Transcript (leftward shift) in the demand curve

Adèle Breytenbach
[email protected]
*
Important! Read the detail in tutorial letter (TL) 101.
*
Assignment 1 or 2 must be submitted (not necessarily
passed) for admission to examination.
*
Look at the weights of the 4 assignments – better to
submit ALL 4 as learning experience & to accumulate
better semester mark.
*
Semester mark contributes 10% to final mark
Examination mark contributes 90% to final mark
2
*
Assignment
x Weight
Semester Mark
01
x 0,2
20%
02
x 0,2
20%
03
x 0,3
30%
04
x 0,3
30%
Total
1
100%
Your final mark is calculated as follow:
Semester mark (out of 100) x 10% +
Examination mark (out of 100) x 90%
3
*
Economics is concerned with the efficient use or
management of limited productive resources to achieve
maximum satisfaction of human material wants.
- Campbell McConnell –
*
Economics is the study of how individuals, firms,
governments and other organizations within our society
make choices and how those choices determine how the
resources of society are used.
- Joseph Stiglitz –
*
Economics is the study of how our scarce productive
resources are used to satisfy human wants.
- George Leland Bach 5
*
Microeconomics focus on the individual parts of the
economy such as households, firms, price formation and
changes in prices of a single product, like tomatoes, pencils,
watches.
*
Macroeconomics on the other hand focus on the economy
as a whole. It focuses on topics such as inflation,
unemployment, economic growth, total production, imports
and exports.

6
*
The essence of economics lies in the fact that wants are
unlimited while the means that are available to satisfy those
wants are limited.
*
The basic fact of economic life is scarcity and anyone
confronted with scarcity has to make choices.
*
For example:
It is Saturday evening and a student has a choice between
studying, watching sport on television or going to see a
movie at the cinema. He wants to do everything, but his
time is limited. He therefore has to choose what to do and
what to forgo.
7
*
To solve his problem the student has to make a choice, but
whenever a choice is made, something is sacrificed.
Economists call this sacrifice opportunity cost.
*
Opportunity cost measure the cost of the alternatives that
we have chosen in terms of the alternatives that we have to
sacrifice.
*
In other words, the cost of using a resource is measured by
determining how it could have been used alternatively, not
necessarily what it cost to purchase.
8
*
Since resources are limited, choices always have to be made
and every time a choice is made opportunity cost is
incurred.
*
To illustrated scarcity, choice and opportunity cost a
production possibilities curve (PPC) can be used.
*
The PPC indicates the different combinations of any two
goods or services that are attainable when the community’s
resources are fully and efficiently employed
9
Figure 1: A production possibilities curve
•A,B,C,D,E,F
1. Choice
2. Efficient resources
•G
•H
1. Unattainable
resources
2. Scarcity
1. Attainable
2.Unemployed
3. Inefficient
resources
Chapter1 What economics is all about
© Van Schaik Publishers
10
10
* The PPC is concave to the origin (i.o.w. it bulges outwards
from the origin).
* This is because extra production of one product will
increase the opportunity cost of the other product.
* According to the above PPC, the opportunity cost of each
additional basket of fish will increases as we move along
the PPC.
* Examples of opportunity cost in everyday life:
• Watching television or studying.
• Choose between ice cream and chocolates.
• Playing football or cricket.
11
* Combinations of output of goods X and Y lying inside the PPC
occur when there are unemployed resources or when the
economy uses resources inefficiently.
* We could increase total output by moving towards the
production possibility curve and reaching any of points A,
B,C,D,E and F.
* Point G is unattainable because it lies outside the PPC and
therefore the combination cannot be produced with the
available resources. To achieve the output combination G an
increase in:
• factor resources,
• efficiency (or productivity) of factor resources
• or an improvement in technology is required.
12
* Producing more of both goods would represent an
improvement in economic welfare providing that the
products are giving consumers a positive satisfaction and
therefore an improvement in what is called allocative
efficiency.
* Reallocating scarce resources from one product to another
involves an opportunity cost.
• If we increase our output of Good X (a movement along
the PPC from point C to point D) then fewer resources are
available to produce good Y.
• Because of the shape of the PPC the opportunity cost of
switching resources increases (we have to give up more
of Good Y to achieve gains in the output of good X).
13
[1] the monetary price of any production resource.
[2] the quantity of labour that must be used to
produce one unit of any product.
