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Micro Economics[MNG 609]
Trupti Mishra
Shailesh J Mehta School OfManagement
IIT om!a"
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Session Outline
Elasticit" of #eman$
%rice ceiling an$ %rice &loor
'tilit" (nal"sis
%rice) Income an$ Su!stitution E*ect
+onsumer Surplus
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Elasticit" of #eman$
%rice Elasticit" of #eman$
Income Elasticit" of #eman$
+ross Elasticit" of $eman$
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Elasticit" of #eman$
Elasticity of Demand measures the $egreeof responsi,eness of the -uantit" $eman$e$of a commo$it" to a gi,en change in an" ofthe $eterminants of $eman$.
Price elasticity of demand is a measure ofho/ much the -uantit" $eman$e$ of a goo$respon$s to a change in the price of that goo$.
%ercentage change in -uantit" $eman$e$gi,en a percent change in the price.
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% Q E
% P
∆=
∆
%rice elasticit" of $eman$
% 1 are in,ersel" relate$ !" the la/ of $eman$ so E is al/a"s negati,e.
The larger the a!solute ,alue of E) the more sensiti,e !u"ers are to a change in price
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Degree of Price Elasticity of Demand
Inelastic #eman$
1uantit" $eman$e$ $oes not respon$ strongl" to price changes.
Elastic #eman$
1uantit" $eman$e$ respon$s strongl" to changes in price.
%erfectl" Inelastic
1uantit" $eman$e$ $oes not respon$ to price changes.%erfectl" Elastic
1uantit" $eman$e$ changes in2nitel" /ith an" change in price.
'nit Elastic
1uantit" $eman$e$ changes !" the same percentage as the price.
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7
Perfectly Elastic
D
Price
Quantity
Perfectly Inelastic
D
Price
Quantity
Perfectly Elastic & Inelastic Demand
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8
E < 1
0 Quantity
Price
100
1. A 25%increase inprice…
5.00
2. … Leads t a 10% decrease in !uantity de"anded.
De"and
#.00
$0
Inelastic Demand
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$
E = 1
0 Quantity
Price
100
1. A 25%increase inprice…
5.00
2. … Leads t a 25% decrease in !uantity de"anded.
De"and
#.00
75
'nit Elastic #eman$
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10
E > 1
0 Quantity
Price
100
1. A 25%increase inprice…
5.00
2. … Leads t a 50% decrease in !uantity de"anded.
De"and
#.00
50
Elastic Demand
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Measurement of Price Elasticity of
Demand
% Q E
% P
∆=
∆
Q
Q
P
P
∆×
=∆
×
100
100
Q P
P Q
∆= ×
∆
Point Elasticity ofDemand
Q P E P Q
∆= ×
∆AverageAverage
ARC Elasticity of Demand
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Determinants of Price Elasticity of
Demand Nature of +ommo$it" (,aila!ilit" an$ pro3imit" of Su!stitutes %roportion of Income Spent on the +ommo$it" Time #ura!ilit" of the +ommo$it" Items of a$$iction
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1
Price
Quantity0 100
De"and
P & Q = #00
're(enue)
#.00
Total Revenue
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1#
Price
Quantity0 80
De"and
.00
P & Q = 240 're(enue)
P & Q = 100 're(enue)
1.00
100
4o/ Total 5e,enue +hanges hen %rices+hanges7 Inelastic #eman$
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15
Price
Quantity
Change in Total Revenue when Price Changes
0 50
De"and
#.00
5.00
20
*e(enue + 100
*e(enue + 200
4o/ Total 5e,enue +hanges hen %rices+hanges7 Elastic #eman$
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1,
Elastic
Q-effect d"inates
nitary elastic
/ d"inant effect
Inelastic
P-effect d"inates
Pricerises
Pricefalls
* falls
* rises
/ cane in *
/ cane in *
* rises
* falls
% Q % P ∆ >∆ % Q % P ∆ =∆ % Q % P ∆
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17
hen in,erse $eman$ is linear) P = A + BQ
Marginal re,enue is also linear) intersects the,ertical 8price a3is at the same point as
$eman$) is t/ice as steep as $eman$ MR = A + 2BQ
#eman$ Marginal 5e,enue
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18
Linear Demand, MR, & Elasticity
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1$
TR decreases as Q increases
TR is maximized
TR increases as Q
increases
3arinalre(enue tal re(enue
Price elasticity fde"and
MR > 0 Elastic ( E >
1)
MR = 0 Unit elastic
( E = 1)
MR < 0 Inelastic (
E
<1)
Unit elastic( E = 1)
Inelastic( E < 1)
Elastic
(
E
> 1)
M5) T5) %rice Elasticit"
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Income elasticit" 8EM measures the responsi,eness
of -uantit" $eman$e$ to changes in income)hol$ing the price of the goo$ all other $eman$$eterminants constant.
