Economics: Elasticity

Unit Elastic

% chg. in price equals % chg. in quantity

Elastic

% chg. in quantity is greater than a % chg. in price

inelastic

% chg. in quantity is less than a % chg. in price

Income Elasticity of Demand

(% Change in Quantity Demanded)/(% Change in Income) *Impact of income changes on demand Size of shift in the demand curve when income changes

What makes demand elastic or inelastic?

-if luxury, demand is elastic -if can substitue cheaper good easily, demand is elastic (if price increases, will you change brands of soap-yes) -if necessity, demand is inelastic -if cant substitute a cheaper good easily, demand is inelastic (if price incrases, will you change apartment?-no)

Why Economists Use Elasticity

Elasticity is a unit-free measure Elasticities allow economists to quantify the differences among markets without standardizing units of measurement By comparing markets using elasticities, it does not matter how the price or the quantity in the markets are measured Understanding market responsiveness to price changes is important in economic analysis, as well as sales strategy

Cross Elasticity of Demand

Impact of price change of substitutes or complements Size of shift in demand curve when price of a related good changes

Factors Influencing Demand

Low Price Goods - changes in price will not result in a change in consumption Income Levels - the higher one's income level, the less sensitive one is to price Substitute Goods - if there are close substitutes for a product (Coke vs. Pepsi) a change in price will affect demand Basic Goods - items or services essential to an individual's well-being or a firm's activity, e.g. bread and phones Linked Goods - items used in conjunction, e.g. cars and gas Time to adjust - short term vs. long term

Elasticity

Market response to changes in price Price drives consumer demand and producer supply The demand relationship between price and quantity is inverse, i.e. quantity moves in the opposite direction of price For supply the relationship is direct, i.e. quantity moves in the same direction as price

Example - Luxury vs. Necessity

Mocha latte at Starbucks is a luxury An appendectomy is not

ex of cross elasticity of demand: What happens to peanut butter sales when price of jelly rises?

PB & jelly are complements

Find elasticity: Mocha Latte at Starbucks Price rises from $3 to $5 per cup Qd falls from 15 to 10 cups per hour

Percect change price=(5-3)/3=66.6% Percent change quantity demand:(10-15)/15=-33.3% Elasticity=Pct Δ quantity demanded/Pct Δ price=-33.3%/66.6%=.5 (below 1 so relationship is INELASTIC)

Total Revenue (TR) =

Pr x QD

When pr increases, Qd__ and Qs___

Qd decreases Qs increases HOLDING OTHER FACTORS CONSTANT

when pr decreases, Qd___ and Qs___

Qd increases Qs decreases HOLDING OTHER FACTORS CONSTANT

Qs

Quantity Supplied

Qd

Quantity demanded

Q

Quantity demanded at that price

IF DEMAND IS ELASTIC, WHAT HAPPENS TO TR?

TR falls as price rises

IF DEMAND IS INELASTIC, WHAT HAPPENS TO TR?

TR rises as price falls

Demand

The desire to pay for a good or service and the ability to pay for that good or service. ___ is not desire alone. We have many market desires, but if we can't pay for them firms will not categorize them as ____.

Elasticity

= % Change in Quantity / % Change in Price

Pr

= Price

Compute elasticity: If the price rises by 1%, quantity demanded might fall by 5% or the quantity supplied might increase by 5%

formula:Q/P=.05/.01=5 The price elasticity of demand is [5] in this example Elasticity values always are stated as absolute values

Initial Pr = $3, Qd = 15. New Pr = $5, Qd = 5 FIND TR AND IF ELASTIC

initial TR = $3 x 15 = $45 new TR = $5 x 5 = $25 Demand for latte is elastic TR falls as Pr rises

perfectly inelastic

quantity is not affected by a change in price)

What happens to Qd of margarine, when price of butter rises?

Butter and margarine are substitutes

ΔQ

Change in quantity demanded

ΔP

Change in the current price

P

Current price of a good