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Chapter 6 - Elasticity, consumer surplus, and producer surplus. In this chapter, students will be able to: Price elasticity of demand, the total revenue test, price elasticity of supply, cross elasticity of demand, income elasticity of demand, consumer & producer surplus, efficiency losses.
Chapter Elasticity, Consumer Surplus, and Producer Surplus McGrawHill/Irwin Copyright © 2009 by The McGrawHill Companies, Inc. All rights reserved Chapter Objectives • • • • • • • Price elasticity of demand The total revenue test Price elasticity of supply Cross elasticity of demand Income elasticity of demand Consumer & producer surplus Efficiency losses 6-2 Price Elasticity of Demand • Measuring responsiveness to price changes • Elastic demand – Large change in quantity purchased for given price change • Inelastic demand – Small change in quantity purchased for given price change 6-3 Price Elasticity of Demand • Price-elasticity coefficient and formula Ed = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product X 6-4 Price Elasticity of Demand • Calculate percentage change • Restate formula Ed = Change in Quantity Demanded of X Original Quantity Demanded of ÷ X Change in Price of X Original Price of X 6-5 Price Elasticity of Demand • Calculation problem • Starting point matters • Midpoint formula Ed = Change in Quantity Sum of Quantities/2 ÷ Change in Price Sum of Prices/2 6-6 Interpretations of Elasticity Elastic Demand Ed = 04 02 =2 Inelastic Demand Ed = 01 02 = 02 02 =1 Unit Elasticity Ed = 6-7 Price Elasticity of Demand • Why use percentages? – Unit free measure – Compare responsiveness across products • Elimination of the (-) sign • Extreme cases – Perfectly inelastic demand – Perfectly elastic demand 6-8 The Total Revenue Test • Total Revenue = TR = PxQ • Inelastic demand – P and TR change in same direction • Elastic demand – P and TR change in opposite direction 6-9 The Total Revenue Test • Lower price and elastic demand – Blue gain exceeds gold loss P $3 a b D1 10 20 30 40 Q 6-10 Price Elasticity of Supply The Short Run • Inelastic supply P Lower Price Impact Ss Ps P0 D1 D2 Q0 Qs Q 6-20 Price Elasticity of Supply The Long Run • Elastic supply P Sl Least Price Impact Pl P0 D1 D2 Q0 Ql Q 6-21 Price Elasticity of Supply • Applications • Antiques and reproductions – Limited, inelastic supply – Strong demand – Resulting high price • Volatile gold prices – Inelastic supply – Shifting demand 6-22 Cross Elasticity of Demand • Responsiveness of sales to change in price of another good Exy = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product Y 6-23 Cross Elasticity of Demand • Substitute goods – Positive sign • Complementary goods – Negative sign • Independent goods – Zero 6-24 Income Elasticity of Demand Ei = Percentage Change in Quantity Demanded Percentage Change in Income • Responsiveness of sales to change in income • Normal goods – positive sign • Inferior goods– negative sign 6-25 Consumer Surplus • Benefit surplus • Maximum willingness to pay (WTP) less than actual price paid Person Bob Barb Bill Bart Brent Betty Max WTP Actual Price $13 $8 $12 $8 $11 $8 $10 $8 $9 $8 $8 $8 CS $5 $4 $3 $2 $1 $0 6-26 Consumer Surplus Price (Per Bag) Consumer Surplus Equilibrium Price = $8 P1 D Q1 Quantity (Bags) 6-27 Producer Surplus • Benefit surplus • Actual price received more than minimum acceptable price (AP) Person Carlos Courtney Chuck Cindy Craig Chad Min AP $3 $4 $5 $6 $7 $8 Actual Price $8 $8 $8 $8 $8 $8 PS $5 $4 $3 $2 $1 $0 6-28 Producer Surplus Price (Per Bag) S Producer Surplus Equilibrium Price = $8 P1 Q1 Quantity (Bags) 6-29 Efficiency Revisited • Productive and allocative efficiency S Price (Per Bag) Consumer Surplus Equilibrium Price = $8 P1 Producer Surplus D Q1 Quantity (Bags) 6-30 Efficiency Loss • Deadweight loss S Price (Per Bag) Efficiency Losses P1 D Q2 Q1 Q3 Quantity (Bags) 6-31 Elasticity and Pricing Power • Competitive markets – No pricing power • Firms with market power – Charge different prices • Differences in group elasticities – Business vs leisure travelers – Discounting for children – College tuition 6-32 Key Terms • price elasticity of demand • midpoint formula • elastic demand • inelastic demand • unit elasticity • perfectly inelastic demand • perfectly elastic demand • total revenue (TR) • total-revenue test • price elasticity of supply • market period • short run • long run • cross elasticity of demand • income elasticity of demand • consumer surplus • producer surplus • efficiency losses (deadweight losses) 6-33 Next Chapter Preview… Consumer Behavior 6-34 ... price change 6- 3 Price Elasticity of Demand • Price-elasticity coefficient and formula Ed = Percentage Change in Quantity Demanded of Product X Percentage Change in Price of Product X 6- 4 Price Elasticity... Price of X 6- 5 Price Elasticity of Demand • Calculation problem • Starting point matters • Midpoint formula Ed = Change in Quantity Sum of Quantities/2 ÷ Change in Price Sum of Prices/2 6- 6 Interpretations... 10 20 30 40 Q 6- 10 The Total Revenue Test • Lower price and inelastic demand – Gold loss exceeds blue gain P c $4 d D2 10 20 Q 6- 11 The Total Revenue Test • Lower price and unit-elastic demand