%ositi,e for a normal goo$
Negati,e for an inferior goo$
:ero for a neutral goo$s
Income Elasticity ofDemand
d d
M
d
% Q Q M E
% M M Q
∆ ∆= = ×
∆ ∆
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If Em ;
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@@
+rossAprice elasticit" of $eman$ 8E XY measures
the responsi,eness of -uantit" $eman$e$ of goo$ X to changes in the price of relate$ goo$ Y )hol$ing the price of goo$ X all other $eman$$eterminants for goo$ X constant
%ositi,e /hen the t/o goo$s are su!stitutes
Negati,e /hen the t/o goo$s are complements
X X Y
XY
Y Y X
% Q Q P E % P P Q
∆ ∆
= = ×∆ ∆
Cross-Price Elasticity of demand
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@B
#eman$ for co*ee C as follo/s7
1C?
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@
Suppose$ that) %C? @) I= %2.&! PY= %1.'0! PS=%0.&0
and A = %1
e get 1C?
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@D
&rom this info) the 2rm can 2n$ elasticit" of$eman$ for co*ee C /ith respect to its price)income) price of competiti,e co*ee H) price ofsugar an$ a$,ertising
E%? AB8@K@ ? AB
EI= 0.'(2.&)2* = 1
EXY= 2(1.')2* = 1.'
EXS= 0.6(0.&0)2* = 0.1& EA= 1.2(1)2* = 0.6
sing Elasticities in ManagerialDecision Ma!ing
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@6
To estimateKforecast $eman$ for ne3t "ear.
Suppose the 2rm7
Lincrease price !" D.
Lincrease a$,ertisement !"
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@
'sing le,el of sales 81C for this "ear of @ millionpoun$s) the 2rm can $etermine its sales for ne3t"ear7
1C? 1CF 1C8P%CK%CE%F 1C8PIKIEIF1C8P%HK%HECHF 1C8P%SK%SECSF 1C8P(K(E(
? @ F @8D8AB F @88
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Go,ernment %olicies That (lter the %ri,ateMarQet Outcome
%rice controls
Price ceiling7 a legal ma3imum on the priceof a goo$ or ser,ice. E,aple- ren" con"rol.
Price "oor7 a legal minimum on the price ofa goo$ or ser,ice. E,aple- ini /ae.
Ta3es
The go,t can maQe !u"ers or sellers pa" aspeci2c amount on each unit !oughtKsol$.
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T#e Mar!et for A$artments
E-m /Koprice
controls
E-m /Koprice
controls
P
Q D
S *entalprice f
apts
4800
00
Quantity fapart"ents
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%o Price Ceilings A'ect Mar!et (utcomes
( price ceiling
a!o,e thee-m price isnot )inding
it has noe*ect on themarQet
outcome.
P
Q D
S
4800
00
Priceceilin
41000
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%o Price Ceilings A'ect Mar!et (utcomes
The e-m price
800 is a!o,ethe ceiling an$thereforeillegal.
The ceilingis a )indingconstraint on the price)
an$ causesa shortage.
P
Q D
S
4800
Priceceilin
4500
250 #00
shortage
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%o Price Ceilings A'ect Mar!et (utcomes
In the longrun) suppl"an$ $eman$are more
priceAelastic.So) theshortageis larger.
P
Q
D
S
4800
150
Priceceilin
4500
#50
shortage
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Shortages an$ 5ationing
ith a shortage) sellers must ration the goo$samong !u"ers.
