Chapter 4: Price Elasticity

Price elasticity of demand/supply

% change in quantity demanded/supplied from a 1% change in price - measures responsiveness of quantity demanded/supplied to changes in price

Price Elasticity Pattern

- high P and low Q, large P/Q -> demand is elastic - at midpoint, demand is unit elastic - low P and high Q, small P/Q -> demand inelastic

Elasticity Demand

- price elasticity > 1 -> demand is elastic - % change in quantity > % change in price - demand responsive to price - price elasticity < 1 -> demand is inelastic - % change in quantity < % change in price - quantity demanded not responsive to price - price elasticity = 1 -> demand is unit elastic - price and quantity change by same %

2 Special Cases of Price Elasticity of Demand

1. Perfectly elastic demand - infinite price elasticity of demand - horizontal straight line - if price change, consumers will desert product and go for substitute 2. Perfectly inelastic demand - 0 price elasticity of demand - vertical straight line - change in price has no effect on quantity demanded as consumers cannot switch products (eg, goods necessary for survival)

2 Special Cases of Price Elasticity of Supply

1. Perfectly elastic supply - infinite price elasticity of supply - horizontal straight line - additional unit of goods can be produced using same combinations of input 2. Perfectly inelastic supply - 0 price elasticity of demand - vertical straight line - same amount available in the market no matter the price (supply is fixed)

Determinants of Price Elasticity of Supply

1. input flexibility: inputs for good A can be used for good B -> supply of good A more elastic 2. mobility of inputs: resources move where needed -> more elastic 3. product substitute inputs: alternative inputs easy to find -> more elastic 4. time: long run -> more elastic

Determinants of Price Elasticity of Demands

1. substitution options: more substitute options -> more elastic demand (eg. white & brown sugar) 2. share of budget: larger size of good in consumer budget -> more elastic demand 3. time period of consumer adjustment: more time to adjust to price change -> more elastic demand

Price Elasticity Graphical View Formula

P/Q x change in quantity/change in price OR P/Q x 1/slope

Relationship of Demand & Supply to Price Elasticity

demand: price increase, elasticity increase supply: price increase, elasticity decrease

Calculating Price Elasticity

ε = % change in quantity demanded or supplied / % change in price - price elasticity of demand always negative (but ignore sign)