[3] the ratio of the prices of goods imported to the prices
of goods exported.
[4] the quantity of one product that must be given up to
produce one more unit of another product.
14
Opportunity cost is best defined as
Answer
[1] the monetary price of any production resource.
[2] the quantity of labour that must be used to
produce one unit of any product.
[3] the ratio of the prices of goods imported to the prices
of goods exported.
[4] the quantity of one product that must be given up to
produce one more unit of another product.
15
15
[1] what does the move from point C to point D on the
curve represent?
[2]
how many kg’s potatoes need to be sacrificed to
produce how many more baskets of fish per day when
we move from point D to E?
[3] how many baskets of fish need to be sacrificed to
produce how many more kg potatoes per day when we
move from point D to C?
[4] what principle is illustrated by the movement from
point C to D OR from E to C?
16
Figure 1: A production possibilities curve
•A,B,C,D,E,F
1. Choice
2. Efficient resources
•G
•H
1. Unattainable
resources
2. Scarcity
1. Attainable
2.Unemployed
3. Inefficient
resources
Chapter1 What economics is all about
© Van Schaik Publishers
17
17
[5] How would you describe the shape of the curve AF?
[6] What does the shape of curve AF imply?
18
[1] It means that the production of a certain number
of
potatoes per day has to be scarified in order to produce
more baskets of fish per day (i.o.w. More
of one product
and less of the other).
[2] the production of 30 kg potatoes (70 – 40 = 30) has
to be sacrificed daily in order to produce 1 more basket
of fish (4 – 3 = 1).
[3] We have to sacrifice the production of 1 basket of fish
(3 – 2 = 1) in order to produce 15 more kg of potatoes
(85 – 70 = 15) daily.
[4] The principle of opportunity cost is illustrated by any
movement from one point to another point on the
production possibilities curve.
19
[5] The curve bulges outwards from the origin (0),
therefore we say the curve is concave from the origin.
[6] As we move from point A to point B and on to point F
on the PPC, the production of fish increases while the
production of potatoes decreases.
In order to produce the first basket of fish society has to
sacrifice 5 kg (from 100 to 95) of potatoes and to
produce the second basket of fish another 10 kg (from
95 to 85) of potatoes need to be sacrificed.
Therefore, as we move form point A to point F on the
PPC, the opportunity cost increases and the shape of the
PPC indicates increasing opportunity cost.
20
* Demand and supply remind us of the two blades of a pair of
scissors that interact to determine the price and the
quantity of goods and services traded in the market.
* The demand curve is downward sloping from left to right
indicating that when the price of the product falls, a greater
quantity will be demanded.
* The other blade of the scissors is the supply curve.
* The supply curve emphasis the positive relationship
between quantity supplied and the price. The higher price of
a product, the greater the quantity supplied.
* "the higher the price of a good or service (all other
things remaining the same), the lower the quantity
demanded or the lower the price of a good or service
(all other things remaining the same), the greater the
quantity demanded".
*
*
P → Qd
P  → Qd 
* The demand curve has a negative slope, consistent with the
law of demand.
Must show :
P
D
* Arrows
* Price
Quantity demanded
70
50
220
250
Q
24
Change in the
price of the
good
(Ceteris paribus)
Price increase
Type of
effect
Substitution Good becomes relatively
effect
more expensive as a
result of higher price
Income
effect
Price decrease
How it works
Real income falls as a
result of higher price
Substitution Good becomes relatively
effect
cheaper as a result of
lower price
Income
effect
Real income increases as
a result of lower price
Impact of quantity
demanded
Quantity
demanded
decreases
Quantity demand
decreases
Quantity
demanded
increases
Quantity demand
increase
* Any change in the price of the product will cause a
movement along the demand curve to the new price level.
* A change in any of the other factors (income, price of
substitutes, preferences, population, etc) will lead to a shift
of the demand curve itself.
* To summarize:
A movement along the demand curve is equal to a change in
the price of a specific product.
A shift of the demand curve is equal to a change in demand.
6
d
5
d'
Rand per bag
4
3
2
1
d
0
0
10000
20000
Quantity
d'
30000
40000
* The situation illustrated is called an increase in demand
or a shift to the right of a demand curve
P
* On Demand curve DD, a
movement from a to b
indicates a decrease in the
quantity demanded, while a
movement from a to c shows
an
increase
in
quantity
demanded.
