CHAPTER

What Is Economics?

AB 106
Instructor:
Microeconomics -- Associate Prof Rosalind Chew
Macroeconomics -- Prof Chew Soon Beng
g
Two quizzes: one in Week 7 and one in Week 12
Format: 10 multiple choice questions
Duration: 30 minutes
Venue: Your Tutorial Classroom
Tutorial participation: 10%
Each quiz: 10%
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Available FREE to students with the text.
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For
h chapter,
h
students
d
can access:
(1) Answers to odd-numbered problems in the text
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Understanding Our Changing World

You are studying economics at a time of enormous

change.
change

Much of the change is for the betterthe information age,

globalization,, and all the benefits that they
g
y bring.
g

But they also bring challenges: inflation, unemployment,

etc.

Did you know that there was a financial meltdown in the

USA in October 2008? And the labour market felt the
i
impact
throughout
h
h
2009
2009. T
Today
d iit h
has recovered
d ffrom the
h
impact.

Your economics course will help you to understand the

powerful forces that are shaping and changing our world.

Definition of Economics
All economic questions arise because we want more than
we can get
get.

Our inability to satisfy all our wants is called scarcity.

Because we face scarcity, we must make choices.
Choices mean making a tradeoff
Thinking about a choice as a tradeoff emphasizes cost as
an opportunity forgone.

Hence,
H
th
the choices
h i
we make
k d
depend
d on th
the iincentives
ti
we
face.

An incentive is a reward that encourages an action or a

penalty that discourages an action.

Definition of Economics
Economics is the social science that studies the choices
g
, and entire
that individuals,, businesses,, governments,
societies make as they cope with scarcity and the
incentives that influence and reconcile those choices.

But scarcity of what? Scarcity of resources and time!

Definition of Economics
Microeconomics
Microeconomics is the study of choices that individuals
and businesses make, the way those choices interact in
markets, and the influence of governments.
Macroeconomics
Macroeconomics is the study of the performance of the
national and global economies.

Economics: A Social Science

Economics is a social science.
Economists distinguish between two types of statement:
What ispositive statements
What
Wh t ought
ht tto benormative
b
ti statements
t t
t

A positive statement can be tested by checking it against

facts.
facts

A normative statement cannot be tested.

Economics: A Social Science

The task of economic science is first to discover positive
statements that are consistent with what we observe in the
world and that enable us to understand how the economic
world works and then seek to improve the outcome.

The first part is Positive Economics and the second part

is Normative Economics

Positive
P iti E
Economics
i iis llarge and
db
breaks
k iinto
t th
three steps:
t
Observation and measurement
Model building
b ilding
Testing models
8

Economics: A Social Science

Obstacles and Pitfalls in Economics
Economists cannot easily do experiments and most
economic behavior has many simultaneous causes.

To isolate the factor of interest,, economists use the

logical device called Ceteris Paribus or other things
being equal.
Economists try to isolate cause-and-effect relationship
by changing only one variable at a time, holding all other
relevant factors unchanged.

Economics: A Social Science

Obstacles and Pitfalls in Economics
Economists try to avoid two common fallacies:

Fallacy of Composition A false statement that what is

true for the p
parts is true for the whole or that what is true
for the whole is true for the parts.

Post Hoc Fallacy From the Latin term Post hoc, ergo
propter hoc, which means after this, therefore because
of this. The error of reasoning that a first event causes
a second event because the first occurs before the
second.

10

Conclusions of Chapter 1
Society is very competitive for individuals, firms and
g
also for governments
Economics will help every economic agent to make
informed decisions

11

CHAPTER

The Economic Problem

12

Production Possibilities and Opportunity

Cost

The production possibilities frontier (PPF) is the

boundary between those combinations of goods and
services that can be produced and those that cannot.

To illustrate the PPF, we focus on two goods at a time

and
dh
hold
ld th
the quantities
titi off allll other
th goods
d and
d services
i
constant.

