Week 3: Supply, Demand, and also Government policies & Consumers, Producers and also the efficiency of Markets


Figure 1. Netflix On-Demand Media Netflix, Inc. Is an American provider that on-demand internet streaming media to countless countries approximately the world, consisting of the united 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 certainly Be just how Much?

Imagine walk to her favorite coffee shop and also having the waiter notify you the pricing has actually changed. Instead of $3 because that a cup that coffee, you will now be fee $2 because that coffee, $1 because that creamer, and $1 because that your choice of sweetener. If girlfriend pay her usual $3 because that a cup of coffee, you must choose between creamer and also sweetener. If you desire both, you now challenge an extra fee of $1. Sound absurd? Well, that is the instance Netflix customers discovered themselves in—a 60% price hike to retain the exact same service. In early 2011, Netflix consumer paid around $10 a month because that a package consisting of streaming video clip and DVD rentals. In July 2011, the agency announced a packaging change. Client wishing to maintain both streaming video clip and DVD rental would certainly be charged $15.98 every month, a price rise of around 60%. Just how would customers of the 14-year-old for sure react? would they give up Netflix? would certainly the lull of accessibility to other venues make a difference in exactly how consumers comment to the Netflix price change? The answers come those concerns will be discover in this chapter: the readjust in quantity with respect to a readjust in price, a principle economists contact elasticity.

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Introduction come Elasticity

Anyone who has actually studied business economics knows the legislation of demand: a greater price will cause a lower quantity demanded. What you may not understand is exactly how much reduced the amount demanded will certainly be. Similarly, the legislation of supply shows that a greater price will cause a greater quantity supplied. The concern is: how much higher? This chapter will define how come answer these questions and also why they are critically vital in the real world. To find answers to these questions, we need to know the concept of elasticity. Elasticity is one economics ide that procedures responsiveness that one variable to alters in an additional variable. Expect you drop two items from a second-floor balcony. The first item is a tennis ball. The second item is a brick. Which will bounce higher? Obviously, the tennis ball. We would certainly say that the tennis round has greater elasticity. Consider an financial example. Tobacco taxes are an instance of a “sin tax,” a taxation on something that is poor for you, choose alcohol. Cigarettes space taxed in ~ the state and also national levels. State taxes selection from a low of 17 cent per pack in Missouri to $4.35 per pack in brand-new York. The mean state cigarette taxation is $1.51 every pack. The present federal tax price on cigarettes is $1.01 every pack, but in April 2013 the Obama administration proposed elevating the commonwealth tax practically a dollar to $1.95 per pack. The an essential question is: how much would cigarette to buy decline? count on cigarettes serve two purposes: to raise taxation revenue because that government and to discourage intake of cigarettes. However, if a higher cigarette taxes discourages usage by fairly a lot, definition a greatly lessened quantity that cigarettes is sold, climate the cigarette taxes on each load will no raise much revenue for the government. Alternatively, a greater cigarette taxes that does not discourage intake by lot will in reality raise much more tax revenue for the government. Thus, once a government agency tries to calculation the results of changing its tobacco tax, it should analyze just how much the taxation affects the amount of cigarettes consumed. This worry reaches past governments and also taxes; every firm faces a similar issue. Every time a certain considers increasing the price that it charges, it must consider how much a price increase will alleviate the amount demanded that what it sells. Conversely, when a certain puts its products on sale, it should expect (or hope) the the lower price will lead to a significantly greater quantity demanded.

Price Elasticity the Demand and also Price Elasticity that Supply

Both the demand and supply curve show the relationship between price and the number of units demanded or supplied. Price elasticity is the ratio in between the percentage readjust in the amount demanded (Qd) or supplied (Qs) and also the equivalent percent adjust in price. The price elasticity that demand is the percentage adjust in the quantity demanded of a great or company divided by the percentage adjust in the price. The price elasticity of supply is the percentage adjust in quantity supplied split by the percentage adjust in price. Elasticities deserve to be usefully split into three vast categories: elastic, inelastic, and also unitary. One elastic demand or elastic supply is one in which the elasticity is better than one, denote a high responsiveness to changes in price. Elasticities the are much less than one suggest low responsiveness to price changes and also correspond come inelastic demand or inelastic supply. Unitary elasticities suggest proportional responsiveness that either need or supply, as summarized in Table 1.

