Quantitative Demand Analysis

Ch 3
Quantitative Demand Analysis
Elasticity
Question: If the price of EF3440A increases from $6300 to $63000, what happen to the quantity demanded of it? Drop, the Law of demand. By HOW MUCH? UNKOWN!
Elasticity
Law of Demand:
Price drops, Qd increases, vice versa Directional Change Magnitude is not given (it does not tell how much the Qd will response to a change in price) Dependent
Elasticity
variable
Independe Measures the responsiveness of one variable nt variable to changes in another variable. The percentage change in one variable that arises to a given percentage change in
Elasticity
Types of Elasticity 1. Price Elasticity of Demand 2. Income Elasticity of Demand 3. Cross-Price Elasticity of Demand
Price Elasticity of Demand

The responsiveness of Qd to a change in price. The % change in Qd when price changes by 1% %Q Dependent variable Ed %P Independent variable Mathematically: =d (Qd/Qdold)x100% Ed = (P/Pold)x100 % Qd Pold Ed = P x Qdold

Demand
Px
Qdx = -10Px + 1500 100 150

0 500
Qdx
50 1000
0 1500
Q: What is the Ed if the price moves from $100 to $50? Qd Pold
Ed = P x Qdold (1000-500) x 100 Ed = (50-100) 50 0 Ed =-2

Question: What does it mean by Ed = -2? The increase in Qd is 2% when price decreases by 1%. The decrease in Qd is 2% when price increases by 1%.

Demand
Px
Qdx = -10Px + 1500 100 150

0 500
Qdx
50 1000
0 1500
Q: Do you expect that if we go back from $50 to $100, the Ed is the same, -2? No!
Qd Pold Ed = P x Qdold (500-1000) x 50 Ed = (100-50) 1000 Ed =-0.5
The Old point changed

The value of an Ed depends on the direction of changes. There are two ways to remove this effect:
Arc price elasticity of demand Qd Pold new+Pold)/2 x (P Edarc = P (Qdold +Qdold)/2 Qd new Point price elasticity of demand
Arc Price Elasticity of Demand

Px Qdx Px 150 100 75 50 A C B 500 750 1000 Demand Curve EdA EdB 150 0 100 500 50 1000 0 1500
1500
Qdx

Question: What is the Sign of Ed, positive or negative? Negative
P ,Q P ,Q The Law of demand
Qd Pold Ed = P x Qdold
(-) (-)
Remark: as it must be negative, we usually ignore the sign and take the absolute

Question: What is the Size of Ed? %Q Ed =d %P Depends on the magnitude of the change of Qd. 0

According to the size, Ed can be divided into five types: 1.Elastic 2.Inelastic 3.Unitarily elastic 4.Perfectly elastic 5.Perfectly inelastic
Elastic
Definition:
% in Qd > % in P
10% 15% P Qd
%Q >1 Ed =d %P
When Ed > 1, the demand is elastic.
Elastic
Graphical representation of Elastic
Px
P Qd D Qdx
Usually, we will use a flat demand curve to represent elastic.
Inelastic
Definition:
% in Qd < % in P
20% 10% P Qd
%Q <1 Ed =d %P
When Ed < 1, the demand is inelastic.
Inelastic
Graphical representation of Inelastic
Px
P Qd D Qdx
Usually, we will use a steep demand curve to represent inelastic.
Unitarily elastic
Definition:
% in Qd = % in P
15% 15% P Qd
%Q =1 Ed =d %P
When Ed = 1, the demand is unitarily elastic.
Unitarily elastic
Graphical representation of Unitarily Elastic
Px
P Qd
D Qdx
Usually, we will use a Rectangular Parabola demand curve to represent unitarily elastic.
Perfectly Elastic
Definition: = % in Qd > % in P
10%
P Qd
%Q = Ed =d %P
When Ed = , the demand is perfectly elastic.
Perfectly Elastic
Graphical representation of Perfectly Elastic
Px
P1
P = 0
Qdx
Usually, we will use a horizontal demand curve to represent perfectly elastic. Implication: Price must set at P1
Perfectly Inelastic
Definition:
=0
% in Qd < % in P
10% 0 P Qd
%Q =0 Ed =d %P
When Ed = 0, the demand is perfectly inelastic.
Perfectly Inelastic
Graphical representation of Perfectly Px D inelastic
Qd = 0
Q1
Qdx
Usually, we will use a vertical demand curve to represent perfectly elastic. Implication: Quantity will not response according to a price change.
Elasticity vs Total Revenue

