELS OF CORN
200 DEMAND B 2,000
P QS $5 4 3 2 1 60 50 35 20 5
MARKET
200 SUPPLY S 12,000
U Y E R S
4,000 7,000 11,000 16,000
E L L E R S
10,000 7,000 4,000 1,000
EQUILIBRIUM
MARKET DEMAND & SUPPLY Price of Corn

CORN MARKET
$5
CORN MARKET
P QD $5 2,000 4 4,000 3 7,000 2 11,000 1 16,000
P Market $5 Clearing Equilibrium 4 3 2 1

D
2 4 6
Q
S 12,000 10,000 7,000 4,000 1,000
78
10 12 14 16
Quantity of Corn

CORN MARKET
$5
Surplus
S
At a $4 price
CORN MARKET
P QD $5 2,000 4 4,000 3 7,000 2 11,000 1 16,000
P more is being $5 supplied than 4 demanded 3 2 1

D
2 4 6
Q
S 12,000 10,000 7,000 4,000 1,000
78
10 12 14 16
Quantity of Corn

CORN MARKET
$5
S
At a $2 price
CORN MARKET
P QD $5 2,000 4 4,000 3 7,000 2 11,000 1 16,000
P more is being $5 demanded than 4 3 supplied 2 1 Shortage

D
2 4 6
Q
S 12,000 10,000 7,000 4,000 1,000
78
101112 14 16
Quantity of Corn
Changes in Supply and Demand, and Equilibrium

A. B. Changing demand with supply held constant. Increase in demand will have effect of increasing equilibrium price and quantity. Decrease in demand will have effect of decreasing equilibrium price and quantity. Changing supply with demand held constant. Increase in supply will have effect of decreasing equilibrium price and increasing quantity. Decrease in supply will have effect of increasing equilibrium price and decreasing quantity.
C. Complex cases: when both supply and demand shift 1. If supply increases and demand decreases, price declines, but the new equilibrium quantity depends on relative sizes of shifts in demand and supply. 2. If supply decreases and demand increases, price rises, but the new equilibrium quantity depends again on relative sizes of shifts in demand and supply. 3. If supply and demand change in the same direction (both increase or both decrease), the change in equilibrium quantity will be in the direction of the shift but the change in equilibrium price now depends on the relative shifts in demand and supply.
A Reminder: Other things equal

Demand is an inverse relationship between price and quantity demanded, other things equal (unchanged). Supply is a direct relationship showing the relationship between price and quantity supplied, other things equal (unchanged). It can appear that these rules have been violated over time, when tracking the price and the quantity sold of a product such as salsa or coffee. Many factors other than price determine the outcome.
If neither the buyers nor the sellers have changed, the equilibrium price will remain the same. The most important distinction to make is to determine if a change has occurred because of something that has affected the buyers or something that is influencing the sellers. A change in any of the determinants of demand will shift the demand curve and cause a change in quantity supplied. A change in any of the determinants of supply will shift the supply curve and cause a change in the quantity demanded.
Application: Government-Set Prices (Ceilings and Floors) Government-set prices prevent the market from reaching the equilibrium price and quantity. A. Price ceilings. The maximum legal price a seller may charge, typically placed below equilibrium. Shortages result as quantity demanded exceeds quantity supplied. Examples: Rent controls and gasoline price controls
B. Price floors The minimum legal price a seller may charge, typically placed below equilibrium. Surpluses result as quantity supplied exceeds quantity demanded. Examples: Minimum wage, farm price supports. Note: The federal minimum wage, for example, will be below equilibrium in some labor markets (large cities). In that case the price floor has no effect.
22
C HAPT E R
The Costs of Production
Costs exist because resources

Are scarce Productive Have alternative uses Use of a resource in a specific use implies an economic or opportunity cost
Explicit and implicit costs