That is,
is we look at a model economy in which everything
remains the same (ceteris paribus) except the two goods
were considering.
13

Production Possibilities and Opportunity

Cost
Production Possibilities
Frontier
The figure shows the PPF
for two goods: CDs and
pizza.

Any point on the frontier

such as E (production
efficiency) and any point
inside the PPF such as Z
(inefficient) are attainable.
attainable

Points outside the PPF

are unattainable.

14

Using Resources Efficiently

All the ppoints alongg the PPF are efficient.
To determine which of the alternative efficient quantities
to produce, we compare costs and benefits.
The PPF and Marginal Cost
The PPF determines opportunity cost.

The marginal cost of a good or service is the opportunity

cost of producing one more unit of it.

15

Using Resources Efficiently

As we move along the
PPF from A to F, the
opportunity cost of
pizza increases.
The opportunity
p
g
cost of producing
one more pizza is
the marginal cost of
a pizza
pizza.

16

Using Resources Efficiently

Higher
g
MC
The black dots and
the line labeled MC
show the marginal
cost of pizza.

The
Th MC curve

passes through the

center of each bar.

17

Using Resources Efficiently

Why do we produce pizza?
Preferences and Marginal Benefit
Preferences are a description of a persons likes and
dislikes.
dislikes

To describe preferences, economists use the concepts of

marginal benefit and the marginal benefit curve.
curve

The marginal benefit of a good or service is the benefit

received from consuming
g one more unit of it.

We measure marginal benefit by the amount that a

person is willing to pay for an additional unit of a good or
service.
18

Using Resources Efficiently

It is a ggeneral pprinciple
p that the more we have of any
y
good, the smaller is its marginal benefit and the less we
are willing to pay for an additional unit of it.

We call this general principle the principle of decreasing

marginal benefit.

The marginal benefit

f curve shows the relationship
between the marginal benefit of a good and the quantity of
that g
good consumed.

19

Using Resources Efficiently

At ppoint B,, with pizza
p
production at 1.5
million, people are
willing to pay 4 CDs for
a pizza.

At point E,
E with pizza
production at 4.5
million, people are
willing to pay 1 CD for
a pizza.

20

Using Resources Efficiently

Efficient Use of Resources
When we cannot produce more of any one good without
giving up some other good, we have achieved productive
efficiency.
efficiency

All points on the PPF are production efficient.

But
B t only
onl one point is allocation efficient
efficient: we
e achie
achieve
e
allocative efficiency at this point.

We prefer this point on the PPF above all other points

points.

21

Using Resources Efficiently

If we pproduce exactlyy
2.5 million pizzas,
marginal cost equals
g
benefit.
marginal

We cannot get more

value from our
resources.
resources

On the PPF at point

B, we are producing
the efficient quantities
of CDs and pizzas.
22

Determination of Allocative Efficiency

y
Marginal Cost and Marginal Benefit (cds per pizza)
$

MC

MB
2.5

Pizza
23

Economic Growth
The expansion
p
of p
production p
possibilitiesand increase
in the standard of livingis called economic growth.

Two key factors influence economic growth:

Technological change
Capital accumulation
Technological change is the development of new goods
and of better ways of producing goods and services.

Capital accumulation is the growth of capital resources,

which includes human capital.
24

Economic Growth
The Cost of Economic Growth
To
T use resources in
i research
h and
dd
development
l
t and
d
to produce new capital, we must decrease our
production of consumption
p
p
g
goods and services.
So economic growth is not free.
The opportunity
pp
y cost of economic g
growth is less
current consumption.

25

Economic Growth
The figure illustrates
the tradeoff we face
face.

We can produce

p
pizzas
or p
pizza ovens
along PPF0.

By using some

resources to
t produce
d
pizza ovens today,
the PPF shifts
outward
t
d in
i th
the ffuture.
t
What happens to
PPF1 if A was
chosen?
h
?
26

Conclusions of Chapter 2
Concept of PPF
Productive efficiency and allocative efficiency
Will PPF shift?