When price increases, what happen to the producers total revenue?
P
P2 P1 Q2 Q1 D Q At P1, TR = (P1 x Q1) =
At P2, TR = (P2 x Q2) =
Unknown, unless we know Ed. Remark: If P and Qd go to opposite direction, Ed is essential for the
Total Revenue (Ed >1)

If Ed >1 (% in Qd > % in P)
P At P1, TR = (P1 x Q1) = Los s Q2 Q1 D Q
P2 Gai P n
1
At P2, TR = (P2 x Q2) =
P increases, TR drops (Gain < Loss) P decreases, TR rises (Gain > Loss)
Total Revenue (Ed >1)

Another way to shows this result Ed >1 (% in Qd > % in P)
(% in Qd > % Price increases TR = P x Q Price decreases(% in Qd > % in P)
in P)
TR = P x Q
Total Revenue (Ed <1)

If Ed <1 (% in Qd < % in P)
P P2 Gai P1 n At P1, TR = (P1 x Q1) = D Q
At P2, TR = (P2 x Q2) =
P increases, TR rises (Gain > Loss) P decreases, TR drops (Gain < Loss)
Los s Q2 Q1
Total Revenue (Ed <1)

Another way to shows this result Ed <1 (% in Qd < % in P)
(% in Qd < % Price increases TR = P x Q Price decreases(% in Qd < % in P)
in P)
TR = P x Q
Application of Elasticity
What happen to producers expenditure under the minimum wage law?
P
wagemin wage
Q2 Q1
Price increases, Qt decreases TE is uncertain (lower if Ed <1)
Government set a per unit tax = t Supply shifts up vertically by t P Results:
Price rises Quantity drops Government tax revenue = t x Q2 How much is shared by Consumers / Producers P2 tax P1 revenue
S2
t S1
D
Q2 Q1 Q
Total tax burden
Tax x Qnew t x Q2
S2 P t S1
P2 CB Consumer burden (CB)P1 PB P0 Price increase x Qnew (P2 P1) x Q2
D Q2 Q1
Producer burden (PB)

Total tax burden CB (P1 P0) x Q2
Which situation will the consumers pay more than producers?
Consumers with smaller Ed tend to pay more tax. S2 S2 P P t S1 t S1
P2 CB P1 PB P0 D Q2 Q1 Q Q2Q1 P2 CB
P1 PB P0
D Q
Question: In April 2009, HK Government announced to raise the tobacco tax by 50%. Do you expect the smokers or the producers to pay more? Smokers!
Smokers Ed is low
Determinants of Ed
1. When there is no close substitute for a good, demand for it tends to be less price elastic.
eg. MTR
2. When a good is necessity, demand for it tends to be less elastic.

eg. Drugs
3. When the expenditure on a good is large (either in absolute terms or relative to total expenditure), demand tends to be more price elastic.
eg. Rent
Ed along a Linear Demand Curve

The slope of a demand curve is just an approximation of Ed. %Q Qd Ed =d %P 1/slope = P For one demand curve, different points will give different Ed. Qd Pold Ed = P x Qdold
Ed of Linear Demand Curve

What is the Ed of A, B, C, D and E?
Px a A Ed = B Ed > 1
As Price increases, Ed gets higher
a/2
Ed = 1 C
Ed < 1 D Ed = 0 E Qd x b
b/2
Ed of Linear Demand Curve

Question As the prices of the following two goods drop by 50%, which one do you care more?
$2 $1
$1000 0 $500 0
Income Elasticity of Demand

The responsiveness of Qd to a change in Income (Y). The % change in Qd when income changes by 1% Mathematically: %Q EY = d %Y (Qd/Qdold)x100% EY = (Y/Yold)x100 % Qd Yold EY = Y x Qdold

Y Qdx 1000 0 2000 500 3000 1000 4000 1500
Q: What is the EY if the income rises from $2000 to $3000? Qd Yold EY= Y x Qdold
(1000-500) x 2000 EY = (3000500 2000)
EY = 2

Question: What does it mean by EY = 2? When income decreases by 1%, Qd increase by 2%. When income increases by 1%, Qd decreases by 2%.

Question: What is the Sign of EY, positive or Positive negative? Negative
Y ,Q
Normal (Superior) Good
Y ,Q
Inferior Good
Remark: EY can be either + or , depends on whether it is Normal or Inferior Good.

