Week 3: Supply, Demand, and Government plans & Consumers, Producers and the performance of Markets


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Figure 1. Netflix On-Demand Media Netflix, Inc. Is an American provider the on-demand net streaming media to plenty of countries about the world, consisting of the joined States, and also of flat rate DVD-by-mail in the united States. (Credit: change of job-related by Traci Lawson/Flickr an innovative Commons)


That will Be how Much?

Imagine walk to your favorite coffee shop and having the waiter inform you the pricing has changed. Rather of $3 because that a cup of coffee, you will currently be charged $2 for coffee, $1 for creamer, and also $1 because that your an option of sweetener. If friend pay your usual $3 because that a cup that coffee, you need to choose in between creamer and also sweetener. If you desire both, girlfriend now confront an extra charge of $1. Sound absurd? Well, the is the instance Netflix customers uncovered themselves in—a 60% price hike to retain the very same service. In early on 2011, Netflix consumers paid around $10 a month because that a parcel consisting that streaming video and DVD rentals. In July 2011, the firm announced a packaging change. Client wishing to retain both streaming video and DVD rental would be fee $15.98 per month, a price boost of about 60%. How would customers of the 14-year-old for sure react? would certainly they give up Netflix? would the lull of accessibility to other venues make a difference in just how consumers responded to the Netflix price change? The answers come those inquiries will be discover in this chapter: the adjust in amount with respect to a change in price, a principle economists contact elasticity.

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Introduction come Elasticity

Anyone who has actually studied economics knows the law of demand: a greater price will bring about a reduced quantity demanded. What you might not understand is how much lower the quantity demanded will certainly be. Similarly, the regulation of supply reflects that a greater price will bring about a greater quantity supplied. The question is: how much higher? This thing will explain how come answer this questions and why they room critically necessary in the genuine world. To discover answers to this questions, we need to recognize the ide of elasticity. Elasticity is one economics ide that steps responsiveness of one change to changes in one more variable. Intend you drop 2 items from a second-floor balcony. The an initial item is a tennis ball. The 2nd item is a brick. Which will bounce higher? Obviously, the tennis ball. We would say that the tennis sphere has better elasticity. Think about an financial example. Tobacco taxes are an example of a “sin tax,” a taxes on something that is bad for you, choose alcohol. Cigarettes are taxed at the state and national levels. State taxes range from a low of 17 cent per pack in Missouri to $4.35 per fill in brand-new York. The typical state cigarette taxes is $1.51 per pack. The existing federal tax rate on cigarettes is $1.01 every pack, but in April 2013 the Obama management proposed increasing the commonwealth tax practically a dollar to $1.95 every pack. The vital question is: how much would cigarette purchases decline? counting on cigarettes serve 2 purposes: to raise tax revenue because that government and to discourage usage of cigarettes. However, if a greater cigarette taxation discourages intake by fairly a lot, an interpretation a greatly reduced quantity that cigarettes is sold, climate the cigarette taxation on each pack will no raise lot revenue because that the government. Alternatively, a higher cigarette taxation that does no discourage usage by lot will actually raise an ext tax revenue for the government. Thus, when a government company tries to calculation the impacts of altering its cigarette tax, it must analyze how much the taxes affects the amount of cigarettes consumed. This problem reaches past governments and also taxes; every firm deals with a comparable issue. Every time a certain considers increasing the price the it charges, that must consider how lot a price increase will alleviate the quantity demanded that what it sells. Conversely, as soon as a for sure puts its products on sale, it must expect (or hope) the the lower price will lead to a significantly greater quantity demanded.

Price Elasticity of Demand and also Price Elasticity that Supply

Both the demand and also supply curve show the relationship between price and also the number of units request or supplied. Price elasticity is the ratio in between the percentage adjust in the amount demanded (Qd) or offered (Qs) and the matching percent readjust in price. The price elasticity that demand is the percentage adjust in the quantity demanded of a good or organization divided by the percentage readjust in the price. The price elasticity of supply is the percentage change in amount supplied divided by the percentage readjust in price. Elasticities have the right to be usefully separated into three wide categories: elastic, inelastic, and unitary. One elastic demand or elastic supply is one in i m sorry the elasticity is greater than one, describe a high responsiveness to alters in price. Elasticities that are less than one suggest low responsiveness to price changes and also correspond come inelastic demand or inelastic supply. Unitary elasticities indicate proportional responsiveness that either need or supply, as summarized in Table 1.