Explicit costs The monetary payments a firm must make to those who supply it. Implicit costs The opportunity costs of using selfemployed resources.
Economic costs
The payment the firm must make or income it must provide to attract resources away from alternative production opportunities Normal profit as a cost Implicit costs are a normal profit: Foregone wages Foregone interest Foregone rent Foregone entrepreneurial income
Economic profit
Economic profit is: Total revenue economic costs Or Total revenue (explicit + implicit costs)
Example
Hamad is working as a manager for 22000. his entrepreneurial talent worth 5000. He decides to open his own business. He invested his 20000 of savings that earn 1000 The new firm will occupy a store he used to let out for 5000. He hired labor for 18000 Cost of raw materials is 40000 and other utilities is 5000. Total revenue is 120000 Calculate the explicit and implicit costs Calculate the accounting and economic profits.
ECONOMIC COSTS
Profits to an Economist
Economic (opportunity) Costs
Profits to an Accountant
T O T A L R E V E N U E
Economic Profit
Implicit costs (including a normal profit)
Accounting Profit
Explicit Costs
Accounting costs (explicit costs only)
SHORT RUN AND LONG RUN
Accounting:
Short and long run is based upon annual chronology
Economics:
Short run has fixed plant capacity size Long run has variable plant capacity size
SHORT-RUN PRODUCTION RELATIONSHIPS
Total Product (TP) Marginal Product (MP)

Marginal Product =
Change in Total Product Change in Labor Input
Average Product (AP)

Average Product =
Total Product Units of Labor
Variable resource (labor)
Total product
Marginal product
Average product
Comments
0 1 2 3 4 5 6 7 8
0 10 25 45 60 70 75 75 70 10 15 20 15 10 5 0 -5
10 12.5 15 15 14 12.5 10.71 8.75

Increasing marginal returns
Increasing marginal returns Increasing marginal returns Diminishing marginal returns Diminishing marginal returns Diminishing marginal returns Diminishing marginal returns Negative marginal returns
Law of diminishing marginal returns As successive units of a variable resource are added to a fixed resource, beyond some point, the extra, or marginal product that can be attributed to each additional unit of the variable resource will decline WHY?
Total Product, TP
SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns

Total Product
Average Product, AP, and marginal product, MP
Quantity of Labor
Negative Marginal Returns

Average Product Marginal Product
Quantity of Labor
SHORT-RUN PRODUCTION COSTS
Fixed Costs
Total Fixed Costs Average Fixed Costs =
Total Fixed Costs Quantity
Variable Costs
Total Variable Costs Average Variable Costs =
Total Variable Costs Quantity
Total Cost
Total Fixed and Variable Costs Average Total Cost =
Total Costs Quantity
Marginal Cost
Total Variable Costs Marginal Cost =
Change in Total Costs Change in Quantity
Total Product
Total Fixed Costs
Total Variable Costs
Total Costs
0 1 2 3 4 5 6 7 8 9 10
100 100 100 100 100 100 100 100 100 100 100
0 90 170 240 300 370 450 540 650 780 930
100 190 270 340 400 470 550 640 750 880 1030
Total Product
Average Fixed Costs
Average Variable Costs
Average Total Costs
Marginal Costs
0 1 2 3 4 5 6 7 8 9 10
100 50 33.33 25 20 16.67 14.29 12.50 11.11 10
90 85 80 75 74 75 77.14 81.25 86.67 93
190 135 113.33 100 94 91.67 91.43 93.75 97.78 103
90 80 70 60 70 80 90 110 130 150
Summary of Definitions Total Fixed Costs = Total Variable Costs = Total Costs = Average Fixed Costs = Average Variable Costs = Average Total Costs = Marginal Cost =
TFC TVC TC AFC AVC ATC MC
Summary of Definitions Total Fixed Costs = Total Variable Costs = Total Costs = Average Fixed Costs = Average Variable Costs = Average Total Costs = Marginal Cost =
TFC TVC TC AFC AVC ATC MC
SHORT-RUN COSTS GRAPHICALLY
Costs (dollars)
Combining TVC With TFC to get Total Cost
TC TVC
Fixed Cost
Total Cost
Variable Cost
TFC
Quantity
SHORT-RUN COSTS GRAPHICALLY

MC
Costs (dollars)
Plotting Average and Marginal Costs ATC

AVC
AFC
Quantity
PRODUCTIVITY AND COST CURVES

Average product and marginal product
AP MP
Quantity of labor
Costs (dollars)
MC AVC
Quantity of output
LONG-RUN PRODUCTION COSTS
For every plant capacity size... There is a short-run ATC curve
All such plant capacities can be plotted...
Unit Costs
Output
Unit Costs
Output

The Long-run ATC just envelopes all of the short-run ATC curves
Unit Costs
Output
Unit Costs
Long-run ATC
Output
ECONOMIES AND DISECONOMIES OF SCALE