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

Link it Up

Before we get into the nitty gritty that elasticity, reap this short article on elasticity and also ticket price at the at sight Bowl.
To calculate elasticity, instead of using an easy percentage alters in quantity and also price, financial experts use the average percent adjust in both quantity and price. This is called the Midpoint technique for Elasticity, and also is stood for in the complying with equations:

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

ext% change 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 very same elasticity in between two price points whether over there is a price boost or decrease. This is because the formula uses the very same base for both cases.

Calculating Price Elasticity the Demand

Let’s calculation the elasticity in between points A and B and also between points G and H presented in number 2.


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

First, use the formula to calculation the elasticity as price decreases indigenous $70 at point B to $60 at allude A:

eginarray ext ext% readjust in quantityhfill&=frac3000-28003000+2800div 2 imes 100 \ hfill& =frac2002900 imes 100 \ hfill& =6.9 \ ext% readjust 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, one amount smaller than one, mirroring that the need is inelastic in this interval. Price elasticities of demand are always an unfavorable since price and also quantity demanded always move in opposite direction (on the need curve). By convention, we always talk around elasticities as hopeful numbers. Therefore mathematically, we take the absolute worth of the result. We will overlook this information from currently on, if remembering to analyze elasticities as optimistic numbers. This method that, follow me the demand curve between allude B and A, if the price changes by 1%, the quantity demanded will readjust by 0.45%. A adjust in the price will an outcome in a smaller sized percentage adjust in the amount demanded. Because that 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 only a 4.5% increase in the amount demanded. Price elasticities of demand are negative numbers indicating that the demand curve is downward sloping, but are check out as pure values.

Finding the Price Elasticity the Demand

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

Step 1. We know that:

extPrice Elasticity of Demand=frac ext% readjust in quantity ext% adjust in price

Step 2. native the Midpoint Formula we recognize that:

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

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

Step 3. therefore we can use the values noted in the number in each equation:

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

Step 4. Then, those values have the right to be provided to identify the price elasticity that demand:

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

Therefore, the elasticity of need from G come H 1.47. The magnitude of the elasticity has actually increased (in absolute value) together we relocated up along the demand curve native points A to B. Recall the the elasticity between these 2 points to be 0.45. Need was inelastic in between points A and also B and elastic in between points G and also H. This shows us the price elasticity of demand alters at different points along a straight-line need curve.

Calculating the Price Elasticity the Supply

Assume the an apartment leas for $650 every month and also at that price 10,000 units space rented as shown in number 3. When the price rises to $700 every month, 13,000 units space supplied right into the market. By what percentage does apartment it is provided increase? What is the price sensitivity?


Figure 3. Price Elasticity of Supply The price elasticity of supply is calculated as the percentage adjust 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% change 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 that demand, the elasticity of supply is not complied with by any kind of units. Elasticity is a ratio of one percentage adjust to one more percentage change—nothing more—and is review as an absolute value. In this case, a 1% rise in price causes an increase in quantity provided of 3.5%. The higher than one elasticity of supply means that the percentage readjust in quantity provided will be higher than a one percent price change.

Is the elasticity the slope?

It is a common mistake to confuse the slope of either the it is provided or demand curve with its elasticity. The steep is the price of change in systems along the curve, or the rise/run (change in y end the change in x). Because that example, in figure 2, each point shown ~ above the need curve, price drops by $10 and the number of units demanded boosts by 200. For this reason the steep is –10/200 follow me the entire demand curve and does not change. The price elasticity, however, changes along the curve. Elasticity in between points A and also B to be 0.45 and also increased to 1.47 in between points G and also H. Elasticity is the percentage change, which is a different calculation from the slope and has a various meaning.

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

Polar instances of Elasticity and continuous Electricity

There room two extreme instances of elasticity: when elasticity equates to zero and also when it is infinite. A 3rd case is that of consistent unitary elasticity. We will explain each case. Infinite elasticity or perfect elasticity describes the extreme instance where one of two people the quantity demanded (Qd) or supplied (Qs) changes by an infinite amount in an answer to any adjust in price at all. In both cases, the supply and also the need curve space horizontal as presented in number 4. While perfectly elastic supply curves are unrealistic, products with readily available inputs and whose production deserve to be quickly expanded will function highly elastic it is provided curves. Examples include pizza, bread, books, and also pencils. Similarly, perfectly elastic need is an extreme example. However luxury goods, goods that take it a huge share that individuals’ income, and goods with many substitutes are likely to have actually highly elastic need curves. Instances of such goods are Caribbean cruises and also sports vehicles.