27

From Chapter 1: Two Big Economic

Questions
Two big questions summarize the scope of economics:
(1) How much to produce? How to produce and for
whom to produce?

Examples: (a) investment goods or consumption goods;

(b) Weapons or food; rice or healthcare

(2) When do choices made in the pursuit of self-interest

also promote the social interest?

28

How much to produce?

Production Possibilities
Frontier
We can choose any
point
i t on the
th PPF

29

How to produce?
Goods and services are produced by using productive
resources that economists call factors of production.

Factors of pproduction are ggrouped

p into four categories:
g
Land
Labor
Capital
Entrepreneurship

30

How to produce?
The gifts of nature that we use to produce goods and
services are land.

The work time and work effort that people devote to

producing goods and services is labor.

The quality of labor depends on human capital,

which is the knowledge and skill that people obtain
from education, on
on-the-job
the job training, and work
experience.
The tools, instruments, machines, buildings, and other
constructions that are used to produce goods and services
are capital.

The human resource that organizes

g
land,, labor,, and
capital is entrepreneurship.

31

How to produce?
The figure shows a
measure off the
th growth
th off
human capital in the
United States over the last
centurythe percentage
of the population that has
completed different levels
of education.

Economics explains these

trends.
32

Employed Residents by Education and Gender,

Singapore: 1996, 2006

Education/Year

1996
Total

2006
Total

1996
Male

2006
Male

Primary and
Below

373.6
((24.7))

295.7
((15.7))

243.4
((65.1))

178.0
((60.2))

Lower Secondary

212.7
(14.1)

236.7
(12.6)

150.5
(70.8)

153.5
(64.9)

Secondary

458.6
(30 3)
(30.3)

456.1
(24 3)
(24.3)

247.2
(53 9)
(53.9)

242.8
(53 2)
(53.2)

Upper Secondary

175.1
(11.6)

236.6
(12.6)

95.6
(54.6)

127.4
(53.8)

Polytechnic
Ed
Education
ti

117.5
(7 8)
(7.8)

215.0
(11 4)
(11.4)

77.3
(65 8)
(65.8)

128.1
(59 6)
(59.6)

Degree

173.9
(11.4)

440.6
(23.4)

102.7
(59.1)

251.3
(57.0)

1,511.5
(100%)

1,880.8
(100%)

916.6
(60.6)

1,081.2
(57.5)

Total

33

For whom we produce?

For Whom?
Who gets the goods and services depends on the
incomes that people earn.
Land
L d earns rent.
t
Labor earns wages. (Raw labour earns
subsistence wages while human capital generates
high salary.)
Capital earns interest.
Entrepreneurship earns profit.

34

Self-Interest vs Social Interest

You make choices that are in your self-interestchoices
self interest choices
that you think are best for you.

Choices that are best for society as a whole are said to

be in the social interest.

Is it possible that when each one of us makes choices

that are in our self-interest, it also turns out that these
choices are also in the social interest?
For example, when we choose to drive a car, it
contributes to pollution. Choices that affect the
social interest generate what is known as externality
in economics.

35

CHAPTER

Demand and Supply

36

Markets and Prices

A market is any arrangement that enables buyers and
sellers to get information and do business with each other
other.

A competitive market is a market that has many buyers

and many sellers so no single buyer or seller can influence
the price.

The moneyy p
price of a g
good is the amount of money
y
needed to buy it.

The relative price of a goodthe ratio of its money price

to the money price of the next best alternative goodis its
opportunity cost.
37

Demand
If you demand something, then you
1. W
1
Wantt it,
it
2. Can afford it, and
3 Have made a definite plan to buy it.
3.
it
Wants are the unlimited desires or wishes people have
for g
goods and services. Demand reflects a decision about
which wants to satisfy.

