ECONOMIC THINKING

Understanding Economics 3. Labor – any human service—

and Scarcity physical or intellectual. Also referred
to as human capital.
Scarcity – means that there are never 4. Entrepreneurship – the ability of
enough resources to satisfy all human someone (an entrepreneur) to
wants. recognize a profit opportunity,
▪ Every society, at every level, must organize the other factors of
make choices about how to use its production, and accept risk.
resources.
Economics – is the study of the trade-offs Labor, Markets, and Trade
and choices that we make, given the fact
of scarcity. The Division and
Opportunity Cost – is what we give up Specialization of Labor
when we choose one thing over another.
Division of Labor – the way in which the
Goods and Resources work required to produce a good or
service is divided into tasks performed by
Economic Goods – goods or services a different workers.
consumer must pay to obtain; also called Specialization – when workers or firms
scarce goods. focus on particular tasks for which they
Free Goods – goods or services that a are well suited within the overall
consumer can obtain for free because production process.
they are abundant relative to the
demand. Why the Division of Labor
Productive Resources – the inputs used Increases Production?
in the production of goods and services to
make a profit: land, economic capital, Economies of Scale – when the average
labor, and entrepreneurship; also called cost of producing each individual unit
“factors of production”. declines as total output increases.
1. Land – any natural resource,
including actual land, but also trees, Trade and Markets
plants, livestock, wind, sun, water,
etc. ▪ Specialization only makes sense if
2. Economic Capital – anything that’s workers (and other economic agents
manufactured in order to be used in such as businesses and nations) can
the production of goods and services. use their income to purchase the
Note the distinction between other goods and services they need.
financial capital (which is not ▪ Specialization requires trade.
productive) and economicww ▪ The market allows you to learn a
capital (which is productive). While specialized set of skills and then use
money isn’t directly productive, the the pay you receive to buy the goods
tools and machinery that it buys can and services you need or want.
be. ▪ This is how our modern society has
evolved into a strong economy.
Microeconomics vs. Macroeconomics
Macroeconomics – the branch of Macroeconomics: Macroeconomic policy
economics that focuses on broad issues pursues its goals through monetary
such as growth, unemployment, inflation, policy and fiscal policy.
and trade balance. ▪ Monetary Policy: policy that
Microeconomics – the branch of involves altering the level of
economics that focuses on actions of interest rates, the availability of
particular agents within the economy, credit in the economy, and the
like households, workers, and businesses. extent of borrowing
We learn about the theory of consumer ▪ Fiscal Policy: economic policies
behavior and the theory of the firm that involve government
spending.
Understanding Microeconomics
Using Economic Models
Questions to Ask with
Microeconomics Economic Model: a simplified version of
reality that allows us to observe,
▪ What determines how households understand, and make predictions about
and individuals spend their budgets? economic behavior.
▪ What combination of goods and
services will best fit their needs and Economic Models and Math
wants, given the budget they have to ▪ Economic models can be represented
spend? using words or using mathematics.
▪ How do people decide whether to ▪ Algebra and graphs are utilized to
work, and if so, whether work full explain economic models.
time or part time?
▪ How do people decide how much to
save for the future, or whether they Using Economic Models: Examples
should borrow to spend beyond their
current means?

More Microeconomics Questions

▪ What determines the products, and
how many of each, a firm will produce
and sell?
▪ What determines what prices a firm Circular Flow Diagram: a diagram
will charge? indicating that the economy consists of
▪ What determines how a firm will households and firms interacting in a
produce its products? goods-and-services market and a labor
▪ What determines how many workers market.
it will hire? ▪ Goods-and-services Market the
▪ How will a firm finance its business? product market, in which firms sell
▪ When will a firm decide to expand, and households buy.
downsize, or even close? ▪ Labor Market, in which households
sell labor to business firms or other
Understanding Macroeconomics employees.
▪ Real World, there are many different
markets for goods and services and Variable
markets for many different types of A quantity that can assume a range of
labor. The circular flow diagram values represented by a letter or a
simplifies these distinctions in order symbol.
to make the picture easier to grasp. ▪ For example: y = 9 + 3x

Economists don’t figure out the solution to a Working with Variables

problem and then draw the graph. Instead, When you're trying to solve an equation
they use the graph to help them discover the with one or more variables, you need to
answer isolate the variable.
▪ What does x equal if y=12?
Purpose of Functions
12 = 9 + 3x
Function: a relationship or expression -9 = -9
involving one or more variables. 3 = 3x
▪ In economics, functions frequently 3 / 3 = 3x / 3
describe cause and effect. 1=x
▪ The variable on the left-hand side is
what is being explained ("the effect"). Creating and Interpreting Graphs
▪ On the right-hand side is what's doing
the explaining ("the causes").