D2
D
D1
b
Price
a
c
D2
D
D1
0
Quantity demanded
Qd
* An increase in demand is
represented by a rightward
shift of the demand curve,
from DD to D2D2. A decrease in
demand represented by a
leftward shift of the demand
curve, from DD to D1D1.
Determinant
Price of the
good
Change
Effect on market demand curve Correct description
of effect
Increase
Upward movement along demand
curve
A fall in the quantity
demanded
Decrease
Downward movement along
demand curve
An increase in the
quantity demanded
Increase
Rightward shift in demand curve
Increase in demand
Decrease
Leftward shift in demand curve
Fall in demand
Leftward shift in demand curve
Fall in demand
Decrease
Rightward shift in demand curve
Increase in demand
Increase
Rightward shift in demand curve
Increase in demand
Decrease
Leftward shift in demand curve
Fall in demand
Price of related goods
Substitutes
Complements Increase
Income
(normal
goods)
p 120 Textbook
Determinant
Change
Effect on market demand
curve
Taste/
preferences
Increased
desire to buy
Rightward shift in demand curve Increase in demand
Reduced
desire to buy
Leftward shift in demand curve
Increase
Rightward shift in demand curve Increase in demand
Decrease
Leftward shift in demand curve
Price is
expected to
increase
Rightward shift in demand curve Increase in demand
Price is
expected to
fall
Leftward shift in demand curve
Population
Expected
price of the
good
Correct
description of
effect
Fall in demand
Fall in demand
Fall in demand
p 120 Textbook
* " the higher the price of a good, the greater the quantity
supplied or the lower the price, the smaller the quantity
supplied (all other things remaining the same)".
* P → Qs 
* P  → Qs 
* The supply curve has a positive slope, consistent with the law
of supply.
6
s
Rand per bag
5
s'
4
3
2
1
s
0
0
s'
10000
20000
30000
Quantity
* Any situation which causes supply to rise will cause an
outward shift (to the left) of the supply curve. This implies
that more will be supplied at each price level than before.
P
Price of the product
S1
S
S2
P1
* Any factor which reduces
supply will shift the supply
curve to the left S1S1.
S1
S
S2
0
* Any change in supply other
that the price of the product
will lead to a change in supply,
and hence a shift of the supply
curve.
Q1
Q2
Q3
Qs
Quantity supplied per period
* Any factor that increases
supply will shift the supply
curve to the right, to S2S2.
Determinant
Price of the
good
Change
Effect on market supply
curve
Correct description
of effect
Increase
Upward movement along
supply curve
An increase in the
quantity supplied
Decrease
Downward movement along
supply curve
A decrease in the
quantity supplied
Increase
Leftward shift of supply curve
A decrease in supply
Decrease
Rightward shift of supply curve
An increase in supply
Increase
Rightward shift of supply curve
An increase in supply
Decrease
Leftward shift of supply curve
A decrease in supply
Price of alternative goods
Substitutes in
production
Price of joint products
Complements
in production
p 126 Textbook
Determinant
Price of
inputs
Expected
future prices
Change
Effect on market supply curve
Correct
description of
effect
Increase
Leftward shift of supply curve
A decrease in the
quantity supplied
Decrease
Rightward shift of supply curve
An increase in the
quantity supplied
Expected
price
increase
Rightward shift of supply curve
An increase in
supply
Expected
price
decrease
Leftward shift of supply curve
A decrease in
supply
p 126 Textbook
Determinant
Technology
Number of
firms
(sellers)
Change
Effect on market supply curve
Correct
description of
effect
Cost-reducing
improvement in
technology
Rightward shift of supply curve
An increase in
supply
Cost-increasing
changes in
technology
Leftward shift of supply curve
A decrease in
supply
More firms enter
market
Rightward shift of supply curve
An increase in
supply
Firms leave market Leftward shift of supply curve
A decrease in
supply
p 126 Textbook
* In economics, an equilibrium is a situation in which:
* there is no natural tendency to change,
* quantity demanded equals quantity supplied, and
* the market clears.
6
Price per bag
5
D
S
Excess supply
4
3
Equilibrium point
2
1
Excess demand
D
S
0
0
6
Quantity (thousand bags)
12
Price per bag
Quantity
demanded
Quantity
supplied
Pressure on
price
5
9 000
18 000
Decrease ↓
4
10 000
16 000
Decrease ↓
3
12 000
12 000
Neutral
2
15 000
7 000
Increase ↑
1
2 000
0
Increase ↑
-
*A state of balance between suppliers and consumers can only
be reached at a price of 3. In Economics we refer to such a
point as the equilibrium.