The quantity demanded of a good or service is the

amount that consumers plan to buy during a particular
time period, and at a particular price.
38

Demand
A rise in the price,
other
th thi
things remaining
i i
the same, brings a
decrease in the
quantity demanded
and a movement
along the demand
curve.

Known as Law of
Demand

39

Demand
Demand Curve and Demand Schedule

The term demand refers to the entire relationship

between the price of the good and quantity demanded of
the good.

A demand curve shows the relationship between the

quantity demanded of a good and its price when all other
influences on consumers planned purchases remain the
same.

40

Why Law of Demand

Substitution effect
When the relative price (opportunity cost) of a
good or service rises, people seek substitutes for
it; so the quantity demanded of the good or
service decreases.

Income effect
When the p
price of a good
g
or service rises relative
to income, people cannot afford all the things they
previously bought, so the quantity demanded of
the good or service decreases.
decreases
41

Demand
Willingness and
Ability
y to Pay
y
A demand curve is
also a willingnessand ability to pay
and-ability-to-pay
curve.
The smaller the
quantity available,
the higher is the
price that someone
is willing to pay for
another unit.
Willingness
g
to pay
p y
measures marginal
benefit.

42

Demand
A Change in Demand

When some influence on buying plans other than the

price of the good changes, there is a change in demand
for that good.

The quantity of the good that people plan to buy changes

at each and every price, so there is a new demand curve.

When demand increases, the demand curve shifts

rightward.

When demand decreases, the demand curve shifts

leftward.
43

Demand
Six main factors that change demand are
The prices of related goods
Expected future prices
Income
Expected future income
Population
Preferences

44

Demand
Prices of Related Goods

A substitute is a good that can be used in place of

another good.

A complement is a good that is used in conjunction with

another good.

When the price of substitute for an energy bar rises or

when the price of a complement of an energy bar falls, the
demand for energy bars increases.

45

Demand
Expected Future Prices

If the price of a good is expected to rise in the future,

current demand for the good increases and the demand
curve shifts rightward.
g
Income

When income increases

increases, consumers buy more of most
goods and the demand curve shifts rightward.
A normal g
good is one for which demand increases as
income increases.
An inferior good is a good for which demand decreases as
income increases
increases.
46

Demand
Expected Future Income

When income is expected to increase in the future, the

demand might increase now.
Population

The larger the population, the greater is the demand for

all goods.
Preferences

People with the same income have different demands if

they have different preferences.
47

Demand
The figure
g
shows an
increase in demand.

Because an energy
bar is a normal good,
an increase in income
increases the demand
for energy bars.

48

A Movement along the Demand Curve

When the price of the
good changes and
everything else
remains
i th
the same, th
the
quantity demanded
changes and there is
a movement along the
demand curve.

49

A Shift of the Demand Curve

If the price remains
the same but one of
the other influences
on buyers plans
changes demand
changes,
changes and the
demand curve shifts.

Caused by
parameters such as
change in income
price of related
goods
taste

50

Demand Curve
Ceteris Paribus
Inverse relationship
between price and
quantity
q
y demanded
provided taste (T),
income (Y) and prices
of substitutes (Ps) and
complements (Pc)
remain unchanged
(T,Y, Ps ,Pc )
51

Supply
If a firm supplies a good or service, then the firm
1. Has the resources and the technology to produce
it,
2 Can profit from producing it,
2.
it and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is possible
to produce.
Supply
pp y reflects a decision about which
technologically feasible items to produce.
The quantity supplied of a good or service is the amount
that producers plan to sell during a given time period at a
particular price.
52

Supply Curve
A rise in the price of
an energy bar,
b other
th
things remaining the
same, brings
g an
increase in the
quantity supplied.

Known as Law of
Supply

53

Supply
The Law of Supply

The
Th law
l
off supply
l states:
t t
Other things remaining the same, the higher the price of a
good the greater is the quantity supplied; and
good,

the lower the price of a good, the smaller is the quantity

supplied.