Economies of scale
Unit Costs
Long-run ATC
Output

Economies of scale Constant returns to scale Diseconomies of scale
Unit Costs
Long-run ATC
Output
Economies of scale
Labor specialization: working at fewer tasks workers become efficient in them. Greater labor specialization eliminates the loss of time that accompanies each shift of a worker from one task to another Managerial specialization: small firms cant use management specialists to best advantages. Large companies can use specialists full time, which means greater efficiency and lower costs
Economies of scale
Efficient capital. Large firms can afford the most efficient equipments, these requires high volume of production and large scale producers, e.g., car robots. Other factors: design and development and other startup costs,
Diseconomies of scale
The main reason is difficulty of efficiently controlling and coordinating a firms operation when it becomes large.
Constant returns of scale

Effect of factors of economies and factors of diseconomies is equal. Minimum efficient size: The lowest level of output at which a firm can minimize long run average costs.

Where extensive economies of scale exist: Natural Monopolies. Unit Costs
Long-run ATC
Output

Where economies of scale are quickly exhausted
Unit Costs
Long-run ATC
Output
23
C HAPT E R
Pure Competitio n
FOUR MARKET MODELS

Pure Competition
Very large number of firms, standardized product, new firms can enter or exit from the industry very easily
FOUR MARKET MODELS

Pure Monopoly
Pure Competition One firm is the sole seller of a product, entry of additional producers is blocked, produces a unique product, it makes no effort to differentiate its product.
FOUR MARKET MODELS

Imperfect Competition
Pure Competition
Pure Monopoly
FOUR MARKET MODELS

Monopolistic Competition
Pure Competition Relatively large number of sellers, producing different products, widespread non-price competition, product differentiation.
Pure Monopoly
FOUR MARKET MODELS

Oligopoly
Pure Competition
Pure Monopoly
Few sellers of an identical product, each is affected by decisions of others.
FOUR MARKET MODELS 1. Pure Competition:
Very Large Numbers Standardized Product Price Takers Free Entry and Exit
Pure Competition Monopolistic Competition Oligopoly Pure Monopoly
Market Structure Continuum
Very large numbers Very large number of independently acting sellers, e.g., farm products, stock market, foreign exchange market. Standardized product Identical or homogeneous product. As long as the price is the same, consumers will be indifferent about which seller they buy the product from Price takers - Individual firms exert no significant control over the market price. Each firms quantity is too small to affect the market supply or price. - Competitive firms are price takers, they cannot affect the price, but adjust to it. - None of the sellers can ask for a higher price - None will sell at a lower price
Free entry and exit New firms can freely enter and existing firms can freely leave the market. No significant legal, technological, financial, or other obstacles prohibit new firms from selling their output in the market. Relevance of pure competition Pure competition is rare It is highly relevant, we can learn much about markets by studying pure competition model. It is meaningful as a starting point for discussing price and output determination.
Revenue
Average revenue Revenue per unit The firms demand schedule is its revenue schedule Price and average revenue are the same Total revenue The price times the quantity (TR=P x Q) Total revenue increases by a constant amount for each unit of sales Marginal revenue The change in total revenue due to the change in the quantity of sales by one unit Marginal revenue is constant Marginal revenue equals the price.
note
In a competitive market: Price = Average revenue = Marginal revenue
DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER

Product Price (P) Quantity Total (Average Revenue) Demanded (Q) Revenue (TR) Marginal Revenue (MR)
$131 131 131
0 1 2
0] 131 ] 262
$131 131
DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER

Product Price (P) Quantity Total (Average Revenue) Demanded (Q) Revenue (TR) Marginal Revenue (MR)
$131 131 131 131 131 131 131 131 131 131 131
0 1 2 3 4 5 6 7 8 9 10
0 ] 131 ] 262 ] 393 ] 524 ] 655 ] 786 ] 917 ] 1048 ] 1179 ] 1310
$131 131 131 131 131 131 131 131 131 131
Perfectly elastic demand A firm cannot obtain a higher price by restricting its output, nor does it need to lower its price to increase its sales volume. Demand curve faced by the individual competitive firm is perfectly elastic at the market price Note that competitive market demand curve is a downsloping curve.
DEMAND, MARGINAL REVENUE, AND TOTAL REVENUE IN PURE COMPETITION