* The equilibrium price is the only price which can persist
in the long run.
* It is the price at which the quantity voluntarily supplied
and the quantity voluntarily demanded are equal.
* Competitive equilibrium must be at the point where the
quantity demanded and quantity supplied are the same.
* A shortage occurs when quantity demanded exceeds
quantity supplied.
* A shortage implies the market price is too low.
* A surplus occurs when quantity supplied exceeds
quantity demanded.
* A surplus implies the market price is too high.
[1] If there is an increase in the price of DVDs, a substitute in
production for CDs then:
a. The supply of CDs will increase
b. The demand for CDs will fall.
c. The supply of CDs will decrease.
d. there will be a movement along the supply curve for CDs.
[2] If there is an increase in the price of manure (a joint product
in dairy farming) then, ceteris paribus, there will be:
a. An increase in the supply of dairy farmers.
b. A decrease in the demand for manure.
c. An increase in the demand for manure
d. a decrease in the demand for dairy products.
42
Determinant
Price of the
good
Change
Effect on market supply
curve
Correct description
of effect
Increase
Upward movement along
supply curve
An increase in the
quantity supplied
Decrease
Downward movement along
supply curve
A decrease in the
quantity supplied
Increase
Leftward shift of supply curve
A decrease in supply
Decrease
Rightward shift of supply curve
An increase in supply
Increase
Rightward shift of supply curve
An increase in supply
Decrease
Leftward shift of supply curve
A decrease in supply
Price of alternative goods
Substitutes in
production
Price of joint products
Complements
in production
p 126 Textbook
[3] If the equation for the demand curve is Q = 450 – 25P and the
equation for the supply curve is Q = - 175 + 37.5P, then the
equilibrium values for price and quantity are:
a. P = 4.4 and Q = 340
b. P = 5 and Q = 325
c. P = 10 and Q = 200
d. P = 11 and Q = 175
e. P = 12 and Q = 150
44
[1] If there is an increase in the price of DVDs, a substitute in
production for CDs then:
c. The supply of CDs will decrease.
If goods are substitutes in production (not consumption) and
there is an increase in the price of a substitute product (DVDs) this
will cause the supply of our product (CDs) to fall.
[2] If there is an increase in the price of manure (a joint product in
dairy farming) then, ceteris paribus, there will be:
a. An increase in the supply of dairy farmers.
If there is an increase in the price of a joint product (complement
in production) then this will cause the supply of dairy farmers to
increase, ceteris paribus.
45
[3] If the equation for the demand curve is Q = 450 – 25P and the
equation for the supply curve is Q = - 175 + 37.5P, then the
equilibrium values for price and quantity are:
Equilibrium price:
Equilibrium quantity:
450 – 25P = -175 + 37.5P
Q = 450 – 25 P
450 – 175 = 37.5P + 25P
but P = 10
62.5P = 625
Q = 450 – 25 (10)
P = 10
Q = 450 – 250
Q = 200
c. P = 10 and Q = 200
46
* A change in any variable other than price that influences
quantity demanded produces a shift in the demand curve
or a change in demand.
* Factors that shift the demand curve include:
* Change in consumer incomes
* Population change
* Consumer preferences
* Prices of related goods:
* Substitutes: goods consumed in place of one
another
* Complements: goods consumed jointly
* A change in any variable other than price that
influences quantity supplied produces a shift in the
supply curve or a change in supply.
* Factors that shift the supply curve include:
* Change in input costs
* Increase in technology
* Change in size of the industry
P
D
90
70
S
E1
E
D1
220
260
Q
50
D1
P
D
E
S
90
70
E1
220
260
Q
51
* Increase in income:
* Normal goods – Demand curve increases
* Inferior goods – Demand curve decreases
* Decrease in income:
* Normal goods – Demand curve decreases
* Inferior goods - Demand curve increases
* Increase of complements and substitute prices
* Decrease in complements and substitute prices.