The law of supply results from the general tendency for

the marginal cost of producing a good or service to
increase as the quantity produced increases
increases, e
e.g
g risk is
higher because more is at stake (Chapter 2, page 37).

Producers are willingg to supply

pp y a g
good only
y if they
y can at
least cover their marginal cost of production.

54

Supply
Supply Curve and Supply Schedule

The term supply refers to the entire relationship between

the quantity supplied and the price of a good.

The supply curve shows the relationship between the

quantity supplied of a good and its price when all other
influences on producers planned sales remain the same.

55

Supply
Minimum Supply Price

A supply curve is also a

minimum-supply-price
curve.

As the quantity
produced increases,
marginal
g
cost increases.

The lowest price at

which someone is willing
to sell an additional unit
rises.

This
Thi llowestt price
i iis th
the
marginal cost.

56

Supply
A Change
g in Supply
pp y

When some influence on selling plans other than the

price of the good changes, there is a change in supply of
that good.

The quantity of the good that producers plan to sell

changes
h
att each
h and
d every price,
i
so th
there iis a new supply
l
curve.

When supply increases,

increases the supply curve shifts rightward.
rightward
When supply decreases, the supply curve shifts leftward.
57

Supply
The five main factors that change supply of a good are

The prices of productive resources such as wages

The prices of related goods produced
Expected
E
d ffuture prices
i
The number of suppliers
Technology

58

Supply
Prices of Productive Resources

If the price of resources used to produce a good rises,

rises the
minimum price that a supplier is willing to accept for
producing each quantity of that good rises.

So a rise in the price of productive resources decreases

supply and shifts the supply curve leftward.

59

Supply
pp y
Prices of Related Goods Produced

A substitute in production for a good is another good that

can be produced using the same resources.
The supply of a good increases if the price of a
substitute in production falls.
Goods are complements in production if they must be
produced together.
The supply of a good increases if the price of a
complement in production rises.

60

Supply
Expected Future Prices

If the price of a good is expected to rise in the future,

supply of the good today decreases and the supply curve
shifts
hift leftward.
l ft
d
The Number of Suppliers

The larger the number of suppliers of a good, the greater

is the supply of the good. An increase in the number of
suppliers shifts the supply curve rightward.
rightward

61

Supply
Technology

Advances in technology create new products and lower

the cost of producing existing products, so advances in
technology increase supply and shift the supply curve
rightward.

A natural disaster is a negative technology change, which

d
decreases
supply
l and
d shifts
hift th
the supply
l curve lleftward.
ft
d

62

An increase in supply
An advance in the
technology for
producing energy
bars increases the
supply of energy
bars and shifts the
supply curve
rightward.

63

A Movement Along the Supply Curve

When
Wh th
the price
i off th
the
good changes and
other influences on
sellers plans remain
the same, the quantity
supplied changes and
there is a movement
along the supply
curve.

64

A Shift of the Supply Curve

If the price remains

the same but some

other influence on
sellers plans changes,
supply changes and
the supply curve shifts.

Caused byy

parameters such as
change in wages,
improvement in
technology

65

Supply Curve
(Tech W,
(Tech,
W Oil,
Oil Pol)

Ceteris Paribus
A positive
relationship between
price and quantity
supplied provided
technology (Tech)
(Tech),
wage rate (W), Oil
prices and govt
policy (Pol) remain
unchanged

66

Market Equilibrium
Equilibrium is a situation in which opposing forces
q
in a market occurs when
balance each other. Equilibrium
the price balances the plans of buyers and sellers.

The equilibrium price is the price at which the quantity

demanded equals the quantity supplied.

The equilibrium quantity is the quantity bought and sold

att the
th equilibrium
ilib i
price.
i

Price regulates buying and selling plans.

Price adjusts when plans dont match.