1179 1048
TR
Price and revenue
917 786 655 524 393 262 131 0 1 2 3 4 5 6 7 8 9 10
D = MR
Quantity Demanded (sold)
SHORT RUN PROFIT MAXIMIZATION
Two Approaches...
First: Total-Revenue -Total Cost Approach
The Decision Process: Should the firm produce? If so What quantity should be produced? What profit or loss will be realized? The Decision Rule: Produce in the short-run if it can realize: 1- A profit (or) 2- A loss less than its fixed costs
TOTAL REVENUE-TOTAL COST APPROACH
Total Total Total Fixed Variable Total Product Cost Cost Cost
0 1 2 3 4 5 6 7 8 9 10 $ 100 $ 0 $ 100 100 90 190 100 170 270 100 240 340 100 300 400 100 370 470 100 450 550 100 540 640 100 649 749 100 780 880 100 930 1030
Total Revenue Profit

$ 0 131 262 393 524 655 786 917 1048 1179 1310
Price: $131
- $100 - 59 -8 + 53 + 124 + 185 + 236 + 277 + 299 + 299 + 280
Total Total Total Fixed Variable Total Product Cost Cost Cost
0 1 2 3 4 5 6 7 8 9 10 $ 100 $ 0 $ 100 100 90 190 100 170 270 100 240 340 100 300 400 100 370 470 100 450 550 100 540 640 100 649 749 100 780 880 100 930 1030
Total Revenue Profit

$ 0 131 262 393 524 655 786 917 1048 1179 1310
Price: $131
- $100 - 59 -8 + 53 + 124 + 185 + 236 + 277 + 299 + 299 + 280

$1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100 0
Break-Even Point
(Normal Profit)
Total revenue and total cost
Total Revenue
Maximum Economic Profits $299
Total Cost
Break-Even Point
(Normal Profit)
1 2 3 4 5 6 7 8 9 10 11 12 13 14
SHORT RUN PROFIT MAXIMIZATION
Two Approaches...
First: Total-Revenue -Total Cost Approach Second: Marginal-Revenue Marginal-Cost Approach
MR = MC Rule
Three Characteristics: The rule applies only if producing is preferred to shutting down (otherwise the firm will
shut down)
Rule applies to all markets Rule can be restated P=MC
MR = MC rule
In the short run, the firm will maximize profit or minimize losses by producing the output at which marginal revenue equals marginal cost.
MARGINAL REVENUE-MARGINAL COST APPROACH
Average Average Average Price = Total Total Fixed Variable Total Marginal Marginal Economic Cost Cost Revenue Profit/Loss Product Cost Cost 0 1 2 3 4 5 6 7 8 9 10
The $100.00 $90.00 $190.00 same profit 50.00 85.00 135.00 33.33 80.00 113.33 maximizing 25.00 75.00 100.00 94.00 20.00 74.00 result! 91.67 16.67 75.00
14.29 12.50 11.11 10.00 77.14 81.25 86.67 93.00 91.43 93.75 97.78 103.00
90 80 70 60 70 80 90 110 131 150
$ 131 131 131 131 131 131 131 131 131 131
- $100 - 59 -8 + 53 + 124 + 185 + 236 + 277 + 299 + 299 + 280
Two ways to calculate profit

First Calculate total profit TR = P . Q TC = Q . ATC = TR TC Second calculate profit per unit per unit = P (AR) ATC = per unit . Q
Profit Maximization Position

$200
Cost and Revenue
Economic Profit
150
MC MR ATC AVC
MR = MC 100 $97.78 Optimum Solution 50

0
1 2 3 4 5 6 7 8 9 10
$131.00
Loss Minimization Position

If the price is lowered from $131 to $81 The MR=MC rule still applies
But the MR = MC point changes Note: = per unit . Q
Loss Minimization Position

$200
Cost and Revenue
Economic Loss
150 100
MC
$91.67 $81.00
ATC AVC MR
50
1 2 3 4 5 6 7 8 9 10
Short-Run Shut Down Point

$200
Cost and Revenue
MC
150 100
$71.00
ATC AVC MR Minimum AVC is the Shut-Down Point

1 2 3 4 5 6 7 8 9 10
50
Marginal Cost & Short-Run Supply Observe the impact upon profitability as price is changed
Price Quantity Supplied Maximum Profit (+) Or Minimum Loss (-)
$151 131 111 91 81 71 61
10 9 8 7 6 0 0
$+480 +299 +138 -3 -64 -100 -100
Marginal Cost & Short-Run Supply