Text book page 156:
52
P
D
E1
90
70
S
E
D1
220
260
Q
53
D1
P
D
E
S
90
70
E1
220
260
Q
54
D1
P
D
E
S
90
70
E1
220
260
Q
55
P
D
E1
90
70
S
E
D1
220
260
Q
56
* Increase of a substitute price:
* Demand curve increases
* Increase in the price of a complement:
* Demand curve decreases
* Decrease in the price of a substitute:
* Demand curve decreases
* Decrease in the price of a complement:
* Demand curve increase
Text book page 156
57
P
D
E1
90
70
S
E
D1
220
260
Q
58
P
D1
D
E
S
90 000
70 000
E1
220
260
Q
59
D1
P
D
E
S
260
200
E1
500
600
Q
60
P
D
E1
160 000
130 000
S
E
D1
220
280
Q
61
P
S1
D
S
E1
90
E
70
180
220
Q
62
S
P
D
90
S1
E
E1
70
180
220
Q
63
* Increase in price of production factor
* Supply curve decreases
* Decrease in price of production factor
* Supply curve increases
* Increase of in productivity
* Supply curve increases
* Decrease in productivity
* Supply curve decreases
Text book page 158
64
P
S1
D
S
E1
90
E
70
180
220
Q
65
S
P
D
S1
E
90
E1
70
180
220
Q
66
P
S1
D
S
E1
90
E
70
180
220
Q
67
S
P
D
S1
E
90
E1
70
180
220
Q
68
* Equilibrium Price increases
* Equilibrium quantity uncertain – 3 possibilities:
* Decrease in equilibrium quantity
* Increase in equilibrium quantity
* Equilibrium quantity remains unchanged
Text book page 137 - 139
69
Change in
Demand
Increase
Change in
Supply
Increase
Change in
Price
Uncertain
Change in
Quantity
Increase
Increase
Decrease
Increase
Uncertain
Decrease
Increase
Decrease
Uncertain
Decrease
Decrease
Uncertain
Decrease
Textbook p 139- 141
70
* When consumers, trade unions, farmers, business people
and politicians are not satisfied with prices and market
demand and supply they put pressure on government to
intervene.
*
*
*
*
*
This intervention can take different forms, such as:
Setting maximum prices (price ceilings)
Setting minimum prices (price floors)
Subsidising certain products and activities
Taxing certain products or activities.
* Why impose ceiling prices:
*
*
*
*
Keep prices of basic food low
Keep inflation low
Restrict exploitation of consumers
To restrict the production of certain products during war
periods
* If the maximum price (price ceiling) is set above the
equilibrium price, it will have no effect on the market price
or the quantity exchanged.
* Prices and quantities will still be determined by demand
and supply.
72
* However, when a maximum price is set below the
equilibrium price, it will result in a market shortage (or
excess demand).
* To solve the shortage the following can be introduced:
* Consumers may be served on a first come first serve
basis
* Government has to issue coupons
* Suppliers may set up informal rationing systems
73
P
D
S
70
E
220
Q
74
* Problems of Price ceilings:
* Bribery
* High Administration cost - More admin to be
appointed & salaries
* Black market may exist – show graphically.
75
* Due to large fluctuations in price of agricultural products,
farmers income tend to be unstable and uncertain.
* To stabilise farmers’ income, governments often introduce
minimum (floor) prices which serve as guaranteed prices
to producers.
* If the floor price is below the equilibrium price, the
operation of market forces is not disturbed.
* However, if the floor price is above the equilibrium price,
there is a surplus (or excess supply).
P
D
70
S
E
220
Q
77
* To solve the surplus the following can be introduced:
*
*
*
*
*
Government can purchase the surplus and export it.
Government purchase the surplus and stores it
Limit the quantity produced by farmers
Government purchase and destroys the surplus
Producer destroy the surplus.
* Problems of Price floors:
* Consumers pay high prices
* Only large farmers receive the benefits of price floors
* Inefficient producers are protected and continue with
existing practices
* Disposal of market surplus has additional cost for tax
payers.
78
[1] If there is a decrease in the demand for domestic air tickets, while the
cost of insurance of airlines increase, in comparison with the original
equilibrium there would be:
a. An increase in equilibrium price and quantity.
b. An increase in equilibrium quantity but a decrease in price.
c. A decrease in equilibrium quantity but an increase in price.
d. A decrease in equilibrium quantity but an indeterminate effect on
price.
[2] The equilibrium price will fall if there is:
a. An increase in both demand and supply.
b. A decrease in both demand and supply.
c. A decrease in supply only
d. A decrease in demand together with an increase in supply.