67

Market Equilibrium
Price as a Regulator
g

If the price is $2
$2.00
00 a
bar, the quantity
supplied exceeds the
quantity
tit demanded.
d
d d

There is a surplus of
6 million energy bars
bars.

68

Market Equilibrium
Price Adjustments

At prices above the

equilibrium
eq
ilibri m price
price, a surplus
s rpl s
forces the price down.

At prices below the

equilibrium price, a
shortage forces the price
up.

At the equilibrium price,

buyers plans and sellers
buyers
sellers
plans agree and the price
doesnt change until some
event changes either
demand or supply.

69

Predicting Changes in Price and Quantity

An Increase in Demand

When demand

increases the demand

curve shifts rightward.
rightward

The price rises, and

the quantity supplied
increases along the
supply curve from A to
B.

70

An Increase in Supply
An Increase in Supply
When supply
increases the supply
curve shifts rightward.
rightward

The price falls, and

the q
quantity
y demanded
increases along the
demand curve from A
to B.
B

A
B

71

Increase in Both Demand and Supply

pp y
An increase in
demand and an
increase in supply
increase the
equilibrium quantity
from A to B.

The change in
equilibrium price is
uncertain because the
increase in demand
raises the equilibrium
price and the increase
in supply lowers it.
72

Summary
y
P

S(W left;
Tech right)

A
A is the equilibrium point
D(Y right;
T right;
i ht
Ps right;
Pc left)
Q

Difference between demand and quantity demanded

Difference between supply and quantity supplied

73

CHAPTER

Elasticity

74

Elasticity
When price falls,
quantity demanded
rises by different
amounts depending
on price
i sensitivity
iti it

P
Total Revenue is P.Q
TR is affected as price falls

Impacts on revenue

P0

differently depending
on price sensitivity

P1
D2

D1
Q0 Q1

Q2

Q
75

Price Elasticity of Demand

An increase in supply can bring about a large P and a
small Q or a small P and a large Q

76

Price Elasticity of Demand

The contrast between the two outcomes in the figures
g g
the need for
earlier highlights
A measure of the responsiveness of the quantity demanded
to a price change.

The price elasticity of demand is a units-free measure

of the responsiveness of the quantity demanded of a good
to a change in its price when all other influences on
buyers plans remain the same.

77

Price Elasticity of Demand

Measures the sensitivity of quantity demanded to price
g
changes.
It measures the percentage change in the quantity
demanded of a good that results from a one percent
change
h
iin price.
i

E PD

% Q D

% P

78

Price Elasticity of Demand

The p
percentage
g change
g in a variable is the absolute
change in the variable divided by the original level of
the variable.
Th f
Therefore,
elasticity
l ti it can also
l be
b written
itt as:

Q Q P Q
E

P P Q P
D
P

79

Price Elasticity of Demand

A negative number, because price and quantity move
in opposite directions
As price increases, quantity decreases

As price decreases
decreases, quantity increases
When EP > 1, the good is price elastic

%Q > % P
When EP < 1, the good is price inelastic

%Q < % P

80

Price Elasticity of Demand

But it is the magnitude, or absolute value, of the
p
the quantity
q
y
measure that reveals how responsive
change has been to a price change.
The primary determinant of price elasticity of demand
is the availability of substitutes.
If there are many substitutes, demand is price elastic
Can easily move to another good with price increases

If there are few substitutes, demand is price inelastic

Necessities, such as food or housing, generally have
inelastic demand.

Luxuries, such as exotic vacations, generally have

elastic demand.

81

Price Elasticity of Demand

Other determinants of price elasticity of demand are

The proportion of income spent on the good

The greater the proportion of income consumers spent
on a good,
good the larger is its elasticity of demand
demand.