Cost and Revenue, (dollars)
MC
P5
MR5
ATC
P4 P3 P2 P1
AVC
MR4 MR3 MR2 MR1
Do not Produce Below AVC

Q2 Q3 Q4 Q5
Quantity Supplied

P5
Yields the Short-Run Supply Curve
Supply
MC MR5 MR4 MR3 MR2 MR1
P4 P3 P2 P1
No Production Below AVC

Q2 Q3 Q4 Q5
Quantity Supplied

Cost and Revenue, (dollars) MC2 S2 MC1 S1 AVC2 AVC1
Higher Costs Move the Supply Curve to the Left

Quantity Supplied

Lower Costs Move the Supply Curve to the Right
MC1 S1 MC2 S2 AVC1 AVC2
Quantity Supplied
SHORT RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm Takes its Price from the Industry Equilibrium
P Economic ATC Profit S=MC D
AVC
S= 7MCs
$111
$111
D
8
8000
Firm
(price taker)
Industry
PROFIT MAXIMIZATION IN THE LONG-RUN
Assumptions...
Entry and Exit Only

Identical Costs Constant-Cost Industry (entry and exit does not affect resource prices)
Goal.. Price = Minimum ATC .
Zero Economic Profit Model
Temporary Profits and the Reestablishment Of Long-Run Equilibrium

P
ATC
$60 50 40
P
MC
S1
$60
MR
50 40
D1
100
100,000
Firm
(price taker)
Industry
New Competitors increase supply and lower Prices decrease economic profits
Zero Economic P Profits
ATC
$60 50 40
S1 S2
MC
$60
MR
50 40
D2 D1
100
100,000
Firm
(price taker)
Industry
An increase in demand increases profits

P Economic Profits
ATC
$60 50 40
P
MC
S1
$60
MR
50 40
D2 D1
100
100,000
Firm
(price taker)
Industry
Decreases in demand, Losses and the Reestablishment of Long-Run Equilibrium

P
ATC
$60 50 40
P
MC
S1
MR $60 50
40
D1
100
100,000
Firm
(price taker)
Industry
Competitors with losses decrease supply and prices return to zero economic profits S3
Return to Zero P Economic Profits
ATC
$60 50 40
S1
MC
MR $60 50
40
D1 D2
100
100,000
Firm
(price taker)
Industry
LONG-RUN SUPPLY IN A CONSTANT COST INDUSTRY
Constant Cost Industry

Perfectly Elastic Long-Run Supply: entry and exit will set the price back to its original level
Graphically...
LONG-RUN SUPPLY IN A CONSTANT COST INDUSTRY

P
P1 P2 =$50 P3
Z3
Z1
Z2
D3 D1 D2
Q3 Q1 Q2
90,000 100,000 110,000
LONG-RUN SUPPLY IN AN INCREASING COST INDUSTRY

P S
P1 $55 P2 50 P3 45
Y1 Y3 Y2
D3
Q3 Q1 Q2
90,000 100,000 110,000
D1
D2 Q
LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM

MC Price ATC
MR Price = MC = Minimum ATC (normal profit)

Q
Quantity
PURE COMPETITION AND EFFICIENCY
Productive Efficiency
Price = Minimum ATC
Allocative Efficiency
Price = MC Underallocation
Price > MC
Overallocation
Price < MC
PURE COMPETITION AND EFFICIENCY
Productive Efficiency
Price = Minimum ATC Resources are Allocative Efficiency efficiently allocated Price = MC under competition Underallocation
Price > MC
Overallocation
Price < MC
25
C HAPT E R
Monopolistic Competition and Oligopoly
FOUR MARKET MODELS Monopolistic Competition:
Pure Competition
Oligopoly
Pure Monopoly
CHARACTERISTICS
1) Relatively Large Number of Sellers Small Market Shares No Collusion (collusion needs few producers) Independent Action (each firm sets its price without considering the possibility of rival reactions, provide variable locations and proclaim special qualities) remember rivals are relatively large
CHARACTERISTICS
2) Differentiated Products Product Attributes Service Location (accessibility) Brand Names and Packaging Some Control Over Price 3) Role of Advertising
The firms demand curve
Demand is highly elastic