Figure 4. Infinite Elasticity The horizontal lines display that an infinite quantity will certainly be demanded or provided at a certain price. This illustrates the situations of a perfect (or infinitely) elastic need curve and also supply curve. The quantity supplied or inquiry is very responsive to price changes, moving from zero for prices nearby to p to unlimited when price with P.

Zero elasticity or perfect inelasticity, as portrayed in number 5 refers to the extreme instance in which a percentage change in price, no matter how large, outcomes in zero adjust in quantity. If a perfectly inelastic supply is an extreme example, products with limited supply of input are likely to feature highly inelastic it is provided curves. Examples encompass diamond rings or real estate in prime areas such together apartments facing main Park in brand-new York City. Similarly, while perfect inelastic demand is an extreme case, necessities v no nearby substitutes are most likely to have highly inelastic need curves. This is the situation of life-saving drugs and also gasoline.


Figure 5. Zero Elasticity The vertical supply curve and vertical need curve show that there will be zero percentage change in amount (a) provided or (b) demanded, regardless of the price. This illustrates the case of zero elasticity (or perfect inelasticity). The quantity supplied or inquiry is no responsive to price changes.

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


Figure 6. A constant Unitary Elasticity demand Curve A need curve with consistent unitary elasticity will be a curved line. Notification how price and also quantity demanded adjust by an identical amount in each action down the need curve.

Unlike the demand curve v unitary elasticity, the it is provided curve through unitary elasticity is represented by a directly line. In relocating up the it is provided curve native left come right, each boost in quantity of 30, from 90 to 120 come 150 to 180, is equal in absolute value. However, in portion value, the procedures are decreasing, native 33.3% to 25% to 16.7%, due to the fact that the initial quantity clues in each percentage calculation are getting larger and larger, which broadens the denominator in the elasticity calculation. Take into consideration the price changes moving up the it is provided curve in figure 7. From points D to E to F and also to G on the supply curve, each step of $1.50 is the very same in absolute value. However, if the price transforms are measure in percentage adjust terms, castle are likewise decreasing, native 33.3% come 25% to 16.7%, since the original price clues in each portion calculation are acquiring larger and also larger in value. Along the continuous unitary elasticity it is provided curve, the percent quantity increases on the horizontal axis exactly complement the portion price rises on the upright axis—so this it is provided curve has a consistent unitary elasticity at every points.


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

Studying elasticities is useful for a number of reasons, pricing being many important. Let’s check out how elasticity relates to revenue and pricing, both in the long run and also short run. Yet first, let’s look at the elasticities the some typical goods and also services. Table 2 shows a an option of demand elasticities for different goods and services attracted from a variety of various studies by economists, noted in bespeak of increasing elasticity.

Table 2. part Selected Elasticities the DemandGoods and also ServicesElasticity that Price
Transatlantic air take trip (economy class)0.12
Rail transit (rush hour)0.15
Taxi cabs0.22
Transatlantic air take trip (first class)0.40
Transatlantic air travel (business class)0.62
Kitchen and household appliances0.63
Cable TV (basic rural)0.69
 Soft drinks0.70
New vehicle0.87
Rail transit (off-peak)1.00
Cable TV (basic urban)1.51
Cable TV (premium)1.77
Restaurant meals2.27

Note that necessities such as housing and electricity are inelastic, if items that space not necessities such together restaurant meals are much more price-sensitive. If the price that the restaurant meal rises by 10%, the quantity demanded will certainly decrease through 22.7%. A 10% increase in the price of housing will cause a slight decrease of 1.2% in the quantity of housing demanded.

Does increasing Price carry in an ext Revenue?