Economic Models tend to express

relationships using economic variables,
such as:
▪ Budget = money spent on econ books
+ money spent on music.

Solving Simple Equations

Intercept: the point on a graph where a
Order of Operations line crosses the vertical axis or horizontal
When you solve an equation it's axis.
important to do each operation in Slope: the change in the vertical axis
the following order: divided by the change in the horizontal
▪ Simplify inside parentheses and axis.
brackets. Variable: a quantity that can assume a
▪ Simplify the exponent. range of values.
▪ Multiply and divide from left to right. x - axis: the horizontal line on a graph,
▪ Add and subtract from left to right. commonly represents quantity (q) on
graphs in economics.
Lines y - axis: the vertical line on a graph,
In this course the most common equation commonly represents price (p) on graphs
you will see is for a line in graphs: y = in economics.
b+mx
Equation for a Line: y = mx + b
In any equation for a line, m is the slope
and b is the y-intercept.

Interpreting Graphs in Economics

▪ It is rare for real-world data points to
arrange themselves as a perfectly
straight line.
▪ It often turns out that a straight line Slope of Zero indicates that there is a
can offer a reasonable constant relationship between two
approximation of actual data. variables: when one variable the other
does not change.
Interpreting Slope

Slope: the change in the vertical axis

divided by the change in the horizontal
axis.

Calculating Slope
▪ The slope of a straight line between
two points can be calculated in
numerical terms.
▪ To calculate slope, begin by
Positive Slopes indicates that two designating one point as the "starting
variables are positively related: when one point" and the other point as the "end
variable increases, so does the other, and point" and then calculating the rise
when one variable decreases, the other over run between these two points.
also decreases. ▪ Graphs of economic relationships are
not always straight lines but often
nonlinear (curved) lines. Can
interpret nonlinear relationships
similarly to the way we interpret
linear relationships.
▪ Their slopes can be positive or
negative. We can calculate the slopes
similarly also, looking at the rise over
Negative Slope indicates that two the run of a segment of a curve.
variables are negatively related; when one Nonlinear Relationship can be
variable increases, the other decreases, interpreted similar to linear relationships.
and when one variable decreases, the ▪ Their slopes can be positive or
other increases. negative.
 ▪ Sometimes it's useful to show more
than one set of data on the same
axes.
▪ The data in the table, below, is
displayed in Figure 1, which shows
the relationship between two
variables: length and median weight
for American baby boys and girls
during the first three years of life.
▪ The line graph measures length in
▪ We can calculate the slopes similarly inches on the horizontal axis and
also, looking at the rise over the run weight in pounds on the vertical axis.
of a segment of a curve. For example. point A on the figure
▪ A higher positive slope means a shows that a boy who is 28 inches
steeper upward tilt to the curve, long will have a median weight of
which you can see at higher output about 19 pounds.
levels. ▪ One line on the graph shows the
▪ A negative slope that is larger in length- weight relationship for boys,
absolute value (that is, more and the other line shows the
negative) means a steeper downward relationship for girls.
tilt fo the line. ▪ This kind of graph is widely used by
▪ A slope of zero is a horizontal line. health- care providers to check
▪ A vertical line has an infinite slope. • If whether a child's physical
a line has a larger intercept, development is roughly on track.
graphically, it would shift out (or up)
from the old origin, parallel to the old
line.
▪ If a line has a smaller intercept, it
would shift in (or down), parallel to
the old line.