Reasons: The seller has many competitors Close substitutes Elasticity of demand for the producer depends on: The number of rivals The degree of product differentiation
Optimal Output: The Short Run Rule:
MC = MR
There are tow possibilities: Profit Losses
Optimal Output: the long run: Only a Normal Profit (i.e. economic profit = zero)
Profits: Firms enter. In the short run economic profits attract new comers Demand facing the firm shifts to the left Profits decline Demand curve is tangent to ATC No further incentive for entry
Losses: Firms leave In the short run economic losses force some firms to leave Demand facing the firm shifts to the right losses disappear Demand curve is tangent to ATC No further incentive to exit
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Expect New Competitors MC

ATC
Price and Costs
P1 A1
Economic Profits MR
Q1 Quantity
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Expect New Competitors MC

ATC
Price and Costs
New competition drives down the P price level leading to economic A losses in the short run
1 1
Economic Profits MR
Q1 Quantity
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION

MC ATC
Price and Costs
A2 P2
Economic Losses D MR
Q2 Quantity
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION

MC ATC
Price and Costs
With economic losses, firms will exit the market Stability occurs Economic when economic profits are zero
Losses D MR
Q2 Quantity
A2 P2
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Long-Run Equilibrium MC

Normal Profit Only ATC
Price and Costs
P3 = A3
D MR
Q3 Quantity
MONOPOLISTIC COMPETITION AND EFFICIENCY In Pure Competition only Economic Efficiency P = MC = Minimum ATC Productive Efficiency P = ATC Goods are produced in the least costly way. Price is just efficient to cover total costs including a normal profit
Allocative Efficiency P = MC The right amount of output is being produced The right amount of the societys scarce resources is being devoted to this specific use.
MONOPOLISTIC COMPETITION AND EFFICIENCY

In Monopolistic Competition
Not Productively Efficient price { Minimum ATC P > Minimum ATC Not Allocatively Efficient Price { MC Monopolistic competition causes under allocation of the societys resources Monopolistic competition is not allocatively efficient
Consumers pay a higher than the competitive price Monopolistic competition producers must charge a higher than the competitive price in the long run in order to achieve a normal profit
Excess Capacity
(Optimal capacity is to produce at minimum ATC) The gap between minimum ATC and the profit maximizing price identifies excess capacity Plant and equipment are under used because production is at less than minimum ATC

Long-Run Equilibrium
Price is Not = Minimum ATC Price { MC D MR
Q3 Quantity Q4
Excess capacity
MC
ATC
Price and Costs
P3 = A3

Long-Run Equilibrium
Price is Not = Minimum ATC Price { MC D MR
Q3 Quantity Q4
Excess capacity
MC
ATC
Price and Costs
P3 = A3
24
C HAPT E R
Pure Monopol y
FOUR MARKET MODELS Pure Monopoly: Single Seller No Close Substitutes Price Maker Blocked Entry Nonprice Competition
Pure Competition Monopolistic Competition Oligopoly Pure Monopoly
MONOPOLY EXAMPLES Pure Monopoly Regulated Monopoly Near Monopolies Dual Objectives of the Study Monopoly as a Market Structure To Better Understand Other Market Structures
BARRIERS TO ENTRY Economies of Scale

The Natural Monopoly Case
Legal Barriers to Entry

Patents Licenses
Ownership or Control of Essential Resources Pricing and Other Strategic Barriers to Entry
THE NATURAL MONOPOLY CASE
Average Total Cost
$20 15
ATC
10
If ATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly
0 50 100 Quantity 200
MONOPOLY DEMAND 3 Basic Assumptions: Monopoly Status is Secure No Governmental Regulation Firm Charges the Same Price for all Units Sold Market Demand Curve is the Firms Demand Curve
The monopolist sets the price in the elastic region of demand In the elastic region of demand lower price leads to higher total revenue The monopolist avoids the inelastic region in the demand curve.
Profit maximization rule of monopolist MR = MC Note that price > MR Loss minimization rule MR = MC
The monopolist has no supply curve The monopolist equates MR and MC to determine output The monopolist does not set the highest possible price. Monopolist goal is maximum profit not maximum price. Higher price may lead to less profit.
MONOPOLY REVENUES & COSTS

