Mircroecon Chapter 5: Elasticity

perfectly inelastic supply

% change in quantity supplied is zero for any % change in price The quantity supplied is unchanged for any change in price Vertical supply curve

Total Revenue and Price of elasticity demand

If demand is elastic, a higher price yields less revenue If demand is inelastic, a higher price yields more revenue

Supply elasticity factor two: Easily available variable inputs make supply elastic.

If the variable inputs you need to expand production are easily available, then your supply will be more elastic. This is because you'll be able to increase production swiftly in response to a price rise. It's also important to think about reallocating your existing resources, because that can give you greater flexibility to respond to changes in the prices of specific products.

Supply elasticity factor one: Inventories make supply more elastic.

If your business's product is easily stored, then you can use inventories to provide the flexibility to respond quickly to price changes. Inventories provide flexibility by breaking the link between production and supply.

Income elasticity of demand equation

Income elasticity of demand = % change in quantity demanded divide by % change in income

Inelastic

When buyers are not very responsive to price changes Demand is inelastic when the absolute value of the percent change in quantity is smaller than absolute value of the percent change in price, which means that the absolute value of the price elasticity is less than 1.

Elastic

When buyers are very responsive to price Demand is elastic when the absolute value of the percent change in quantity is larger than the absolute value of the percent change in price, which means that the absolute value of the price elasticity is greater than 1.

The cross-price elasticity is positive for substitutes

When goods are close substitutes, such as cars and public transportation, people tend to buy more of a good when the price of its substitute increases. The cross-price elasticity of substitutes is always positive

Perfectly elastic demand 1

When the demand curve is completely horizontal it means that the price elasticity of demand is infinite—any change in price leads to an infinite change in quantity.

Perfectly inelastic demand 1

When the demand curve is completely vertical it means that the price elasticity of demand is zero—no matter what the change in price, the total quantity demanded is unchanged.

Demand curves

Whenever two demand curves pass through the same point, the demand curve that's flatter at that point is the more elastic demand curve.

Price elasticity of supply is all about flexibility.

Your business's flexibility is the underlying determinant of your price elasticity of supply. It describes how easily and cheaply you can mobilize resources to expand production when prices rise, and how easily you can cut your expenses or repurpose your resources when the price falls. The more flexible you are, the greater your price elasticity of supply will be.

Inelastic demand curve

Relatively steep

price elasticity of demand equation

% change in quantity demanded / % change in price

Perfectly elastic supply

% change in quantity supplied is infinite for any % change in price The quantity supplied is infinitely responsive to a change in price Horizontal supply curve

Elastic supply

% change in quantity supplied is larger than % change in price The quantity supplied is relatively responsive to a change in price Relatively flat supply curve

Inelastic supply

% change in quantity supplied is smaller than % change in price The quantity supplied is relatively unresponsive to a change in price Relatively steep supply curve

Different demand elasticities measure the responsiveness of the quantity demanded to:

1. Price elasticity of demand: Price of this good 2. Cross-price elasticity of demand: Price of another good 3. Income elasticity of demand: Income

cross-price elasticity of demand 1

A measure of how responsive the demand of one good is to price changes of another. It measures the percent change in quantity demanded that follows from a 1% change in the price of another good. Cross-price elasticity of demand = % change in quantity demanded divide by % change in price of another good

Absolute value

Absolute value focuses on the magnitude of the price elasticity of demand.

Figure 6:

Demand for health expenditures, gas, and houses all increase with income, but their income elasticities are small. In contrast, demand for airplane tickets and new cars is highly sensitive to income, and both goods have a large income elasticity of demand.

Elasticity formula

Elasticity = Percent change in quantity / Percent change in some other factor

Elasticity

Elasticity is given by the percent change in quantity divided by the percent change in price. elasticity is all about substitutability

How does elasticity vary?

Elasticity varies according to who you are, what product you're considering, what the price is, and how quickly you need to respond.

price elasticity of demand

Measures how responsive buyers are to price changes. Specifically, it measures by what percent the quantity demanded will change in response to a 1% price change. The availability of substitutes determines the price elasticity of demand.

The formula for calculating the percent change in price is:

Percent change in price = (P2 - P1) / (P2 + P1)/2 x 100

The income elasticity of demand is positive for normal goods.