Types of Graphs

Pie Graphs: (sometimes called a pie

chart) is used to show how an overall total
is divided into parts. A circle represents a
group as a whole. The slices of this
Line Graphs: show a relationship circular "pie" show the relative sizes of
between two variables: one measured on subgroups.
the horizontal axis and the other ▪ These pie graphs show how the U.S.
measured on the vertical axis. population was divided among
 children, working-age adults, and the rather than trying to compare several
elderly in 1970. 2000, and what is pie graphs.
projected for 2030. ▪ The three bar graphs are based on
▪ In a pie graph, each slice of the pie the information from the chart about
represents a share of the total, or a the US, age distribution in 1970, 2000,
percentage. For example, 50% would and 2030.
be half of the pie and 20% would be ▪ Graph (a) shows three bars for each
one-fifth of the pie. year, representing the total number
▪ The three pie graphs show that the of persons in each age bracket for
share of the US. population 65 and each year.
over is growing. ▪ Graph (b) shows just one bar for each
▪ The pie graphs allow you to get a feel year, but the different age groups are
for the relative size of the different now shaded inside the bar.
age groups from 1970 to 2000 to ▪ Graph (c), still based on the same
2030, without requiring you to slog data, the vertical axis measures
through the specific numbers and percentages rather than the number
percentages in the table. of persons.
▪ Some common examples of how pie
graphs are used include dividing the Comparison: How do you know which
population into groups by age. graph to use for your data?
income level, ethnicity, religion
Occupation: dividing different firms Bar Graphs – are especially useful when
into categories by size, industry, comparing quantities.
number of employees; and dividing ▪ For example, if you are studying the
up govemment spending or taxes populations of different countries,
into its main categories. bar graphs can show the
relationships between the population
sizes of multiple countries.
▪ Not only can it show these
relationships, but it can also show
breakdowns of different groups
within the population.

Pie Graphs – are often better than line

graphs at showing how an overall group is
divided.
▪ However, it a pie graph has too many
slices, it can become difficult to
Bar Graphs: uses the height of different
interpret.
bars to compare quantities.
Line Graphs – are often the most
▪ It can be subdivided in way that
effective format for illustrating a
reveals information similar to that we
relationship between two variables that
can get from pie charts.
are both changing.
▪ It is sometimes easier for a reader to
▪ For example, time-series graphs can
run his or her eyes across several bar
show patterns as time changes, like
graphs, comparing the shaded areas,
the unemployment rate over time.
▪ Line graphs are widely used in
economics to present continuous
data about prices, wages, quantities
and sold, the size of the economy.
 CHOICE IN A WORLD OF SCARCITY

Budget Constraints and Choices decision would be less housing,

environmental protection, or national
Budget Constraint – refers to all possible defense. These trade-offs also arise
combinations of goods that someone
with government policies.
can afford, given the prices of goods and
the income (or time) we have to spend.
Opportunity Cost – may be defined as
Sunk Costs – costs incurred in the past
that can’t be recovered. “the cost of choosing to use resources
Opportunity Cost – measures cost by for one purpose measured by the
what is given up in exchange; measures sacrifice of the next best alternative for
the value of the forgone alternative. using those resources.”

Types of Budget Constraints Steps to Calculate Opportunity Cost

▪ Limited amount of money to spend Step 1. Use this equation where P and
on the things we need and want. Q are the price and respective quantity
▪ Limited amount of time.
of any number, n, of items purchased
and Budget is the amount of income
Budget Constraints Results
one has to spend.
▪ You have to make choices.
Budget = P1×Q1+P2×Q2+⋯+Pn×Qn
▪ Every choice involves trade-offs.
Step 2. Apply the budget constraint
▪ No matter how many goods a
equation to the scenario.
consumer has to choose from,
$10=$2×Q1+$0.50×Q2
every choice has an opportunity
Step 3. Simplify the equation.
cost, i.e. the value of the other
goods that aren’t chosen.
▪ The budget constraint framework
assumes that sunk costs—costs
incurred in the past that can’t be
recovered—should not affect the
current decision.
Step 4. Use the equation.
Concept of Opportunity Cost

Opportunity Cost – the value of the

next best alternative. Step 5. The results.
Individual Decisions – Recognizing the
opportunity cost can alter personal Rationality and Self-Interest
behavior.
Assumption of Rationality
Societal Decisions – Opportunity cost
▪ also called the Theory of Rational
comes into play with societal decisions.
Behavior, it is the assumption that
Universal health care would be nice,
people will make choices in their
but the opportunity cost of such a
own self-interest.
▪ is primarily a simplification that Marginal Benefit – the difference (or
economists make in order to create change) in what you receive from a
a useful model of human decision- different choice.
▪ The amount of benefit a person
making.
receives from a particular good or
▪ The assumption that individuals
service is subjective; one person may
are purely self-interested doesn’t get more satisfaction or happiness
imply that individuals are greedy from a particular good or service than
and selfish. People clearly derive another.
satisfaction from helping others, so Economic Rationality Revisited
“self-interest” can also include ▪ How, then, do you decide on a
pursuing things that benefit other choice? The answer is that you
people. compare, to the best of your ability,
Rationality in Action the marginal benefits with the
Rationality suggests that consumers will marginal costs.
act to maximize self-interest and ▪ Marginal Analysis – is an important
businesses will act to maximize profits. part of economic rationality and good
Both are taking into account the benefits decision- making.
of a choice, given the costs.