Revenue Data
Quantity Price of (Average Total Marginal Output Revenue) Revenue Revenue Average Total Cost
Cost Data
Profit + Total Marginal or loss Cost Cost
0 1 2 3 4 5 6 7 8 9 10
$172 $ 0 ] 162 162 ] 152 304 ] 142 426 ] 132 528 ] 122 610 ] 112 672 ] 102 714 ] 92 736 ] 82 738 ] 72 720
$162 $190.00 142 135.00 122 113.33 102 100.00 82 94.00 62 91.67 42 91.43 22 93.73 2 97.78 - 18 103.00
$100 ] 190 ] 270 ] 340 ] 400 ] 470 ] 550 ] 640 ] 750 ] 880 ] 1030
90 80 70 60 70 80 90 110 130 150
- $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310

Revenue Data
Quantity Price of (Average Total Marginal Output Revenue) Revenue Revenue Average Total Cost
Cost Data
Profit + Total Marginal or loss Cost Cost
Can you see profit 0 $172 $ 0 ] $162 162 162 1 maximization?142 ]

2 3 4 5 6 7 8 9 10 152 142 132 122 112 102 92 82 72
304 ] 122 426 ] 102 528 ] 82 610 ] 62 672 ] 42 714 ] 22 736 ] 2 738 ] - 18 720
$100 90 - $100 MR190 ] MC - 28 >= $190.00 ] 80 135.00 270 70 + 34 ] 113.33 340 60 + 86 ] 100.00 400 70 + 128 ] 94.00 470 80 + 140 ] 91.67 550 90 + 122 ] 91.43 640 110 + 74 ] - 14 93.73 750 ] 130 97.78 880 ] 150 - 142 - 310 103.00 1030
As price decreases from $142 to $132... but revenue will $142 Loss = $30 increase with the 132 additional unit sold D
Gain = $132
MONOPOLY DEMAND
As price decreases from $142 to $132... but revenue will $142 Loss = $30 increase with the 132 additional unit sold
MONOPOLY DEMAND
Marginal Revenue Gain = $142 - $30 = $102 $132 will necessarily be less than price $132
1 2 3 4 5 6

Elastic
$200
Inelastic
Dollars
150
200 50
MR
D Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
$750
Dollars
500
TR
250
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
OUTPUT AND PRICE DETERMINATION
Cost Data MR = MC Rule No Monopoly Supply Curve Monopoly Pricing Misconceptions Not Highest Price Total, Not Unit, Profit Possibility of Losses
Graphically
Profit Maximization Under Monopoly
Remember the MR=MC Rule? 200

175 150 125 100 75 50 25
Price, costs, and revenue
Profit Per Unit
MC ATC D
$122 $94
Profit
MR = MC
0 1 2 3 4 5 6 7 8
MR
9 10
Profit Maximization Under Monopoly

200 175
What About $122 Loss Minimization?ATC Profit $94

125 100 75 50 25
150
Profit Per Unit
MC
D
MR = MC
0 1 2 3 4 5 6 7 8
MR
9 10
Loss Minimization Under Monopoly

200 175
Since Pm exceedsLoss AVC, Per Unit the firm will produce

MC ATC AVC D
MR = MC
0 1 2 3 4
150
A 125 Loss Pm
100
V
75 50 25
MR
Qm
5 6 7 8 9 10
Loss Minimization Under Monopoly

200 175
Loss Per Unit
What are the A P Economic Effects V of Monopoly? D

150 125 100
Loss
MC ATC AVC
75 50 25
MR = MC
0 1 2 3 4
MR
Qm
5 6 7 8 9 10
INEFFICIENCY OF PURE MONOPOLY

P An industry in pure competition S = MC sells where supply and
demand are equal
Pm Pc
At MR=MC A monopolist will sell less units at a higher price than in competition
D MR Qm Qc Q
INEFFICIENCY OF PURE MONOPOLY