The income elasticity of demand for a normal good is positive, since the change in demand goes in the same direction as the change in income. Necessities tend to have a small income elasticity for many of the same reasons that their price elasticity of demand is inelastic.

Demand elasticity factor one: More competing products = greater elasticity

The more competing products there are, the more likely you are to find a close substitute. If the price of Quilted Northern Ultra Plush Double Roll Bath Tissue rises, you might buy Charmin Ultra Strong Mega Roll toilet paper instead.

Supply elasticity factor four: Easy entry and exit make supply more elastic.

The quantity supplied in the market is also a function of the number of suppliers. When the price rises, new businesses may enter the market, and when it falls some businesses may exit. Market supply will be more elastic when it is easier for businesses to enter or exit a market. The entry of new businesses leads to a rise in the total quantity supplied at a higher price.

cross-price elasticity of demand 2

The sign of the cross-price elasticity of demand tells you something important: When it's positive, it means that you buy more of a good when the price of another good goes up; when it's negative, it means that you buy less.

Total revenue 1

The total amount you receive from buyers, which is calculated as price × quantity.

Demand elasticity factor three: Necessities have less elastic demand.

Things that you really can't do without are things that you will keep buying even as the price rises. What makes something a necessity? A necessity is something where there isn't a good substitute available and doing without isn't a good option. Food is a necessity. What is the alternative to food? To go hungry. That's not a viable alternative, and it helps explain why demand is inelastic for food staples like eggs, rice, pasta, fruits, and vegetables.

The cross-price elasticity is near zero for independent goods.

Unrelated goods (like Pepsi and shoes)

Price elasticity of supply

measures how responsive sellers are to price changes. Specifically, it measures by what percent the quantity supplied will increase following a 1% price change. The larger this percent change in quantity supplied, the more responsive sellers are to price changes.

If cross-price elasticity of demand is very small

you know that two products are not close substitutes.

If you discover that demand for your product is elastic

you should lower your prices in order to increase your profits

If you discover that demand for your product is inelastic

you should raise your prices in order to increase your profits

The cross-price elasticity is negative for complements

your quantity demanded falls in response to a rise in the price of another good the cross-price elasticity between complementary goods is negative.

Perfectly elastic demand 2

|% change in quantity| is infinite for any |% change in price| horizontal demand curve

Elastic demand

|% change in quantity| is larger than |% change in price| relatively flat demand curve

Inelastic demand

|% change in quantity| is smaller than |% change in price| relatively steep demand curve When demand is inelastic, a decrease in price actually increases revenue.

Perfectly inelastic demand 2

|% change in quantity| is zero for any |% change in price| vertical demand curve

Supply elasticity factor three: Extra capacity makes supply elastic.

Fixed inputs provide a constraint on a business's ability to expand production. That means that if a business is already using its fixed input at full capacity, it will be difficult to respond even if a business can easily access more of its variable inputs. If, on the other hand, it has extra capacity, then its supply will be more elastic.

Income elasticity of demand

Measures how responsive your demand for a good is to changes in your income. Specifically, it measures by what percent the quantity demanded will change following a 1% change in income.

Step one: What was the percent change in the price?

Percent change in price = 140 - 100 / (140 + 100)/2 x 100 = 42 / 120 x 100 = 33%

Elastic demand curve

relatively flat

Demand elasticity factor two: Specific brands tend to have more elastic demand than categories of goods.

Because specific brands tend to have more close substitutes, demand for these goods is typically more elastic than demand for broad categories of goods. For example, there are many close substitutes for Honey Nut Cheerios, and so when the price goes up many people will substitute to a different breakfast cereal (or other breakfast item). As a result, demand for Honey Nut Cheerios is quite elastic.

The income elasticity of demand is negative for inferior goods.

Because the quantity of inferior goods you consume moves in the opposite direction of your income, their income elasticity of demand is negative.

Let's calculate the change in Uber drivers supplying rides when the price rises using the midpoint formula. Usually an Uber driver can expect to earn $100 driving a 6-hour shift. But surge pricing on particularly busy nights mean that Uber drivers can expect to earn $140 driving a 6-hour shift. Typically, there are 200 drivers on the road, but surge pricing leads that to rise to 300 drivers.