Rationality and Consumers

▪ When a consumer is thinking about
buying a product, what does he or
she want? The theory of rational
behavior would say that the
consumer wants to maximize benefit
and minimize cost.
▪ As the cost of the product increases,
it becomes less likely that the
consumer will decide that the
benefits of the purchase outweigh
the costs.

Marginal Analysis – examination of

decisions on the margin, meaning
comparing costs of a little more or a little
less.
Marginal Cost – the difference (or
change) in cost of a different choice.
▪ It sometimes go up and sometimes
go down, but to get the clearest view
of your options, you should always try
to make decisions based on marginal
costs, rather than total costs.
 DEMAND

Economic Systems charged. Most economies in the real

world are mixed.
Market – any situation that brings
together buyers and sellers of goods or Demand for Goods and Services
services.
Types of Economies Demand – the relationship between the
price of a certain good or service and
1. Market Economy – an economy the quantity of that good or service
where economic decisions are someone is willing and able to buy.
decentralized, resources are owned Price – what a buyer pays for a unit of the
by private individuals, and businesses specific good or service.
supply goods and services based on Quantity Demanded – the total number
demand. of units of a good or service consumers
2. Competitive Market – a market in wish to purchase at a given price.
which there is a large number of Law of Demand – the common
buyers and sellers so that no one relationship that a higher price leads to
can control the market price. a lower quantity demanded of a certain
3. Free Economy – a market in which good or service and a lower price leads
the government does not to a higher quantity demanded, while
intervene in any way. all other variables are held constant.
4. Planned (Command) Economies – Demand Schedule – a table that shows
an economy where economic the quantity demanded for a certain
decisions are passed down from good or service at a range of prices.
government authority and where Demand Curve – a graphic
resources are owned by the representation of the relationship
government. between price and quantity demanded
▪ Resources and businesses are of a certain good or service, with price on
owned by the government. the vertical axis and quantity on the
▪ Government decides what goods horizontal axis.
and services will be produced
and what prices will be charged What is Assumed in Demand Curve?
for them.
▪ Government decides what Ceteris Paribus
methods of production will be ▪ a Latin phrase meaning “other things
used and how much workers will being equal.”
be paid. ▪ Any given demand or supply curve
5. Mixed Economy – they combine is based on the ceteris paribus
elements of command and market assumption that all else is held equal.
systems. ▪ When changing one variable in a
function (e.g. demand for some
The primary distinction between a free product), we assume everything else
and command economy is the degree to is held constant.
which the government determines what ▪ A demand curve or a supply curve
can be produced and what prices will be is a relationship between two, and
only two, variables when all other
 variables are held equal. If all else is Factors Affecting Demand:
not held equal, then the laws of Goods or Services
supply and demand will not
necessarily hold. Goods or Services Terms – the demand
for a product can be affected by changes
What Affects a Demand Curve? in the prices of related goods such as
substitutes or complements.
Demand Curves Affected by:
Substitute – goods or services that can
“Willingness to Purchase” suggests a be used in place of one another
desire to buy, and it depends on what Complements – goods or services that
economists call tastes and preferences. If are used together because the use of one
you neither need nor want something, enhances the use of the other.
you won’t be willing to buy it. Inferior Good – good or service whose
“Ability to Purchase” suggests that demand decreases when a consumer’s
income is important. Professors are income increases and demand increases
usually able to afford better housing and when income decreases.
transportation than students, because Normal Good – good or service whose
they have more income. demand increases when a consumer’s
“Price of Related Goods” can also affect income increases and demand decreases
demand. If you need a new car, the when income decreases.
price of a Honda may affect your demand
for a Ford.
“Size or Composition of the
Population” The more children a family
has, the greater their demand for
clothing. The more driving-age children a
family has, the greater their demand for
car insurance and the less for diapers and
baby formula.

Factors Affecting Demand:

Other Factors

“Shift in Demand” happens when a

change in some economic factor (other
thanprice) causes a different quantity to
be demanded at every price.