Table 1. Elastic, Inelastic, and Unitary: Three situations of ElasticityIf…Then…And that is called…
% readjust in amount > % readjust in pricefrac ext% change in quantity ext% readjust in price>1Elastic
% change in quantity = % adjust in pricefrac ext% adjust in quantity ext% change in price=1Unitary
% readjust in quantity

Link that Up

Before we acquire into the nitty gritty the elasticity, enjoy this article on elasticity and ticket prices at the at sight Bowl.
To calculation elasticity, instead of using basic percentage changes in quantity and also price, financial experts use the median percent adjust in both quantity and price. This is dubbed the Midpoint an approach for Elasticity, and also is represented in the following equations:

ext% change in quantity=fracQ_2-Q_1left(Q_2+Q_1 ight)div 2 imes 100

ext% readjust in price=fracP_2-P_1left(P_2+P_1 ight)div 2 imes 100

The advantage of the is Midpoint Method is the one obtains the same elasticity in between two price point out whether over there is a price rise or decrease. This is because the formula offers the very same base for both cases.

Calculating Price Elasticity of Demand

Let’s calculate the elasticity in between points A and B and also between clues G and also H presented in figure 2.


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Figure 2. Calculating the Price Elasticity of Demand The price elasticity of demand is calculated as the percentage readjust in quantity divided by the percentage readjust in price.


First, apply the formula to calculate the elasticity together price decreases native $70 at suggest B come $60 at point A:

eginarray ext ext% adjust in quantityhfill&=frac3000-28003000+2800div 2 imes 100 \ hfill& =frac2002900 imes 100 \ hfill& =6.9 \ ext% change in pricehfill&=frac60-7060+70div 2 imes 100 \ hfill&=frac-1065 imes 100 \ hfill&=-15.4 \ extPrice Elasticity of Demandhfill&=frac6.9\%-15.4\% \ hfill&=0.45 endarray

Therefore, the elasticity of demand in between these 2 points is frac6.9\%-15.4\% which is 0.45, an amount smaller than one, reflecting that the demand is inelastic in this interval. Price elasticities of need are always negative since price and also quantity demanded always move in opposite directions (on the need curve). By convention, we constantly talk around elasticities as optimistic numbers. For this reason mathematically, we take the absolute value of the result. We will ignore this information from now on, while remembering to analyze elasticities as positive numbers. This method that, follow me the demand curve between point B and A, if the price changes by 1%, the quantity demanded will readjust by 0.45%. A adjust in the price will result in a smaller sized percentage adjust in the amount demanded. For example, a 10% increase in the price will an outcome in only a 4.5% decrease in amount demanded. A 10% decrease in the price will an outcome in just a 4.5% increase in the quantity demanded. Price elasticities of demand are an unfavorable numbers indicating the the need curve is bottom sloping, but are review as pure values.


Finding the Price Elasticity the Demand

Calculate the price elasticity of need using the data in figure 2 for rise in price native G come H. Has the elasticity boosted or decreased?

Step 1. We understand that:

extPrice Elasticity of Demand=frac ext% change in quantity ext% change in price

Step 2. indigenous the Midpoint Formula we understand that:

ext% change in quantity=fracQ_2-Q_1left(Q_2+Q_1 ight)div 2 imes 100

ext% readjust in price=fracP_2-P_1left(P_2+P_1 ight)div 2 imes 100

Step 3. therefore we can use the values provided in the figure in every equation:

eginarray ext ext% readjust in quantityhfill&=frac1600-18001600+1800div 2 imes 100 \ hfill& =frac-2001700 imes 100 \ hfill& =-11.76 \ ext% change in pricehfill&=frac130-120130+120div 2 imes 100 \ hfill&=frac10125 imes 100 \ hfill&=8.0 endarray

Step 4. Then, those values deserve to be supplied to recognize the price elasticity of demand:

eginarray ext extPrice Elasticity the Demandhfill& =frac ext% readjust in quantity ext% adjust in price \ hfill&=frac-11.768 \ hfill&=1.47endarray

Therefore, the elasticity of demand from G to H 1.47. The magnitude of the elasticity has increased (in pure value) together we moved up along the demand curve from points A to B. Recall that the elasticity in between these 2 points was 0.45. Need was inelastic in between points A and B and also elastic in between points G and H. This shows us that price elasticity that demand changes at different points follow me a straight-line need curve.