79
Change in
Demand
Increase
Change in
Supply
Increase
Change in
Price
Uncertain
Change in
Quantity
Increase
Increase
Decrease
Increase
Uncertain
Decrease
Increase
Decrease
Uncertain
Decrease
Decrease
Uncertain
Decrease
Textbook p 139- 141
80
[1]
If there is a decrease in the demand for domestic air tickets, while the cost of
insurance of airlines increase, in comparison with the original equilibrium
there would be:
d. A decrease in equilibrium quantity but an indeterminate effect on price.
If there is a decrease in the demand of air tickets and an increase in the cost
of insurance it will cause a decrease in supply (an increase in the input cost
of providing airline tickets). This will result in a decrease in the equilibrium
quantity traded and an indeterminate effect on price.
[2] The equilibrium price will fall if there is:
d. A decrease in demand together with an increase in supply.
A decrease in demand combined with an increase in supply will result in an
decrease in price seeing as all the other options result in either an increase in
price or an indeterminate effect on price.
81
* Price elasticity of demand is the quantitive measure of
consumer behaviour that indicates the quantity of demand
(of a product or service) depending on its increase or
decrease in price.
* Price elasticity can be defined as the percentage change in
the quantity demanded if the price of the product changes
by one per cent, ceteris paribus.
* ep = Relative change in quantity required
Relative change in the price
Q
Q

P
P
83
* Suppose the price changes from R8 to R5 while the quantity
demanded changes from 4 units to 10 units.
* The price elasticity of demand will be calculated as
follow:
ep =
6 (10 units – 4 units)
4
3 (R5-R8)
8
=
6/4 x 8/3
=
4
* Five elasticity values:
* Perfectly inelastic
ep = 0
* Relatively elastic
ep > 1
* Unit elastic
ep = 1
* Relatively inelastic
ep <1
* Perfectly elastic
ep = 
85
D
ep = 0
86
* When a price change has no effect on the supply and demand
of a good or service, it is considered perfectly inelastic.
* An example of perfectly inelastic demand would be a life
saving drug that people will pay any price to obtain.
* Even if the price of the drug were to increase dramatically, the
quantity demanded would remain the same.
* Habit forming products
* Fashionable Products
* Complementary products
* Products that is non-durable
* Necessities
87
D
0 < ep <1
88
* Unit elastic demand is a type of elasticity when there is a change in the
price say from R5 to R6, there will be a change in quantity demanded from
6 to 5.
* That is when the price changes by one unit, the quantity demanded also
changes by 1 unit. revenue remains unchanged.
D
ep = 1
89
* A good or service is considered to be highly elastic if a slight
change in price leads to a sharp change in the quantity
demanded or supplied.
* Usually these kinds of products are readily available in the
market and a person may not necessarily need them in his or
her daily life.
* Luxury products
* Products that you spend a large percentage of income on.
* Substitute products
* Durable products
90
D
ep
>1
91
ep = ∞
92
Price in Quantity
rand
demanded
% in price
(
P/average P)
%  in quantity
demanded
( Q/ average Q)
Elasticity
value
( Q /  P)
200
24
-
-
-
400
20
0.67
(200/300)
0.18
(4/22)
0.27
(0.18/0.67)
600
16
0.40
(200/500)
0.22
(4/18)
0.55
(0.22/0.40)
800
12
0.29
(200/700)
0.29
(4/14)
1.0
(0.29/0.29)
1 000
8
0.22
(200/900)
0.40
(4/10)
1.82
(0.40/0.22)
1 200
4
0.18
(200/1 100)
0.67
(4/6)
3.72
(0.67/0.18)
ep =  (Perfectly
Elastic)
ep >1 (Elastic)
ep =1
0< ep <1 (Inelastic)
ep = 0 (Perfectly Inelastic
0
1000
2000
3000
4000
5000
6000
7000
8000
94
Price
Quantity
TR = P x Q
ELASTICITY VALUE
8
0
0
ep = 
7
1000
7000
ep > 1
6
2000
12000
ep > 1
5
3000
15000
ep > 1
4
4000
16000
ep = 1
3
5000
15000
0 < ep < 1
2
6000
12000
0 < ep < 1
1
7000
7000
0 < ep < 1
0
8000
0
ep = 0
95
Total Revenue
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
0
1000
2000
3000
4000
5000
6000
7000
8000
Quantity
96
* Elasticity measures the degree to which the quantity
demanded responds to a change in price.