▪ changing tastes or preferences

▪ changes in the composition of the
population
▪ changes in the prices of related goods
▪ changes in expectations about future
prices
 SUPPLY

Supply of Goods and Services remain unchanged, a firm’s profits

go up.
Supply – the relationship between the ▪ When a firm’s profits increase, it’s
price of a certain good or service and the more motivated to produce output
quantity of that good or service (goods or services), since the more it
producers are willing to offer for sale. produces the more profit it will earn.
Law of Supply – the common relationship ▪ When costs of production fall, a firm
that a higher price leads to a higher will tend to supply a larger quantity
quantity supplied of a certain good or at any given price for its output. This
service and a lower price leads to a lower can be shown by the supply curve
quantity supplied, while all other variables shifting to the right.
are held constant.
Quantity Supplied – the total number of Factors Affecting Supply:
units of a good or service producers are Higher Costs
willing to supply at a given price.
Shift in Supply Due to Increased in
Supply refers to the curve, and Quantity Production Costs
Supplied refers to the (specific) point on ▪ If a firm faces higher costs of
the curve. production, then it will earn lower
profits at any given selling price for
Supply Schedule – a table that shows the its products.
quantity supplied for a certain good or ▪ As a result, a higher cost of
service at a range of prices. production typically causes a firm to
Supply Curve – a graphic supply a smaller quantity at any
representation of the relationship given price. In this case, the supply
between price and quantity supplied of curve shifts to the left.
a certain good or service, with price on
the vertical axis and quantity on the Equilibrium, Surplus, and Shortage
horizontal axis.
Demand and Supply
What Affects a Supply Curve? ▪ Graphs for demand and supply
curves both have price on the
Factors Affecting Supply: vertical axis and quantity on the
Lowered Costs horizontal axis, the demand curve
and supply curve for a particular
Production Costs Affect Supply good or service can appear on the
▪ If other factors relevant to supply do same graph.
change, then the entire supply curve ▪ Together, demand and supply
will shift. determine the price and the quantity
▪ Shift in Supply – means a change in that will be bought and sold in a
the quantity supplied at every price. market.
▪ If a firm faces lower costs of ▪ What does it mean when the quantity
production, while the prices for the demanded and the quantity supplied
good or service the firm produces aren’t the same? The answer is a
surplus or a shortage.
Surplus or Excess Supply – situation Efficiency in the demand and supply
where the quantity demanded in a model has the same basic meaning:
market is less than the quantity The economy is getting as much benefit
supplied; occurs at prices above the as possible from its scarce resources, and
equilibrium. all the possible gains from trade have
Equilibrium – price and quantity been achieved.
combination where supply equals
demand.

Shortage or Excess Demand – situation

where the quantity demanded in a
market is greater than the quantity
supplied; occurs at prices below the
equilibrium.
▪ Generally any time the price for a
good is below the equilibrium level,
incentives built into the structure of
demand and supply will create
pressures for the price to rise.
▪ Similarly, any time the price for a
good is above the equilibrium level,
similar pressures will generally cause
the price to fall.

Equilibrium: Where Supply and

Demand Intersect

Equilibrium – price and quantity

combination where supply equals
demand.
Equilibrium Price – the (only) price
where the quantity supplied in a
market equals the quantity demanded.
Equilibrium Quantity – the quantity both
supplied and demanded at the
equilibrium price.

Equilibrium and Economic Efficiency

Equilibrium is important to create both a
balanced market and an efficient market.
Efficiency – when the optimal amount of
goods are produced and consumed,
minimizing waste.
 APPLICATIONS OF SUPPLY AND DEMAND

