Mic03_Applying the Supply-and-Demand Model.pptxVIP

Chapter 3Applying the Supply-and-Demand Model Topics How Shapes of Supply and Demand Curves Matter. Sensitivity of the Quantity Demanded to Price. Sensitivity of the Quantity Supplied to Price. Effects of a Sales Tax. How Shapes of Supply and Demand Curves Matter The shapes of the supply and demand curves determine by how much a shock affects the equilibrium price and quantity. Example: avocado (same as Chapter 2) The supply of avocados depends on the price of avocados and the price of fertilizer. Figure 3.1 How the Effect of a Supply Shock Depends on the Shape of the Demand Curve A 55￠ increase in the price of fertilizer shifts the avocado supply curve to the left from S1 to S2. Sensitivity of Quantity Demanded to Price Elasticity – the percentage change in one variable in response to a given percentage change in another variable. Price elasticity of demand (e) – the percentage change in the quantity demanded in response to a given percentage change in the price, at a particular point on the demand curve. Price Elasticity of Demand Formally, where D indicates a change. Example If a 1% increase in price results in a 3% decrease in the quantity demanded, the elasticity of demand is e = -3%/1% = -3. Price Elasticity of Demand (cont.) Along a linear demand curve with a function of: Where -b is the ratio of the fall in quantity to the rise in price: the elasticity of demand is Solved Problem 3.1 The estimated linear demand function for corn is: Q = 15.6 – 0.5p where Q is the quantity demanded in billion bushels per year and p is the price per bushel. What is the elasticity of demand at the point on the demand curve where the price is p = $7.20 per bushel? Solved Problem 3.1: Answer Substitute the slope coefficient b, the price, and the quantity values into Equation 3.4. By inspection, the slope coefficient for this demand equation is b = 0.5 (and a = 15.6). Substituting b = 0.5, p = $7.20, and Q = 12 into Equation 3.4, we find that the elasticity of demand at t