Calculate the price elasticity of supply of Uber drivers using the midpoint formula.

Demand elasticity factor five: Demand gets more elastic over time.

On any given day, many of your decisions about what to purchase are difficult to change. This happens because as time passes, you will tend to have more options to choose from, which is another way of saying that more substitutes become available. More substitutes mean more elastic demand, so over time, demand tends to become more elastic.

Step two: How much did the quantity supplied change as a percent, in response?

Percent change in quantity = 300 - 200 / (300 + 200)/2 x 100 = 100 / 250 x 100 = 40%

As a manager, you will want to use the price elasticity of demand for your product to forecast the likely consequences of any change in price.

Percent change in quantity demanded = Price elasticity of demand x Percent change in price The price elasticity of demand tells you whether the percent change in price is larger than the percent change in quantity (when demand is inelastic) or smaller than the percent change in quantity (when demand is elastic).

The formula for calculating the percent change in quantity is:

Percent change in quantity supplied = (Q2 - Q1) / (Q2 + Q1)/2 x 100

Price elasticity of supply equation

Price elasticity of supply = % change in the quantity supplied divided by % change in price

Following the end of an Ariana Grande concert in New York City, demand for rides rose. In response, Uber increased prices by 80%. This price increase led to a 100% increase in Uber drivers supplying rides. Use the percent change in the price and the percent change in the quantity supplied to calculate the price elasticity of supply for Uber rides:

Price elasticity of supply = +100% / +80% = 1.25

Step three: Calculate the elasticity:

Price elasticity of supply = Percent change in quantity / percent change in price = +40% / +33% = 1.2

When demand is elastic

Price increases also lead to large changes in the quantity demanded quantity demanded is relatively responsive

When demand is inelastic

Quantity demanded is relatively unresponsive

Is pizza elastic or inelastic?

Tends to be elastic, where even slightly higher prices may cause a change in demand

Example: When Uber cut the price of a ride in New York City by 15%, it found that the quantity of rides demanded rose by 30%. What is the absolute value of the price elasticity of demand for Uber rides?

Absolute value of the price elasticity of demand: |+30% / -15%| = |-2| = 2

Price elasticity of supply is positive.

Changes in price lead to changes in quantity supplied in the same direction as you move along a supply curve Raising the price increases the quantity supplied, while lowering the price reduces the quantity supplied.

Perfectly elastic and inelastic supply represent the extremes.

For any two supply curves passing through the same point, the supply curve that is relatively flatter at that point will have more elastic supply at that point than the supply curve that is relatively steeper.

Is insulin elastic or inelastic?

Highly inelastic because the demand is so great that price increases have very little effect on the quantity demanded

Supply elasticity factor five: Over time, supply becomes more elastic.

Supply adjustments often take time, and so the quantity supplied will adjust by a lot more over a period of several years than it will over several days. As a result, the price elasticity of supply is typically larger when you're looking over a longer time period

Demand elasticity factor four: Consumer search makes demand more elastic.

When consumers are willing to search a lot for a low-cost alternative for something, demand for that product is more elastic. Why? Because the more you search for a good deal, the more likely you are to find an acceptable, lower-priced substitute. If stores raise their price, customers actively searching are more likely to find a good alternative. Therefore, those who are most willing to search will be more responsive to price changes.

Quantity is relatively unresponsive when supply is inelastic.

When suppliers can't increase the quantity supplied by much in response to higher prices, economists describe their supply as inelastic. Just as with the price elasticity of demand, we say that supply is inelastic whenever the magnitude of the percent change in quantity supplied is smaller than the percent change in price. This means that supply is inelastic if the price elasticity of supply is smaller than 1.

Quantity is relatively responsive when supply is elastic.

When suppliers like Marcus are very responsive to price, economists describe their supply as elastic. Just as with the absolute value of the price elasticity of demand, we say that supply is elastic whenever the magnitude of the percent change in quantity supplied is larger than the percent change in price. This means that supply is elastic if the price elasticity of supply is larger than 1.

Unit elastic

When the absolute value of the price elasticity of demand is exactly equal to 1 it is neither elastic nor inelastic. Divides the line between elastic and inelastic