Question: What is the Size of EY? %Q EY = d %Y Depends on the magnitude of the change of Qd. -

Less will be consumed with More will be consumed with higher income. higher income. Inferior Normal Good Good
Income NecessityLuxury
0 1
Neutral Good The same quantity will be consumed even with higher income.

Is Sushi a normal, inferior or income neutral?

Is a cheeseburger a normal, inferior or income neutral?

Is a toilet paper a normal, inferior or income neutral?
The responsiveness of Qd of good x to a change in Price of good y (EPy). The % change in Qdx when Py changes by 1% %Qdx Mathematically: EPy = %P y (Qdx/Qdxold)x100 EPy =%(P / P old)x100% y y Qdx Py old EPy = P x Qdxold y
Cross-Price Elasticity of Demand

Question: What is the Sign of EPy, positive or Positive negative? Negative
Py , Qx
Substitutes
Py , Qx
Complements
Remark: EPy can be either + or , depends on whether the goods are

Question: What is the Size of EPy? %Qdx EPy = %P y Depends on the magnitude of the change of Qdx. -

Complements Substitutes
Increasing degree of Substitutability

Question Which pair of goods give a larger EPy?
Price Elasticity of Supply

The responsiveness of Qs to a change in price. The % change in Qs when price changes by 1% %Q Es Mathematically: = s%P (Qs/Qsold)x100% Es = (P/Pold)x100 % Qs Pold Es = P x Qsold

Question: What is the Sign of Es, positive or negative? Positive
P ,Q P ,Q The Law of supply
Qs Pold Ed = P x Qsold
(+) (+)
Remark: Es must be positive

According to the size, Es can be divided into five types: Flat 1.Elastic % in Qs > % in P Es >1 2.Inelastic % in Qs < % in P Es <1
S
Steep S
3.Unitarily % in Qs = % in P elastic
Es =1
0

4. Perfectly % in Qs = Es = elastic
Horizontal S
5. Perfectly % in Qs = 0 inelastic
vertical S
Es = 0

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Ch 3

Quantitative Demand Analysis

Price Elasticity of Demand

Price Elasticity of Demand

Qdx = -10Px + 1500 100 150

Q: What is the Ed if the price moves from $100 to $50? Qd Pold

Ed = P x Qdold (1000-500) x 100 Ed = (50-100) 50 0 Ed =-2

Price Elasticity of Demand

Price Elasticity of Demand

Qdx = -10Px + 1500 100 150

Qd Pold Ed = P x Qdold (500-1000) x 50 Ed = (100-50) 1000 Ed =-0.5

The Old point changed

Price Elasticity of Demand

Arc Price Elasticity of Demand

Price Elasticity of Demand

Price Elasticity of Demand

Price Elasticity of Demand

Usually, we will use a flat demand curve to represent elastic.

Usually, we will use a steep demand curve to represent inelastic.

Elasticity vs Total Revenue

At P2, TR = (P2 x Q2) =

Total Revenue (Ed >1)

At P2, TR = (P2 x Q2) =

Total Revenue (Ed >1)

Total Revenue (Ed <1)

At P2, TR = (P2 x Q2) =

Total Revenue (Ed <1)

Price increases, Qt decreases TE is uncertain (lower if Ed <1)

P2 CB Consumer burden (CB)P1 PB P0 Price increase x Qnew (P2 P1) x Q2

Producer burden (PB)

2. When a good is necessity, demand for it tends to be less elastic.

Ed along a Linear Demand Curve

Ed of Linear Demand Curve

As Price increases, Ed gets higher

Ed of Linear Demand Curve

Income Elasticity of Demand

Income Elasticity of Demand

Income Elasticity of Demand

Income Elasticity of Demand

Remark: EY can be either + or , depends on whether it is Normal or Inferior Good.

Income Elasticity of Demand

Income Elasticity of Demand

Income Elasticity of Demand

Income Elasticity of Demand

Income Elasticity of Demand

Cross-Price Elasticity of Demand

Cross-Price Elasticity of Demand

Remark: EPy can be either + or , depends on whether the goods are

Cross-Price Elasticity of Demand

Cross-Price Elasticity of Demand

Increasing degree of Substitutability

Cross-Price Elasticity of Demand

Price Elasticity of Supply

Price Elasticity of Supply

Remark: Es must be positive

Price Elasticity of Supply

Price Elasticity of Supply

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