Study Unit 1 Elasticity Introduction Elasticity of Demand Elasticity and Total Expenditure Income Elasticity of Demand Cross Elasticity of Demand Elasticity of Supply
Elasticity of Demand Elasticity of Demand Responsiveness of the quantity demanded of that goods to changes in its own price. = = / / Strictly speaking, 0 For convenience, we usually drop the negative signand focus only on the absolute value. Elasticity of Demand Elastic: the percentage change in quantity demanded is greaterthan the percentage change in price, >1 Inelastic:the percentage change in quantity demanded is lessthan the percentage change in price, <1 Unit elastic: the percentage change in quantity demanded is equal to the percentage change in price, =1
Determinants of Elasticity of Demand The availability of close substitutes The more substitutes for a product, the greater the price elasticity of demand The passage of time Demand becomes more elastic as more time passes Luxuries versus necessities The demand curve for a luxury is more elastic than the demand curve for a necessity Share of the good or services in the consumer s budget The smaller the share of the good or service in the consumer s budget, the more inelastic the demand for that good or service will be Graphical Interpretation $20.00 = / / $8.00 A = 1 The price elasticity at point A is equal to (8/3) (1/4) = 2/3 Demand 3 5 Quantity
Graphical Interpretation a εx > 1 a/2 εx = 1 εx < 1 For a straight-line demand curve, demand is elastic on the top half, unit elastic at the midpoint, and inelastic on the bottom half. b/2 Demand b Quantity Perfectly Elastic and Perfectly Inelastic Demand Curves Perfectly elastic demand εx = Infinity Perfectly inelastic demand εx = 0 Quantity Quantity
Elasticity and Total Expenditure $30.00 $20.00 C=160 16 A D=320 E=80 B Total revenue before price falls = C+D = 480 Total revenue after price falls = D+E = 400 Demand ( inelastic) 20 Quantity When demand is inelastic, changes in price will result in changes in total expenditure in the same direction. When demand is elastic, change in price will result in changes in total expenditure in the opposite direction. When demand is unitelastic, changes in price will result in no change in total expenditure. Elasticity and Total Expenditure $30.00 $20.00 C=160 16 A D=320 E=240 Total revenue before price falls = C+D = 480 B Total revenue after price falls = D+E = 560 Demand ( elastic) 28 Quantity When demand is inelastic, changes in price will result in changes in total expenditure in the same direction. When demand is elastic, change in price will result in changes in total expenditure in the opposite direction. When demand is unitelastic, changes in price will result in no change in total expenditure.
Income Elasticity of Demand Income elasticity of demand Responsiveness of quantity demanded to changes in income = If the income elasticity of demand is Then the good is Example Positive, but less than 1 Normal and a necessity Milk Positive and greater than 1 Normal and a luxury Caviar Negative Inferior High-fat meat Cross Elasticity of Demand Cross price elasticity of demand Responsiveness of quantity demanded to changes in the prices of its related goods. = If the two goods are Then the cross price elasticity of demand is Example Substitutes Positive Two brands of printers Complements Negative Printers and toner cartridges Unrelated Zero Printers and peanut butter
Elasticity of Supply elasticity of supply Responsiveness of the quantity supplied to a change in price = Determinants of Elasticity of Supply Flexibility and mobility of inputs Production that requires less skillful labor is likely to be more elastic in terms of its supply. Availability of production capacity Supply becomes more elastic if sellers are able to increase production quickly even with only a small change in price because of excess capacity. Adjustment time Because it takes time for producers to switch from one activity to another and because it takes time to trained workers, buy new machines and build new factories, the price elasticity of supply will be higher in the long run than in the short run.
Summary elasticity of demand and its determinants Cross-price elasticity of demand and income elasticity of demand How changes in the price of a good affect total expenditure and total revenue depends on the price of elasticity of demand for the good elasticity of supply and its determinants Reflection Question Why is the demand for business travel less elastic than that for leisure travel?