Imagine the a band on tour is play in an at home arena through 15,000 seats. To store this instance simple, assume that the band keeps all the money native ticket sales. Assume further that the band pays the prices for that is appearance, yet that these costs, favor travel, setting up the stage, and also so on, room the very same regardless of exactly how many human being are in the audience. Finally, assume that all the tickets have actually the very same price. (The same insights use if ticket price are much more expensive for some seats than for others, yet the calculations become more complicated.) The band knows the it faces a downward-sloping demand curve; that is, if the band raises the price of tickets, it will offer fewer tickets. Exactly how should the band collection the price because that tickets to lug in the most full revenue, which in this example, due to the fact that costs room fixed, will also mean the highest possible profits because that the band? should the tape sell much more tickets at a reduced price or under tickets in ~ a greater price? The crucial concept in thinking about collecting the most revenue is the price elasticity of demand. Total revenue is price time the amount of ticket sold. Imagine that the tape starts off thinking about a details price, which will result in the revenue of a particular quantity the tickets. The 3 possibilities room laid out in Table 3. If need is elastic at that price level, climate the tape should cut the price, due to the fact that the portion drop in price will an outcome in an also larger percentage boost in the amount sold—thus raising full revenue. However, if demand is inelastic at that initial quantity level, then the band need to raise the price the tickets, because a particular percentage rise in price will an outcome in a smaller portion decrease in the quantity sold—and full revenue will certainly rise. If demand has a unitary elasticity at the quantity, then a moderate percentage change in the price will be offset by an same percentage readjust in quantity—so the band will earn the very same revenue whether it (moderately) increases or to reduce the price the tickets.

Table 3. Will the band Earn more Revenue by an altering Ticket Prices?If demand is…Then…Therefore…
Elastic% adjust in Qd > % adjust in PA offered % climb in P will be an ext than offset by a bigger % fall in Q therefore that complete revenue (P×Q) falls.
Unitary% readjust in Qd = % change in PA given % increase in P will be precisely offset by an same % autumn in Q therefore that complete revenue (P×Q) is unchanged.
Inelastic% readjust in Qd 

What if the tape keeps cut price, due to the fact that demand is elastic, until it will a level whereby all 15,000 seats in the obtainable arena room sold? If demand remains elastic at the quantity, the tape might shot to relocate to a bigger arena, so that it might cut ticket price further and also see a bigger percentage increase in the quantity of tickets sold. Of course, if the 15,000-seat arena is all that is easily accessible or if a larger arena would include substantially to costs, then this option may not work. Vice versa, a couple of bands are so famous, or have actually such fanatical followings, that need for tickets may be inelastic ideal up come the suggest where the arena is full. This bands can, if castle wish, keep elevating the price of tickets. Ironically, few of the most renowned bands might make much more revenue by setup prices therefore high the the arena is no filled—but those that buy the ticket would need to pay very high prices. However, bands sometimes choose to offer tickets for less than the pure maximum castle might have the ability to charge, regularly in the hope the fans will certainly feel happier and spend an ext on recordings, T-shirts, and other paraphernalia.

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Can costs Be happen on come Consumers?

Most businesses challenge a day-to-day battle to figure out means to create at a reduced cost, as one pathway to their goal the earning higher profits. However, in part cases, the price the a crucial input over which the firm has actually no manage may rise. Because that example, many chemical providers use petroleum as a key input, but they have actually no control over the world market price because that crude oil. Coffee shops usage coffee together a key input, yet they have no regulate over the world market price that coffee. If the cost of a key input rises, have the right to the firm happen those higher costs follow me to consumer in the type of greater prices? conversely, if new and much less expensive methods of creating are invented, deserve to the firm save the services in the kind of higher profits, or will the industry pressure castle to happen the gains along to consumer in the kind of lower prices? The price elasticity of demand plays a vital role in answering these questions. Imagine that as a consumer of legal medicine products, you read a newspaper story the a technological breakthrough in the manufacturing of aspirin has occurred, so the every aspirin manufacturing facility can currently make aspirin an ext cheaply 보다 it did before. What go this discovery mean to you? number 8 illustrates two possibilities. In figure 8(a), the demand curve is drawn as very inelastic. In this case, a technological breakthrough that shifts it is provided to the right, from S0 to S1, so that the equilibrium shifts from E0 come E1, create a substantially lower price for the product with fairly little influence on the quantity sold. In number 8(b), the demand curve is attracted as very elastic. In this case, the technological breakthrough leader to a much higher quantity being offered in the sector at really close to the original price. Consumers advantage more, in general, when the demand curve is much more inelastic due to the fact that the transition in the supply outcomes in a much lower price for consumers.