* When the elasticity of demand is greater than one,
demand is considered elastic and lowering the price
leads to an increase in revenue.
* When the elasticity is less than one, demand is
considered inelastic and lowering the price leads to a
decrease in revenue.
* Revenue is maximized when the elasticity is equal to
one.
97
* Price elasticity and total revenue:
*
*
*
*
If ep > 1 – product is elastic
If ep < 1 – product inelastic
If ep = 1 – product unit elastic
In elastic section of demand curve – a price decrease
leads to an increase in total revenue
* In inelastic section of demand curve – a price decrease
leads to a decrease in total revenue
98
* Income elasticity of demand:
* The income elasticity of demand (ey) measures the
responsiveness of the quantity demanded to changes in
income.
* ey = percentage change in quantity demanded of the product
percentage change in consumers’ income
* For example, if income increases from 15% to 25% (10%) and the
demand for a good increased by 20% (from 10% to 30%), the
income elasticity of demand would be 20%/10% = 2.
99
* Income elasticity of demand:
* Inferior products – Negative income elasticity
* Normal products – Positive income elasticity
(ey < 0)
(ey > 0)
* Normal products can be divided in two categories:
* Necessities/essential good
0 < eY < 1
* Luxury products
ey > 1
* Income elastic
* Income inelastic
ey > 1
eY < 1
100
* Cross elasticity of demand:
* The responsiveness of the quantity demanded of a particular
good to changes in the price of a related good.
* ec = percentage change in quantity demanded of product A
percentage change in price of product B
* For example, if the price of fuel increase by 10% (from 25% to
35%) and the demand of new cars that are fuel inefficient
decreased by 20%, the cross elasticity of demand would be:
- 20%/10% = -2
* A negative cross elasticity denotes two products that are
complements, while a positive cross elasticity denotes two
substitute products.
101
* Cross elasticity of demand:
* To establish whether products is a substitute or complement
* Complementary products – Negative cross elasticity (ec < 0)
* Substitute products – Positive cross elasticity (ec > 0)
* Independent goods (ec = 0)
102
[1] Ceteris paribus, if a 10% increase in income has caused a 20% decrease
in quantity of paraffin demanded (at the current price), then from
this we can conclude that paraffin is:
a. price elastic.
b. A necessity.
c. Price inelastic.
d. an inferior good.
[2] If an individual’s income rises by 10%, ceteris paribus, her demand for
a luxury good:
a. Increases by more that 10%.
b. Decreases by more that 10%.
c. Remains unchanged.
d. increases, but by less than 10%.
103
* Income elasticity of demand:
* Inferior products – Negative income elasticity
* Normal products – Positive income elasticity
(ey < 0)
(ey > 0)
* Normal products can be divided in two categories:
* Necessities/essential good
0 < eY < 1
* Luxury products
ey > 1
* Income elastic
* Income inelastic
ey > 1
eY < 1
104
[3] When the price of brandy increases from R10 to R15 a bottle,
the quantity demanded falls from 1 000 to 800 bottles per
week. Using the arc elasticity formula, the price elasticity of
demand will be:
a. – 5/9.
b. + 9/5.
c. – 4/9.
d. - 1.
105
[1] Ceteris paribus, if a 10% increase in income has caused a 20%
decrease in quantity of paraffin demanded (at the current
price), then from this we can conclude that paraffin is:
d. an inferior good.
if income rises the quantity of paraffin demanded falls, which
implies that paraffin must be an inferior good.
[2] If an individual’s income rises by 10%, ceteris paribus, her
demand for a luxury good will:
a. Increases by more that 10%.
If income rises the demand for a luxury good will rise
moreover, the percentage increase in the quantity demanded
of the luxury good will exceed the percentage rise in income.
106
[3] When the price of brandy increases from R10 to R15 a bottle,
the quantity demanded falls from 1 000 to 800 bottles per
week. Using the arc elasticity formula, the price elasticity of
demand will be:
ep = Relative change in quantity required
Relative change in the price
= [800 – 1000]/[(800 + 1000)/2]
[15 – 10]/[(15 + 10)/2]
= -200/900
5/(25/2)
= -2/9
2/5
a. – 5/9.
107