Please enable JavaScript.
Coggle requires JavaScript to display documents.
Reading 12: Topics in Demands and Supply Analysis (Substitution and Income…
Reading 12: Topics in Demands and Supply Analysis
Elasticity
For normal goods, Price going up means Demand going down
Own Price Elasticity
PED > |1|: Demand is elastic
% increase in price leads to a larger % decrease in demand
PED < |1|: Demand is inelastic
% increase in price leads to a smaller % decrease in demand
Price Elasticity of Demand \( (PED)=\frac{\%\Delta Q}{\%\Delta P}=\frac{P_{0}}{Q_{0}}\times \frac{\Delta Q}{\Delta P}\)
\(\frac{\Delta Q}{\Delta P}\) : the Slope Coefficient
(b)
from Demand Function (
Quantity= a +
b
\(\times\) Price
)
Only in extremity (Perfectly Elastic or Inelastic), PED is constant
Cross Price Elasticity
Formula: \(E_{CrossPrice}=\frac{\%\Delta Q_{demanded}}{\%\Delta P_{RelatedGood}}\)
Cross Price Elasticity > 0: Related goods is a substitute
Cross Price Elasticity < 0: Related goods is a complement
Income Elasticity
Formula: \(E_{Income}=\frac{\%\Delta Q_{demanded}}{\%\Delta Income}\)
Income Elasticity > 0: Normal goods (Income Increases, Demand Increases)
Income Elasticity < 0: Inferior goods (Income Increases, Demand Decreases)
Extremity
Perfectly Inelastic (Vertical Demand)
Perfectly Elastic (Horizontal Demand)
Factor influencing Elasticity
Availability of
Substitutes
More substitutes, more elastic
Proportion on income
spent on the item
More money spent on the good, more elastic
Time
elapsed since previous price change
Longer the time since price changes, more elastic
Elasticity is NOT CONSTANT on a straight-line demand curve
For Firms in High Elasticity Zone: Drop price a little bit, pick up huge increase in sale
For Firms in Low Elasticity Zone: Raise price a little bit, only a little drop in sale
Both are movement toward Unitary Elasticity Point
Slope of demand curve \(\neq\) price elasticity
Slope depends on units price and quantity are measured in
Elastiticity is based on % change
There is a point on the demand curve that is UNITARY ELASTICITY (PED = -1)
Price Elasticity & Total Revenue
Greatest Revenue (PxQ) at the UNITARY ELASTICITY POINT (PED =1)
(Different from maximizing PROFIT)
Inelastic Range
%Demand decreased < %Price increased
Price increase will raise total revenue
Elastic Range
%Demand decreased > %Price increased
Price increase will lower total revenue
Substitution and Income Effect when price decreases
Substitution effect
: always increase consumption of the good for which the price has fallen
When price is lower, buy more
Income effect
: is positive for normal good, and negative for inferior good
When price is lower, effectively have more purchasing power
Normal vs. Inferior Goods
Normal Goods
: as price decreases, quantity purchased increases (due to both substitution and income effects)
Inferior Goods
: as price decreases, quantity purchased increases (
Positive
Substitution Effect >
Negative
Income Effect)
Giffen Goods
: as price decreases, quantity purchased decreases (
Positive
Substitution Effect <
Negative
Income Effect) IS AN INFERIOR GOOD
Veblen Goods
: is a status-symbol good. Increasing Price causes higher demand.
NOT AN INFERIOR GOOD
Diminishing Marginal Return
Increasing one factor of production input while holding others constant will increase the marginal return. However, marginal return will gradually decrease, eventually become negative
Breakeven & Shutdown
Under perfect competition
Breakeven quantity of production
: is quantity for which:
Price (P) = Marginal Cost (MC) = Average Total Cost (ATC), and
Total revenue (TR) = Total Cost (TC)
Long-run shutdown quantity
when P < ATC and thus TR < TC
Short-run shutdown quantity
when
P < Average Variable Cost (AVC), and thus
TR < Total Variable Cost (TVC)
Under imperfect competition
Firms face downward-sloping demand
Breakeven quantity
: quantity for which TR=TC
Long-run shutdown
if TR < TC
Short-run shutdown
if TR < TVC
Economies of Scale
Economies of Scale
indicated by the downward-sloping segment of LRATC, where increasing production reduce average total cost.
Diseconomies of Scales
:
indicated by the upward-sloping segment of LRATC, where increasing production quantity will increase average total cost.
Long-run average total cost (LRATC) curve
shows the minimum average total cost fo each level of output.
Profit Maximization
Under perfect competition, in the long run market price is the price where all firms move to minimum efficient scale (lowest point of LRATC)
