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© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Price System
• Price Rationing
• Resource Allocation
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Price Rationing
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Price Rationing
• A decrease in supply
creates a shortage at
P0. Quantity demanded
is greater than quantity
supplied. Price will
begin to rise.
• The lower total supply
is rationed to those
who are willing and
able to pay the higher
price.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Price Rationing
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Alternative Rationing Mechanisms
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Alternative Rationing Mechanisms
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Alternative Rationing Mechanisms
• In 1974, the
government used an
alternative rationing
system to distribute the
available supply of
gasoline.
• At an imposed price of
57 cents per gallon, the
result was excess
demand.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Alternative Rationing Mechanisms
• A black market is a
market in which illegal
trading takes place at
market-determined
prices.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Alternative Rationing Mechanisms
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Prices and the Allocation of Resources
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Supply and Demand Analysis:
An Oil Import Fee
% ∆A
e l a s t oi c f i tA y r we s i p ot he =Bc t t
% ∆B
• Price elasticity of demand measures how
responsive consumers are to changes in the
price of a product.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Price Elasticity of Demand
Type of Substitutes
Elasticity Available
Elastic Many
Inelastic Few
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Shape of Demand According to Elasticity
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Extreme Elasticities
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Hypothetical Demand Elasticities
for Four Products
% CHANGE IN
% CHANGE QUANTITY
IN PRICE DEMANDED ELASTICITY
PRODUCT (% ∆P) (% ∆Qd) (% ∆Qd/% ∆P)
Insulin 10% 0% 0 Perfectly inelastic
Basic telephone service 10% -1% -0.1 Inelastic
Beef 10% -10% -1 Unitary elastic
Bananas 10% -30% -3 Elastic
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Calculating Percentage Changes
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Computing the Value of Elasticity
Q2 − Q1
x1 0 0 %
% ∆Qd (Q 1 + Q 2 ) / 2
=
% ∆P P2 − P1
x 1 0 0 %
( P1 + P2 ) / 2
1 −0 5 5
x1 0 0 % x 1 0 0 6% 6 . 7 %
% ∆Qd ( 5 + 1 ) 0/ 2
= = 7 .5 = = − 1 .6 7
% ∆P 2 − 3 - 1 - 4 0 . 0 %
x 1 0 0 %x 1 0 0 %
(3 + 2 ) / 2 2 . 5
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Interpreting the Value of Elasticity
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Elasticity Changes along a Straight-Line
Demand Curve
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Elasticity Changes along a Straight-
Line Demand Curve
• Along the elastic range,
− 6.4
elasticity values are
greater than one.
• Along the inelastic range,
− .29 elasticity values are less
than one.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Elasticity and Total Revenue
Elastic Greater than 1.0 Larger percentage change in Total revenue Total revenue increases
quantity decreases
Inelastic Less than 1.0 Smaller percentage change Total revenue Total revenue decreases
in quantity increases
Unitary Equal to 1.0 Same percentage change in Total revenue does Total revenue does not
elastic quantity and price not change change
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Determinants of Demand Elasticity
• Availability of substitutes --
demand is more elastic when there
are more substitutes for the product.
• Importance of the item in the
budget -- demand is more elastic
when the item is a more significant
portion of the consumer’s budget.
• Time frame -- demand becomes
more elastic over time.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Other Important Elasticities
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Other Important Elasticities
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Other Important Elasticities
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Other Important Elasticities
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair