Elasticity

Elasticity
..allows us to analyze supply and demand with greater precision. is a measure of how much buyers and sellers respond to changes in market conditions

Elasticity
Elasticity is a measure of responsiveness Many elasticities can be measured: - price elasticity of demand, - cross price elasticity of demand, - income elasticity of demand, and - elasticity of supply Elasticity is a measures of proportionate responsiveness and are unit free

Elasticity
General form: The elasticity of X with respect to Y is given by the % or proportionate change in X divided by the % or proportionate change in Y
EXY = % X / % Y or EXY= X/X / Y/Y or EXY=X/Y Y/X
4

The Elasticity Of Demand

Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

The Price Elasticity of Demand and Its Determinants

Availability of Close Substitutes Necessities versus Luxuries Definition of the Market Time Horizon

The Price Elasticity of Demand and Its Determinants

Demand tends to be more elastic :
the larger the number of close substitutes. if the good is a luxury. the more narrowly defined the market. the longer the time period.

Computing the Price Elasticity of Demand

The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

Percentage change in quantity demanded Price elasticity of demand = Percentage change in price
8

Computing the Price Elasticity of Demand

Elasticity of Demand with respect to the goods own price EDxPx= %Q/%P or EDxPx= Q/Q / P/P or EDxPx= Q/P P/Q For price elasticities of demand the sign is ignored as they are all negative Elastic demand > 1 Inelastic demand < 1 Unit elastic demand = 1
9

Computing the Price Elasticity of Demand

Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:

(10 8) 100 20% 10 2 (2.20 2.00) 10% 100 2.00

10

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.

(Q2 Q1) /[(Q2 Q1) / 2] Price elasticity of demand = (P2 P1) /[(P2 P1) / 2]
11

The Midpoint Method:

Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

(10 8) 22% (10 8) / 2 2.32 (2.20 2.00) 9.5% (2.00 2.20) / 2

12

The Variety of Demand Curves

Inelastic Demand
Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one.

Elastic Demand
Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one.
13

The Variety of Demand Curves

Perfectly Inelastic
Quantity demanded does not respond to price changes.

Perfectly Elastic
Quantity demanded changes infinitely with any change in price.

Unit Elastic
Quantity demanded changes by the same percentage as the price.
14

Inelastic and Elastic Demand

Elasticity = 0
D

Elasticity =

D P

Q
P

Elasticity = 1

Q
15

Inelastic and Elastic Demand

Demand

Demand

Inelastic Demand: Elasticity Is Less Than 1

Elastic Demand: Elasticity Is Greater Than 1

16

Price Elasticity Along a Straight Line Demand Curve

P 200 100 Slope = 2/3 Inverse of slope = 1.5 EDxPx = 1 EDxPx < 1 150 EDxPx > 1 Elastic Demand EDxPx = 1 Unit Elastic Demand EDxPx < 1 Inelastic Demand 300

EDxPx > 1

17

Price Elasticity of Demand and Total Revenue

If the price elasticity of demand is > 1, then a reduction in price will increase demand more than proportionately and TR (P x Q) will increase. If the price elasticity of demand = 1, then a reduction in price will increase demand in proportion and TR will be unchanged If the price elasticity of demand is < 1, then a reduction of price will increase demand less than proportionately and TR will fall.
18

Income elasticity of demand

Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

Percentage change in quantity demanded Income elasticity of demand = Percentage change in income
19

Income Elasticity of Demand

The elasticity of demand for good X with respect to income (I) EDxI= %QX/%I or EDxI= QX/QX / I/I or EDxI= QX/I I/QX EDxI > 1 normal and income elastic EDxI < 1 > 0 normal and income inelastic EDxI <0 inferior good
20

Income Elasticity of Demand

Types of Goods Normal Goods & Inferior Goods Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

Goods consumers regard as necessities tend to be income inelastic

Examples include food, fuel, clothing, utilities, and medical services. Examples include sports cars, furs, and expensive foods.

Goods consumers regard as luxuries tend to be income elastic.

21

Price elasticity of supply

Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price.
22

Price Elasticity of Supply

The elasticity of the supply of good X with respect to its own price ESxPx= %QS/%P or ESxPx= QS/QS / P/P or ESxPx= QS/P P/QS Elasticities of supply can range from zero to infinity. Depends on technology, resource substitution, and time frame All straight line supply curves through the origin will have elasticities of supply = 1
23

The Variety of Elasticity of Supply

P S
P S

Q
Elastic Supply Inelastic Supply

24

The Variety of Elasticity of Supply

P
S

S
S

S :Unit Elastic S : Perfectly Elastic S: Perfectly Inelastic

25

Determinants of Elasticity of Supply

Ability of sellers to change the amount of the good they produce.
Beach-front land is inelastic. Books, cars, or manufactured goods are elastic.

Time period.
Supply is more elastic in the long run.

26

Computing the Price Elasticity of Supply

The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.
Percentage change in quantity supplied Price elasticity of supply = Percentage change in price

27

Cross Price Elasticity of Demand

The elasticity of the demand for good X with respect to the price of another good Y EDxPy= %QX/%PY or EDxPy= QX/QX / PY/PY or EDxPy= QX/PY PY/QX The sign matters, positive cross price elasticities indicate substitutes, negative cross price elasticities indicate complements
28