Elasticity

Elasticity measures
What Why

are they?

Responsiveness measures

introduce them?

Demand and supply responsiveness clearly matters for lots of market analyses.
Why

not just look at slope?

Want to compare across markets slope can be misleading want a unit free measure

Why Economists Use Elasticity

An

elasticity is a unit-free measure. By comparing markets using elasticities it does not matter how we measure the price or the quantity in the two markets. Elasticities allow economists to quantify the differences among markets without standardizing the units of measurement.
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What is an Elasticity?
Measurement

of the percentage change in one variable that results from a 1% change in another variable.

2 VIP Elasticities
Price

elasticity of demand: how sensitive is the quantity demanded to a change in the price of the good. Price elasticity of supply: how sensitive is the quantity supplied to a change in the price of the good. Often referred to as own price elasticities.
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Inelastic Economic Relations

When

an elasticity is small (between 0 and 1 in absolute value), we call the relation that it describes inelastic.
Inelastic demand means that the quantity demanded is not very sensitive to the price. These goods tend to be things that are more of a necessity to the consumer in his or her daily life.
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Inelastic demand is represented with a much more upright curve as quantity changes little with a large movement in price.
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Elastic Economic Relations

When

an elasticity is large (greater than 1 in absolute value), we call the relation that it describes elastic.
Elastic demand means that the quantity demanded is sensitive to the price. Usually these kinds of products are readily available in the market and a person may not necessarily need them in his or her daily life
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As we mentioned previously, the demand curve is a negative slope, and if there is a large decrease in the quantity demanded with a small increase in price, the demand curve looks flatter, or more horizontal. This flatter curve means that the good or service in question is elastic.
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Size of Price Elasticities

Unit elastic Inelastic
0 1 2 3 4 5

Elastic
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Unit

elastic: own price elasticity equal to 1

Inelastic: Elastic:

own price elasticity less than 1

own price elasticity greater than 1

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General Formula for own price elasticity of demand

P

= Current price of good X QD = Quantity demanded at that price DP = Small change in the current price DQD= Resulting change in quantity demanded

Percentage Change in Quantity Demanded Elasticity Percentage Change in Price

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Arc Formula for Own Price Elasticity of Demand

Note:

well take absolute value

Q 2 Q1 P 2 P1 elasticity (Q1 Q 2) / 2 ( P1 P 2) / 2

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Some Technical Definitions For Extreme Elasticity Values

Economists

use the terms perfectly elastic and perfectly inelastic to describe extreme values of price elasticities. Perfectly elastic means the quantity (demanded or supplied) is as price sensitive as possible. Perfectly inelastic means that the quantity (demanded or supplied) has no price sensitivity at all.
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Perfectly Elastic Demand

We say that demand is perfectly elastic when a 1% change in the price would result in an infinite change in quantity demanded.

Price

Perfectly Elastic Demand (elasticity = )

Quantity

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Perfectly Inelastic Demand

We say that demand is perfectly inelastic when a 1% change in the price would result in no change in quantity demanded.

Price

Perfectly Inelastic Demand (elasticity = 0)

Quantity

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Determinants of elasticity

What is a major determinant of the own price elasticity of demand? The availability of substitutes The type of good : necessity vs luxury The percentage of a consumers income allotted for spending on the good The time under consideration

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Other Price Elasticities: CrossPrice Elasticity of Demand

Elasticity of demand with respect to the price of a complementary good (cross-price elasticity) This elasticity is negative because as the price of a complementary good rises, the quantity demanded of the good itself falls. Example (from last week) software is complementary with computers. When the price of software rises the quantity demanded of computers falls. Cross-price elasticity quantifies this effect.

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Other Price Elasticities: Cross Price Elasticity of Demand

Elasticity of demand with respect to the price of a substitute good (also a cross-price elasticity) This elasticity is positive because as the price of a substitute good rises, the quantity demanded of the good itself rises. Example (from last week) hockey is substitute for basketball. When the price of hockey tickets rises the quantity demanded of basketball tickets rises. Cross-price elasticity quantifies this effect.

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Other Elasticities: Income Elasticity of Demand

The elasticity of demand with respect to a consumers income is called the income elasticity.
When the income elasticity of demand is positive (normal good), consumers increase their purchases of the good as their incomes rise (e.g. automobiles, clothing). When the income elasticity of demand is greater than 1 (luxury good), consumers increase their purchases of the good more than proportionate to the income increase (e.g. ski vacations). When the income elasticity of demand is negative (inferior good), consumers reduce their purchases of the good as their incomes rise (e.g. potatoes).

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Type of Goods
An inferior good is a good that decreases in demand when consumer income rise
Normal goods are those for which consumers' demand increases when their income increases This would be the opposite of a superior good, one that is often associated with wealth and the wealthy

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Supply Elasticities
The

price elasticity of supply is always positive. Economists refer to the price elasticity of supply by its actual value. Exactly the same type of point and arc formulas are used to compute and estimate supply elasticities as for demand elasticities.

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Perfectly Elastic Supply

We say that supply is perfectly elastic when a 1% change in the price would result in an infinite change in quantity supplied.

Price

Perfectly Elastic Supply (elasticity = )

Quantity

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Perfectly Inelastic Supply

We say that supply is perfectly inelastic when a 1% change in the price would result in no change in quantity supplied.

Price

Perfectly Inelastic Supply (elasticity = 0)

Quantity

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Determinants of elasticity

What is a major determinant of the own price elasticity of supply? 1. The feasibility and cost of storage 2. The ability of producers to respond to price changes. If the producers can easily increase or decrease output when price rise or fall, supply is elastic 3. Time. With the passage of time, especially for long periods, supply tends to be elastic. If there is a rise in prices, the producers may not be able to make adjustments quickly, but given sufficient time, they may be able to produce more.

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Slope of the Demand Curve

DP

is the change in price. (DP<0) DX is the change in quantity. slope = DP/ DX 1/slope = DX/ DP

Price

Demand

DP slope DX
DP DX

P P+ DP

X + DX

Quantity

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Slope Compared to Elasticity

The

slope measures the rate of change of one variable (P, say) in terms of another (X, say). The elasticity measures the percentage change of one variable (X, say) in terms of another (P, say).

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Exercises
Mangoes

sell at the price of P100.00 per kilo. An increase in the price by 10% causes the demand to decrease from 10 to 8 kilos. Compute and interpret the price demand elasticity.

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Exercises
Price Quantity Demanded
14 12 10 8 6 4 2 0

% change in Qd

% change in Price

Elasticity (Absolute value)

Type of Elasticity

0 1 2 3 4 5 6 7

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1. Determine the elasticity in the given situations and indicate whether the same is elastic, inelastic and unitary

Situation A B C D E F

Price (P) 929 489 365 239 86 39

Quantity (Qd) 71 91 112 145 178 316

1. Situation A & D 2. Situation A & C 3. Situation F & B

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