Calculating the Price Elasticity the Supply

Assume that an apartment rental fees for $650 per month and at the price 10,000 units room rented as presented in number 3. When the price boosts to $700 every month, 13,000 units room supplied right into the market. By what percentage does apartment supply increase? What is the price sensitivity?


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Figure 3. Price Elasticity the Supply The price elasticity of supply is calculated as the percentage readjust in quantity separated by the percentage change in price.


Using the Midpoint Method,

eginarray ext ext% readjust in quantityhfill&=frac13,000-10,00013,000+10,000div 2 imes 100 \ hfill& =frac3,00011,500 imes 100 \ hfill& =26.1 \ ext% readjust in pricehfill&=frac$750-$600$750+$600div 2 imes 100 \ hfill&=frac50675 imes 100 \ hfill&=7.4 \ extPrice Elasticity the Supplyhfill&=frac26.1\%7.4\% \ hfill&=3.53 endarray

Again, just like the elasticity of demand, the elasticity of it is provided is not followed by any kind of units. Elasticity is a proportion of one percentage change to another percentage change—nothing more—and is check out as an pure value. In this case, a 1% climb in price causes an increase in quantity provided of 3.5%. The better than one elasticity that supply means that the percentage readjust in quantity provided will be greater than a one percent price change.


Is the elasticity the slope?

It is a typical mistake to confuse the steep of one of two people the supply or demand curve through its elasticity. The steep is the rate of change in devices along the curve, or the rise/run (change in y over the adjust in x). Because that example, in number 2, each allude shown top top the need curve, price autumn by $10 and also the number of units demanded increases by 200. So the steep is –10/200 along the entire demand curve and does not change. The price elasticity, however, transforms along the curve. Elasticity in between points A and B to be 0.45 and increased come 1.47 in between points G and H. Elasticity is the percentage change, i beg your pardon is a different calculation native the slope and also has a different meaning.

When we space at the upper finish of a need curve, wherein price is high and also the amount demanded is low, a tiny change in the quantity demanded, even in, say, one unit, is pretty huge in portion terms. A adjust in price of, say, a dollar, is going to be much less essential in portion terms than it would have been at the bottom of the demand curve. Likewise, in ~ the bottom of the demand curve, the one unit readjust when the quantity demanded is high will be tiny as a percentage. So, at one finish of the need curve, whereby we have actually a big percentage readjust in quantity demanded over a small percentage change in price, the elasticity worth would it is in high, or need would be relatively elastic. Even with the same readjust in the price and the same adjust in the quantity demanded, in ~ the other end of the demand curve the quantity is lot higher, and also the price is much lower, for this reason the percentage change in amount demanded is smaller and also the percentage change in price is much higher. That way at the bottom of the curve we’d have actually a small numerator end a large denominator, for this reason the elasticity measure would be lot lower, or inelastic. As we relocate along the demand curve, the worths for quantity and also price walk up or down, depending on which means we room moving, for this reason the percentages for, say, a $1 difference in price or a one unit difference in quantity, will change as well, which method the ratios of those percentages will certainly change.


Polar cases of Elasticity and consistent Electricity

There are two extreme instances of elasticity: when elasticity equals zero and also when that is infinite. A third case is that of constant unitary elasticity. Us will describe each case. Infinite elasticity or perfect elasticity refers to the extreme instance where either the quantity demanded (Qd) or offered (Qs) transforms by an infinite amount in an answer to any change in price in ~ all. In both cases, the supply and also the need curve are horizontal as displayed in figure 4. While perfectly elastic supply curves space unrealistic, products with readily available inputs and also whose production deserve to be quickly expanded will function highly elastic supply curves. Examples include pizza, bread, books, and also pencils. Similarly, perfect elastic demand is severe example. However luxury goods, items that take it a large share that individuals’ income, and also goods with many substitutes are likely to have actually highly elastic need curves. Instances of such goods are Caribbean cruises and sports vehicles.


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Figure 4. Infinite Elasticity The horizontal lines present that an boundless quantity will be demanded or offered at a details price. This illustrates the instances of a perfectly (or infinitely) elastic need curve and supply curve. The quantity offered or request is very responsive to price changes, relocating from zero for prices near to ns to boundless when price with P.