P S = MC
At MR=MC A monopolist will sell less Pm Monopoly pricing effectively units at a higher price Pc creates an income transfer from than in buyers to the seller! competition
D MR Qm Qc Q
COST COMPLICATIONS Cost for monopoly may be different from pure competition: why? Economies of Scale: can easily be reached by a monopolist Simultaneous Consumption: produce for a large number of consumers than a
small company (Microsoft and Dell)
Average total costs
Network Effects: more benefits as the number of consumer increases e.g. internet users, i.e. more value to consumers Inefficient internal operation leads to X-Inefficiency higher-thanWhen the cost necessary costs of producing X is more than
the lowest possible cost
ATCx ATC1 ATCx
Average Total Costs
ATC2 Monopolists are likely to experience X inefficiency than pure competition producers (who are under
pressures)
Q1 Quantity
Q2
COST COMPLICATIONS
Economies of Scale Simultaneous Consumption Network Effects X-Inefficiency
Rent-Seeking Expenditures Rent-Seeking Behavior: using the monopolistic position to make more profits Technological Advance: monopolists are less likely to care about R&D Assessment of monopoly and Policy Options: Antitrust Action: the government takes actions against monopoly Regulate Natural Monopoly: regulation prices and operations Ignore it: if monopoly is Short-Lived:
PRICE DISCRIMINATION Conditions
Monopoly Power Market Segregation No Resale

Consequences
More Profit More Production Graphically
PRICE DISCRIMINATION
P Price and Costs
Economic profits with a single MR=MC price
MC
ATC
MR Q1
D Q
PRICE DISCRIMINATION
P Price and Costs
Economic profits with price discrimination
MC
ATC
MR=D D Q1 Q2 Q
REGULATED MONOPOLY Natural Monopolies
Rate (price) Regulation Socially Optimum Price

P = MC
Fair-Return Price
P = ATC
Dilemma of Regulation
Graphically
REGULATED MONOPOLY
P Price and Costs Monopoly Price MR = MC
Pm
ATC MC D MR
Qm
REGULATED MONOPOLY
P Price and Costs Fair-Return Price Normal Profit Only
Pf
ATC MC D MR
Qf
REGULATED MONOPOLY
P Price and Costs
Pr
Socially-Optimum Price P = MC ATC MC D MR

Qr
REGULATED MONOPOLY
P Price and Costs
Dilemma of Regulation MR = MC Which Price?

Fair-Return Price Socially-Optimum Price ATC MC D MR
Qm Qf Qr
Pm
Pf Pr

Managerial Economics

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20

Elasticity of Demand & Supply

Price Elasticity of Demand

Price elasticity formula

PRICE ELASTICITY OF DEMAND Measures Responsiveness to Price Changes

PRICE ELASTICITY OF DEMAND

PRICE ELASTICITY OF DEMAND

Percentage change in price of product X

Percentage change in quantity demanded of X Original quantity demanded of X

Change in price of X Original price of X

Elimination of the Minus Sign

PRICE ELASTICITY OF DEMAND

The midpoint formula for elasticity is

Change in quantity Sum of Quantities/2

Change in price Sum of prices/2

PRICE ELASTICITY OF DEMAND

Perfectly Elastic Demand

Elasticity varies over range of prices

Total Revenue Test

PRICE ELASTICITY & TOTAL REVENUE

PRICE ELASTICITY & TOTAL REVENUE

PRICE ELASTICITY & TOTAL REVENUE

Elastic Demand Inelastic Demand

Elastic Inelastic Demand Demand

PRICE ELASTICITY & TOTAL REVENUE

Elastic Demand Inelastic Demand

Elastic Inelastic Demand Demand

Determinants of Price Elasticity:

Price Elasticity of Supply

PRICE ELASTICITY OF SUPPLY

Percentage change in the price of good X

PRICE ELASTICITY OF SUPPLY

PRICE ELASTICITY OF SUPPLY

PRICE ELASTICITY OF SUPPLY

PRICE ELASTICITY OF SUPPLY

PRICE ELASTICITY OF SUPPLY

PRICE ELASTICITY OF SUPPLY

Applications of the price elasticity of supply.

CROSS ELASTICITY OF DEMAND

Goods are Substitutes

Goods are Complementary

Goods are Independent

Income Ealsticity of Demand

Demand & Supply

Various Amounts A Series of Possible Prices

a specified time period other things being equal

The demand curve

Plot the Points

Plot the Points

Connect the Points

Individual versus market demand

What if Demand Increases?

Increase in Quantity Demanded

Increase in Quantity Demanded

What if Demand Decreases?

Decrease in Quantity Demanded

A summary of what can cause an increase in demand

The supply curve

P Various Amounts $1 A Series of Possible Prices 2 3 4 5

a specified time period other things being equal

Plot the Points

Plot the Points