Demand and Supply Model support a price by preventing it from

▪ Economists believe there are a small falling below a certain level.
number of fundamental principles ▪ An example of a price floor is the
that explain how economic agents minimum wage, which is based on
respond in different situations. Two the view that someone working full
of these principles, are the laws of time should be able to afford a basic
demand and supply. standard of living.
▪ Governments can pass laws affecting ▪ Most common way price supports
market outcomes, but no law can work is the government enters the
negate these economic principles. market and buys up the product,
▪ The laws of supply and demand often adding to demand to keep prices
become apparent in sometimes higher than they otherwise would be.
unexpected ways, which may
undermine the intent of the Price Control – government laws to
government policy. regulate prices instead of letting market
forces determine price.
Price Ceilings – a legal maximum price ▪ Neither price ceilings nor price floors
for a product. cause demand or supply to change.
▪ Keeps a price from rising above a ▪ They simply set a price that limits
certain level (the “ceiling”). what can be legally charged in the
▪ Governments typically set a price market.
ceiling to protect consumers by
making necessary products Elasticity – measures how much one
affordable, but you’ll come to see variable responds to changes in another
how this sometimes backfires by variable.
creating a market shortage. ▪ One type of elasticity measures how
▪ Consumers, who are also potential much demand for your websites will
voters, sometimes unite behind a fall if you raise your price.
political proposal to hold down a
certain price. Elasticity – is a numerical measure of the
responsiveness of 𝑸𝒅 or 𝑸𝒔 to one of its
Five Major Consequences determinant.
of Price Ceilings
1. Shortages Price of Elasticity of Demand
2. Reduced quality
3. Wasted time and resources Price Elasticity = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑸𝒅

4. Deadweight loss, or a loss of gains of Demand 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑷

from trade
Price Elasticity of Demand – measures
5. Misallocation of resources
how much 𝑸𝒅 responds to a change in P.
It measures the price sensitivity of
Price Floor – a legal minimum price for
buyers’ demand.
a product.

▪ Price floors are sometimes called

“price supports”, because they
Example: So, we instead use the midpoint method.

𝑒𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 − 𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒

× 100%
𝑚𝑖𝑑𝑝𝑜𝑖𝑛𝑡

▪ The midpoint is the number

halfway between the start and end
15%
Price Elasticity of Demand = 10% = 1.5 values, the average of those values.
▪ It doesn’t matter which value you use
▪ Along a D curve, P and Q move in as the “start” and which as the “end”.
opposite directions, which would
make price elasticity negative. Using the midpoint method, the %
▪ We will drop the minus sign and change in P
report all price elasticities as positive $250 − $200
× 100 = 22.2%
numbers. $225

The % change in Q
Calculating Percentage Changes
12 − 8
× 100 = 40.0%
10
Standard method of computing the
percentage (%) change: The price elasticity of demand
40
𝑒𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 − 𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒 = 1.8
× 100% 22.2
𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒
Perfectly Inelastic Demand (One
Extreme)

Going from A to B, the % change in P

$250 − $200
× 100 = 25%
$200
Inelastic Demand
Problem:
The standard method gives different
answers depending on where you start.

From A to B
P rises 25%, Q falls 33%,
Elasticity = 33/25 = 1.33

From B to A
P falls 20%, Q rises 50%,
Elasticity = 50/20 = 2.50
Unit Elastic Demand Which of these two effects is bigger?
▪ It depends on the price elasticity of
demand.

Price Elasticity = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑸

of Demand 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑷

𝑹𝒆𝒗𝒆𝒏𝒖𝒆 = 𝑃 × 𝑋
Elastic Demand
▪ If demand is elastic, then price elast.
of demand > 1
o % change in Q > % change in
P
▪ The fall in revenue from lower Q is
greater than the increase in revenue
from higher P, so revenue falls.

▪ If demand is inelastic, then price

Perfectly Elastic Demand
elast of demand < 1
o % change in Q < % change in
P
▪ The fall in revenue from lower Q is
smaller than the increase in revenue
from higher P, so revenue rises.

▪ In our example, suppose that Q only

falls to 10 (instead of 8) when you
raise your price to $250.
Price Elasticity and Total Revenue

Continuing our scenario, if you raise your

price from $200 to $250, would your
revenue rise or fall?

Revenue = P x Q

A price increase has two effects on

revenue:

▪ Higher P means more revenue on

Now, demand is inelastic:
each unit you sell.
Elasticity = 0.82
▪ But you sell fewer units (lower Q),
If P = $200,
due to Law of Demand.
Q = 12 and
Revenue = $2400
 Unit Elastic
If P = $250,
Q = 10 and
Revenue = $2500

When D is inelastic, a price increase

causes revenue to rise.

Price of Elasticity of Supply

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑸𝒔
Price Elasticity = Elastic
of Demand 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑷

Price Elasticity of Supply – measures

how much 𝑸𝒔 responds to a change in P.
It measures the sellers’ price sensitivity.

Example:

16%
Price Elasticity of Supply = 8%
= 2.0

Perfectly Inelastic (One Extreme)

Inelastic