Some rationing mechanisms7 8
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The MarQet for 'nsQille$ =a!or
E-m /Koprice
controls
E-m /Koprice
controls
W
L
D
S aepaid t
uns6illedr6ers
4#
500
Quantity funs6illed r6ers
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%o Price *loors A'ect Mar!et (utcomes
W
L
D
S
4#
500
Priceflr
4
( price oor
!elo/ thee-m price isnot )inding
it has noe*ect on themarQetoutcome.
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%o Price *loors A'ect Mar!et (utcomes
W
L
D
S
4#
Priceflr
45
The e-m /age
8 is !elo/ theoor an$thereforeillegal.
The ooris a )indingconstraint on the /age)
an$ causesa surplus8i.e.! unemplo"ment.
#00 550
labor
surplus
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Min /age la/s$o not a*ecthighl" sQille$/orQers.
The" $o a*ectteen /orQers.
T#e Minimum +age
W
L
D
S
4#
3in.ae
45
#00 550
unemployment
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Taes
The go,t le,ies ta3es on man" goo$s ser,ices to raise re,enue to pa" fornational $efense) pu!lic schools) etc.
The go,t can maQe !u"ers or sellers pa"the ta3.
The ta3 can !e a percentage of the goo$s
price) or a speci2c amount for each unitsol$.&or simplicit") /e anal"Ue perAunit ta3es onl".
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S 1
P
Q
D1
410.00
500
Euili)rium it#out Ta
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S 1
D1
410.00
500#0
A Ta on .uyers( ta3 on!u"ers
shifts the D cur,e $o/n!" theamount of
the ta3.
( ta3 on!u"ers
shifts the D cur,e $o/n!" theamount ofthe ta3.
P
Q
D2
411.00P B +
4$.50P S +
a&
Effects f a 41.50 per unit ta&n uyers
e price
uyers pay
rises9 teprice sellers
recei(e falls9
e!:" Q falls.
e price
uyers pay
rises9 teprice sellers
recei(e falls9
e!:" Q falls.
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#0
S 1
T#e Incidence of a Ta
4o/ the !ur$en of a ta3 is share$ amongmarQet participants
P
Q
D1
410.00
500
D2
411.00P B +
4$.50P S +
a&;ecause
f te ta&9
uyers pay
41.00 "re9
sellers et40.50 less.
;ecause
f te ta&9
uyers pay
41.00 "re9
sellers et40.50 less.
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S 1
A Ta on /ellers
( ta3 on
sellersshifts the S
cur,e up !"the amount
of the ta3.
( ta3 on
sellersshifts the S cur,e up !"
the amount
of the ta3.
P
Q
D1
410.00
500
S 2
#0
411.00P B +
4$.50P S +
a&
Effects f a 41.50 per unit ta& nsellers
e price
uyers pay
rises9 teprice sellers
recei(e falls9
e!:" Q falls.
e price
uyers pay
rises9 teprice sellers
recei(e falls9
e!:" Q falls.
Th O I h S i h +
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S 1
The Outcome Is the Same in oth +ases
hatmatters isthis7
( ta3 $ri,esa /e$ge!et/een theprice !u"ers
pa" an$ theprice sellersrecei,e.
P
Q
D1
410.00
500#0
4$.50
411.00P B +
P S +
a&
e effects n P and Q 9 and te ta& incidence are te
sa"e eter te ta& is i"psed n uyers r sellers<
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Elasticity and Ta Incidence
+(SE
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Elasticity and Ta Incidence
+(SE @7 #eman$ is more elastic than suppl"
P
Q
D
S
a&
;uyers: sare
f ta& urden
=ellers: sare
f ta& urden
Price if n ta&
P B
P S
In tis case9
sellers ear
"st f te
urden fte ta&.
In tis case9
sellers ear
"st f te
urden fte ta&.
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Elasticity and Ta Incidence
If !u"ers price elasticit" ; sellers priceelasticit") !u"ers can more easil" lea,e themarQet /hen the ta3 is impose$) so !u"ers/ill !ear a smaller share of the !ur$en of
the ta3 than sellers. If sellers price elasticit" ; !u"ers price
elasticit") the re,erse is true.