The time elapsed since a price change

The more time consumers have to adjust to a price
change, or the longer that a good can be stored without
losing its value, the more elastic is the demand for that
good.
82

Linear Demand Curve

If we move down a linear demand curve,, slope
p is the
same but price is lower and quantity is larger
Hence, E is smaller

Elasticity will change along the demand curve

Q Q P Q
E

P P Q P
D
P

83

Price Elasticity of Demand

Linear Demand Curve

84

Price Elasticity of Demand

Given a linear demand curve
Elasticity depends on slope and on the values of P and Q

The top portion of the demand curve is elastic

Price is high and quantity small

The bottom portion of the demand curve is inelastic

Price is low and quantity high

85

Price Elasticity of Demand

Price
4

EP = -

Demand Curve
Q = 8 2P

Elastic

Ep = -1

Inelastic

Ep = 0
86

Price Elasticity of Demand

The steeper the demand curve becomes, the more
g
inelastic the good.

The flatter the demand curve becomes, the more elastic

the good

Two extreme cases of demand curves

Completely
p
y inelastic demand vertical
Infinitely elastic demand - horizontal

87

Price Elasticity of Demand

The demand curve is vertical.

88

Price Elasticity of Demand

The price elasticity of demand equals 1 and the good

has unit elastic demand.

89

Price Elasticity of Demand

The price barely changes

the price elasticity of demand is infinite and the good has a
perfectly elastic demand.

A horizontal demand curve.

90

Price Elasticity of Demand

Total Revenue and Elasticity
The total revenue from the sale of good or service
equals the price of the good multiplied by the quantity
sold.
When the price changes, total revenue also changes.
If a price cut increases total revenue, demand is elastic.

If a price cut decreases total revenue, demand is

inelastic.

91

Link between Elasticity and Total Revenue

92

Other Demand Elasticities

Cross-Price Elasticity of Demand
Measures the percentage change in the quantity
demanded of one good that results from a one percent
change in the price of another good
good.

EQb Pm

Qb Qb Pm Qb

Pm Pm Qb Pm

93

Other Demand Elasticities

Complements: Cars and Tyres

Cross
Cross-price
price elasticity of demand is negative
Price of cars increases, quantity demanded of cars
falls leading
g to smaller q
quantity
y demanded of tires
Substitutes: Butter and Margarine

Cross-price elasticity of demand is positive

Price of butter increases, quantity demanded of
butter falls leading to higher quantity of margarine
demanded
94

Cross Price Elasticities

Other Demand Elasticities

Income Elasticity of Demand
Measures how much quantity demanded changes with a
change in income, other things remaining the same

Q/Q
I Q
EI

I/I
Q I
EI > 1, demand is income elastic and the good is a
normal good
good.

0 < EI < 1, demand is income inelastic and the good is a

normal good.
g

EI < 0 (negative), the good is an inferior good.

96

Price Elasticity of Supply

Measures the sensitivity of quantity supplied given a
g in price
p
change
Measures the percentage change in quantity supplied
resulting from a 1 percent change in price.

S
EP

% Q S

% P

97

Elasticity of Supply

(Note that slope is)

irrelevant in this case.

98

Elasticity of Supply
The Factors That Influence the Elasticity of Supply
The elasticity of supply depends on

Resource substitution possibilities

pp y decision
Time frame for supply

Resource Substitution Possibilities

The easier it is to substitute among the resources used
to produce a good or service, the greater is its elasticity of
supply.

Elasticity of Supply
Time Frame for Supply
pp y Decision
The more time that passes after a price change, the
greater is the elasticity of supply.

Momentary supply is perfectly inelastic. The quantity

supplied immediately following a price change is constant.

Short-run supply is somewhat elastic.

Long-run
g
supply
pp y is the most elastic.
Table 4.1 (page 99) provides a glossary of the all
elasticity measures.

THE END

101

How to study for AB 106

Step 1: Study the concepts used in lectures and
examples in tutorials
Step 2: Study the materials according to the Course
O tli
Outline
Step 3: Study the whole book
Step 4: Study another book
Remember: Study in this order