Zero elasticity or perfect inelasticity, as shown in number 5 refers to the extreme situation in which a percentage adjust in price, no matter how large, results in zero readjust in quantity. While a perfectly inelastic it is provided is severe example, items with minimal supply of input are most likely to attribute highly inelastic supply curves. Examples encompass diamond rings or real estate in prime places such as apartments facing central Park in brand-new York City. Similarly, while perfect inelastic need is an extreme case, necessities v no nearby substitutes are most likely to have actually highly inelastic demand curves. This is the case of life-saving drugs and gasoline.


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Figure 5. Zero Elasticity The vertical supply curve and also vertical demand curve display that there will certainly be zero percentage readjust in amount (a) offered or (b) demanded, nevertheless of the price. This illustrates the case of zero elasticity (or perfect inelasticity). The quantity offered or request is not responsive to price changes.


consistent unitary elasticity, in one of two people a supply or need curve, occurs when a price readjust of one percent results in a quantity readjust of one percent. Figure 6 shows a need curve with continuous unit elasticity. Together we move down the need curve native A come B, the price drops by 33% and also quantity inquiry rises by 33%; together you relocate from B come C, the price drops by 25% and the amount demanded rises by 25%; as you move from C to D, the price drops by 16% and also the quantity rises through 16%. Notice that in absolute value, the declines in price, together you step down the demand curve, room not identical. Instead, the price falls by $3 native A to B, through a smaller sized amount the $1.50 from B come C, and also by a still smaller amount that $0.75 from C come D. As a result, a demand curve with continuous unitary elasticity moves from a steeper steep on the left and also a flatter steep on the right—and a curved shape overall.


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Figure 6. A continuous Unitary Elasticity demand Curve A need curve with continuous unitary elasticity will certainly be a bent line. Notice how price and quantity demanded change by an identical amount in each step down the demand curve.


Unlike the demand curve with unitary elasticity, the it is provided curve with unitary elasticity is stood for by a right line. In relocating up the it is provided curve native left to right, each rise in amount of 30, from 90 to 120 to 150 to 180, is same in pure value. However, in percent value, the actions are decreasing, native 33.3% to 25% come 16.7%, because the initial quantity points in each portion calculation are obtaining larger and also larger, which broadens the denominator in the elasticity calculation. Think about the price alters moving increase the supply curve in figure 7. Native points D come E come F and to G top top the it is provided curve, each action of $1.50 is the exact same in absolute value. However, if the price alters are measure up in percentage change terms, castle are additionally decreasing, indigenous 33.3% to 25% to 16.7%, since the original price point out in each percentage calculation are getting larger and also larger in value. Along the continuous unitary elasticity supply curve, the percent quantity boosts on the horizontal axis exactly complement the percent price boosts on the upright axis—so this it is provided curve has actually a constant unitary elasticity at all points.


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Figure 7. A continuous Unitary Elasticity it is provided Curve A continuous unitary elasticity it is provided curve is a right line reaching up native the origin. In between each point, the percentage boost in quantity demanded is the same as the percentage rise in price.


Studying elasticities is advantageous for a variety of reasons, pricing being most important. Let’s discover how elasticity relates to revenue and pricing, both in the long run and also short run. However first, stop look at the elasticities of some usual goods and also services. Table 2 shows a choice of demand elasticities for various goods and services drawn from a range of different studies by economists, noted in stimulate of increasing elasticity.

Table 2. part Selected Elasticities of DemandGoods and also ServicesElasticity of Price
Housing0.12
Transatlantic air travel (economy class)0.12
Rail transit (rush hour)0.15
Electricity0.20
Taxi cabs0.22
Gasoline0.35
Transatlantic air take trip (first class)0.40
Wine0.55
Beef0.59
Transatlantic air take trip (business class)0.62
Kitchen and also household appliances0.63
Cable TV (basic rural)0.69
Chicken0.64
 Soft drinks0.70
Beer0.80
New vehicle0.87
Rail transit (off-peak)1.00
Computer1.44
Cable TV (basic urban)1.51
Cable TV (premium)1.77
Restaurant meals2.27

Note the necessities such together housing and also electricity space inelastic, while items that are not necessities such as restaurant meals are much more price-sensitive. If the price the the restaurant meal rises by 10%, the amount demanded will decrease by 22.7%. A 10% rise in the price of housing will reason a slight decrease of 1.2% in the amount of real estate demanded.


Does increasing Price lug in more Revenue?

