Elasticity Notes

Elasticity Primary - From earth Secondary - Manufactured Tertiary - Services Demand tends to be more elastic (determinants of price elasticity demand) o When theres greater availability of substitutes o The more narrowly defined the market o If the good is a luxury o The longer the time period o PED- Price Elasticity of Demand o What products or services can you think of that if the price changes a little, the quantity demanded will be large/small? PED = A measurement to find out by how much (responsiveness) the quantity demanded fell (increase) when the price was raised (decreased). o PED= % change in quantity demanded/% change in price o

o Specifically, the quantity of popcorn consumed will increase by 5.6 times as fast as price falls. o In other words, a 1% reduction in price brings about a 5.6 percent increase in purchases. o Elastic # is greater than 1 A lot of change Price sensitive Responsive to price changes o Inelastic # is less than 1 Very little change Not price sensitive Not very responsive to price changes o Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.

Because the quantity demanded of a good is relatively related to its price, the percentage change in quantity will always have the opposite sign as the percentage change in price. Because the PED measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.

Total Revenue Total revenue is the amount paid by buyers and received by sellers of a good. Computed as TR = P x Q With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, TR increases. With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, TR decreases.

Cross Elasticity of Demand (XED) XED is a measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement, ceteris paribus. (Of substitute good) If the price of turkey (substitute for chicken) increases, then the demand for chicken will increase. o Then the demand curve for chicken shifts to the right (increase in demand) then XED for chicken positive If pizza and coke are complements o When the price of coke (the complement of pizza) increases o The demand for pizza decreases o Demand for pizza shifts left, XED for pizza is negative

Income Elasticity of Demand (YED) YED can be positive or negative o Normal goods = positive value o If percent increase of quantity demanded is smaller than percent increase of income then the YED is income-inelastic (necessities) (less than 1) o If percent increase of quantity demanded is larger than percent increase of income then YED is income-elastic (luxuries) (greater than 1) o Inferior good = negative value YED is the measure of the responsiveness of the demand for a good or service to a change in income.

Price Elasticity of Supply = PES

A measure of the responsiveness of the quantity of a good supplied to changes in its price o o PES is a positive number as both price and quantity supplied change in the same direction Inelastic PES < 1 (if percentage change in quantity is smaller than percentage change in price) Perfectly Inelastic Supply: elasticity equals 0 (vertical line) Elastic PES > 1 (if percentage change in quantity is larger than percentage change in price) Perfectly Elastic Supply: elasticity equals infinity (horizontal line) Unit elastic PES = 1 (if percentage change in quantity is equal to the percentage change in price) o Determinants of PES Length of time Immediate time period so short that a firm is unable to increase/decrease any of its inputs in order to change quantity it produces; highly inelastic Short run can increase/decrease some but not all of its inputs; relatively inelastic Long run all inputs vary to respond to the price change; relatively elastic Spare capacity of firms Firms may have capacity to produce that is not being used e.g. factories or equipment may be idle for some hours each day Then relatively easy for a firm to respond with increased output to a price rise But must also be able to store stocks/inventories o PED & PES Review The price elasticity of demand and the price elasticity of supply for many primary commodities tend to be low. Explain what this statement means, and how this contributes to the problem of price instability for primary commodity producers. Supply is inelastic because its relatively hard for the companies to find the resources oil, fields are hard to find and they cost money to build the refineries. Demand is inelastic because oil is a necessity and the demand remains the same depending on the prices. Just because there is a greater demand, can producers respond to meet the greater demand with a greater supply? E.g. if demand for wheat goes up, supply remains the same as wheat

takes time to grow (demand is shifting right while supply is staying the same).