[Econ 201] Chapter 5

Price elasticity of demand

% change in quantity demanded/% change in price

Price elasticity of supply

% change in quantity supplied / % change in price

The price of a good rises from $8 to $12, and the quantity demanded falls from 110 to 90 units. Calculated with the midpoint method, the elasticity is

1/2

Graphs and elasticity

At points with a low price and high quantity, the demand curve is inelastic. At points with a high price and low quantity, the demand curve is elastic

The price of coffee rose sharply last month, while the quantity sold remained the same

Demand increased, but supply was perfectly inelastic. Demand increased, but supply decreased at the same time. Supply decreased, but demand was perfectly inelastic.

Revenue and elasticity

Elastic: increase in price causes a decrease in total revenue. The reduction in the quantity demanded is so great that it more offsets the increase in the price. Price and total revenue move in opposite directions Inelastic: price and total revenue move in the same direction. If price increases, total revenue will increase Unit elastic: total revenue remains constant when the price changes

Graphs and elasticity

Flatter the demand curve, the greater the price elasticity of demand. The steeper the demand curve, the smaller the price elasticity of demand

Determinants of Elasticity of Supply: Availability of infrastructure facilities

If infrastructure facilities are available for expanding output of a particular good in response to the rise in prices, the elasticity of supply will be relatively more elastic

Determinants of Elasticity of Supply: Ease of acquiring and utilizing inputs, factor mobility

If the factors of production can be easily moved from one use to another, it will affect elasticity of supply. The higher the mobility of factors, the greater is the elasticity of supply of the good and vice versa

Determinants of Elasticity of Supply: Time required to produce the good or service

If the price of the commodity rises and producers have enough time to make adjustment in the level of output, the elasticity of supply will be more elastic. If the time period is short and the supply cannot be expanded after the price increase, the supply is relatively inelastic

Midpoint Method

[(Q2-Q1) / [(Q2+Q1)/2]] / (P2-P1) / [[P2+P1)/2]] computes percentage change by dividing the change by the midpoint (or average) of the initial and final levels

A life-saving medicine without any close substitutes will tend to have

a small elasticity of demand

total revenue

amount paid by buyers and received by sellers of a good PXQ= Price of good times the quantity of the good sold

price discrimination

charging different people different prices for the same good or service based on differing elasticity of demand for different groups of consumers

perfectly elastic

demand curve is horizontal

perfectly inelastic

demand curve is vertical

Time Horizon

goods tend to have more elastic demand over longer time horizons. eg. price of gasoline rises, quantity of gasoline demanded falls only slightly but significantly over time

Availability of close substitutes

goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others

elastic

if quantity demanded responds substantially to changes in the price

A linear, downward-sloping demand curve is

inelastic at some points, and elastic at others.

Inelastic, elastic, and unit elasticity

inelastic— less than 1 elastic— greater than 1 unit elasticity— if elasticity is 1, the % changes in quantity equals the percentage change in price

Elasticity

measure of how much buyers and sellers respond to changes in market conditions or measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants

price elasticity of demand

measures how much the quantity demanded responds to a change in price (% change in quantity) / (% change in price)

Price elasticity of supply

measures how much the quantity supplied responds to changes in price. Supply of a good is said to be elastic if the quantity supplied responds substantially to changes in the price. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price

Income elasticity of demand

measures how the quantity demanded changes as consumer income changes. It is calculated as the percentage change in quantity demanded divided by the percentage change in income Inferior goods have small income elasticities because consumers still buy them even when income is low Yd>0 , but Luxuries have large income elasticities because consumers feel that they can do without these goods altogether if their incomes are too low. Yd>1 Normal goods or necessity goods are O>Yd>1 so income is inelastic

cross-price elasticity of demand

measures how the quantity demanded of one good responds to a change in the price of another good. it is calculated as the percentage change in quantity demands of good 1 divided by the percentage change in the price of good 2 With substitutes, like hamburgers and hotdogs, CPE is positive but negative with complement goods

Necessities vs. Luxuries

necessities tend to have inelastic demands, where as luxuries have elastic demands

Multi-tiered pricing system

producers charge different groups of consumers different prices

inelastic

quantity demanded responds only slightly to changes of price

If Es>1

supply is elastic

If Es<1

supply is inelastic

Es=1

supply is unitary elastic

An increase in the supply of a good will decrease the total revenue producers receive if

the demand curve is inelastic.

Definition of the market

the elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly define goods.

Determinants of Elasticity of Supply: Ability to store output

the goods which can be safely stored have relatively elastic supply over the goods which are perishable and do not have storage facilities

The flatter the slope,

the more elastic the demand

The ability of firms to enter and exit a market over time means that, in the long run

the supply curve is more elastic.