Imagine the a tape on tourism is play in an at home arena v 15,000 seats. To keep this instance simple, assume that the tape keeps every the money native ticket sales. Assume additional that the tape pays the prices for that appearance, yet that this costs, prefer travel, setting up the stage, and also so on, are the very same regardless of just how many world are in the audience. Finally, assume that all the tickets have the same price. (The very same insights apply if ticket prices are more expensive for some seats than for others, however the calculations become an ext complicated.) The tape knows that it encounters a downward-sloping demand curve; that is, if the band raises the price that tickets, the will offer fewer tickets. Just how should the band set the price for tickets to carry in the most full revenue, which in this example, due to the fact that costs room fixed, will likewise mean the highest profits for the band? have to the band sell more tickets at a reduced price or under tickets in ~ a higher price? The vital concept in thinking around collecting the most revenue is the price elasticity the demand. Full revenue is price time the amount of ticket sold. Imagine the the band starts off thinking about a particular price, which will an outcome in the revenue of a specific quantity that tickets. The three possibilities space laid the end in Table 3. If need is elastic at that price level, climate the tape should cut the price, because the percent drop in price will result in an even larger percentage boost in the amount sold—thus raising total revenue. However, if need is inelastic in ~ that initial quantity level, climate the band have to raise the price the tickets, due to the fact that a certain percentage rise in price will an outcome in a smaller percentage decrease in the quantity sold—and total revenue will certainly rise. If need has a unitary elasticity at that quantity, then a center percentage change in the price will certainly be offset by an equal percentage readjust in quantity—so the band will earn the very same revenue whether it (moderately) increases or to reduce the price that tickets.

Table 3. Will the band Earn more Revenue by an altering Ticket Prices?If need is…Then…Therefore…
Elastic% adjust in Qd > % readjust in PA given % increase in P will be more than offset by a larger % loss in Q for this reason that full revenue (P×Q) falls.
Unitary% change in Qd = % readjust in PA offered % climb in P will be specifically offset by an equal % autumn in Q so that complete revenue (P×Q) is unchanged.
Inelastic% change in Qd 

What if the band keeps cut price, because demand is elastic, until it will a level whereby all 15,000 seat in the obtainable arena space sold? If need remains elastic at the quantity, the tape might try to move to a enlarge arena, so the it might cut ticket price further and also see a larger percentage rise in the quantity of tickets sold. That course, if the 15,000-seat arena is all the is obtainable or if a bigger arena would include substantially come costs, then this option might not work. Whereas a few bands space so famous, or have actually such fanatical followings, that demand for tickets may be inelastic appropriate up to the allude where the arena is full. This bands can, if they wish, keep elevating the price the tickets. Ironically, several of the most famous bands might make more revenue by setup prices so high that the arena is not filled—but those who buy the ticket would need to pay really high prices. However, bands sometimes choose to offer tickets for much less than the absolute maximum lock might have the ability to charge, regularly in the hope that fans will feel happier and spend more on recordings, T-shirts, and also other paraphernalia.

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Can prices Be happen on to Consumers?

Most businesses challenge a day-to-day battle to number out ways to create at a lower cost, together one pathway to your goal the earning higher profits. However, in some cases, the price of a crucial input over which the firm has no manage may rise. Because that example, many chemical providers use petroleum as a vital input, however they have actually no manage over the people market price for crude oil. Coffee shops use coffee as a an essential input, yet they have no regulate over the civilization market price of coffee. If the cost of a key input rises, have the right to the firm happen those greater costs along to consumers in the type of greater prices? whereas if new and less expensive methods of creating are invented, deserve to the firm save the benefits in the kind of higher profits, or will the market pressure lock to pass the gains along to consumer in the kind of lower prices? The price elasticity of need plays a key role in answering these questions. Imagine that as a customer of legal medicine products, you read a newspaper story that a technological breakthrough in the manufacturing of aspirin has actually occurred, so that every aspirin manufacturing facility can now make aspirin much more cheaply 보다 it did before. What walk this exploration mean come you? number 8 illustrates two possibilities. In figure 8(a), the need curve is drawn as extremely inelastic. In this case, a technical breakthrough the shifts supply to the right, from S0 come S1, so that the equilibrium shifts from E0 come E1, creates a substantially reduced price for the product with fairly little influence on the quantity sold. In figure 8(b), the need curve is attracted as extremely elastic. In this case, the technical breakthrough leads to a much greater quantity being offered in the market at really close to the initial price. Consumers benefit more, in general, when the demand curve is more inelastic because the change in the supply outcomes in a much reduced price because that consumers.