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APPLICATIONS OF SUPPLY

AND DEMAND
Sensitivity to Price Changes
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prices change.

Will an increase in price raise a firm's revenue even

though the quantity sold falls?

If a firm raises its price, it loses customers. How many?

Price Elasticity of Demand
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Price elasticity of demand is defined as the percentage change in the

quantity demanded divided by the percentage change in price. In
mathematical terms,

elasticity of demand = Percentage change in quantity demanded

Percentage change in price
When a 1 percent change in price calls forth more than a 1 percent
change in quantity demanded, the good has price-elastic demand.

When a 1 percent change in price produces less than a 1 percent

change in quantity demanded, the good has price-inelastic demand.

When the percentage change in quantity is exactly the same as the

percentage change in price, it is called unit-elastic demand.
Elastic Demand Shows Large Quantity
Response to Price Change
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Elastic Versus Inelastic Demand Curves
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Price Elasticity in Diagrams
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Price Elasticity of Demand Falls into Three Categories

Price Elasticity in Diagrams
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Perfectly Elastic and Inelastic Demands

Slope and Elasticity Are
Not the Same Thing
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Calculating Elasticities: A Short Cut
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A Simple Rule for Calculating the Demand Elasticity

Changing Elasticity Along
a Demand Curve
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Elasticity of Demand over Time
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Elasticity and Revenue
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If p rises but Q falls, what happens to TR? Which effect

dominates?

n If %p > %Q , then TR .

n If %p < %Q , then TR .
Total Revenue
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Elasticity

Percentage change in quantity

Revenues Increase
Ed > 1 Elastic demand demanded greater than
when price decreases
percentage change in price

Percentage change in quantity

Ed = 1 Unit-elastic demanded equal to Revenues unchanged
demand percentage change in price when price decreases

Percentage change in quantity

Ed < 1 Inelastic demanded less than Revenues decrease
demand percentage change in price when price decreases
Price Elasticity of Supply
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Price Elasticity of Supply is the percentage change in quantity

supplied divided by the percentage change in price.

elasticity of supply = Percentage change in quantity supply

Percentage change in price

Definitions of price elasticities of supply are exactly the same as

those for price-elasticities of demand. The only difference is that for
supply the quantity response to price is positive, while for demand
the response is negative.
Supply Elasticity Depends upon
Producer Response to Price
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Examples of Elasticity of Supply
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The Short Run versus the Long Run
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When a product can be stored, demand will be much more price

sensitive in the short run than in the long run.

When a product or service is part of a system, demand will be much

more price sensitive in the long run than in the short run.

The shorter the time frame, the less substitution is possible; the longer
the time frame, the more substitution is possible.

In the short run, demand is less elastic than in the long run.

In the short run, some inputs are fixed, so supply is difficult to

change, while in the long run, all inputs are variable.
Tax Policy and the Law of
Supply and Demand
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Shortages and Surpluses (b)
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In this figure, the horizontal gap between Qd and Qs is

the size of the shortage. Consumers compete to get a
bargain.
Shortages and Surpluses (b) (cont.)
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In this figure, the horizontal gap between Qd and Qs is

the size of the surplus.
Now sellers compete to "move the merchandise."
The rate of adjustment depends on the kind of market as well
as the size of the surplus.
Price Ceilings and Price Floors
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Governments are often asked to interfere with the outcomes of the law of
supply and demand because they are politically undesirable to some
people.

If rents on apartments are seen as too expensive, there will be pressure on

city hall to regulate the market for apartments.

If wages are seen as being too low, there will be pressure on the
government to regulate the labor market.

An obvious way to try to circumvent the law of supply and demand is to

legislate the price of an object.

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