Chapter 4 - Elasticity

Short Run

(1) In microeconomics, a period of time in which producers are able to change the quantities of some but not all of the resources they employ; a period in which some resources (usually plant) are fixed and some are variable. (2) In macroeconomics, a period in which nominal wages and other input prices do not change in response to a change in the price level.

Long Run

(1) In microeconomics, a period of time long enough to enable producers of a product to change the quantities of all the resources they employ; period in which all resources and costs are variable and no resources or costs are fixed. (2) In macroeconomics, a period sufficiently long for nominal wages and other input prices to change in response to a change in the nation's price level.

Determinants of Elasticity of Supply

-ability of sellers to change the amount of the good they produce -time period - Excess Capacity (if a business has excess production capacity (such as equipment not in use, a shift not scheduled, or extra raw materials on hand), the business is most likely able to increase its production without increasing its costs, which allows it to react to a change in price and demand) - Factor Substitution (the ability of a firm to interchange production resources - labor, land, and capital - affects its elasticity to react to price and demand changes) - Length of Production Process (the longer it takes for a firm to produce its products or to ramp up for increased production, the less elastic it is in meeting changes in demand and price)

Market Period

A period in which producers of a product are unable to change the quantity produced in response to a change in its price and in which there is a perfectly inelastic supply.

Total Revenue Test

A test to determine elasticity of demand between any two prices: Demand is elastic if total revenue moves in the opposite direction from price; it is inelastic when it moves in the same direction as price; and it is of unitary elasticity when it does not change when price changes.

Unit Elasticity

Demand or supply for which the elasticity coefficient is equal to 1; means that the percentage change in the quantity demanded or supplied is equal to the percentage change in price.

Elasticity of Demand using mid point formula

Ed = ((q2-q1)/((q2+q1)/2) / ((p2-p1)/((p2+p1)/2)

LO4.5 Explain income elasticity of demand and cross-elasticity of demand and how they can be applied.

Income elasticity of demand indicates the responsiveness of consumer purchases to a change in income. The coefficient of income elasticity of demand is found by the formula Ei=(% change in quantity demanded)/(% change in income) The coefficient is positive for normal goods and negative for inferior goods. Cross-elasticity of demand indicates the responsiveness of consumer purchases of one product (X) to a change in the price of some other product (Y). The coefficient of cross-elasticity is found by the formula Exy=(% change in quantity demanded of product X)/(% change in price of product Y) The coefficient is positive if X and Y are substitute goods, and negative if X and Y are complements.

Determinants of Elasticity of Demand

substitutability - more substitutes demand is more elastic proportion of income - Higher proportion of income demand is more elastic luxuries vs necessities - Luxury goods demand more elastic time- more time available, demand is more elastic

LO4.4 Apply price elasticity of demand and supply to real-world situations.

Price elasticity of demand and supply have numerous private and public sector applications. For example, they inform pricing and output decisions by firms, and government policies regarding the legalization and taxation of goods.

LO4.1 Discuss price elasticity of demand and how it can be measured.

Price elasticity of demand measures the responsiveness of the quantity of a product demanded when the price changes. If consumers are relatively sensitive to price changes, demand is elastic. If they are relatively unresponsive to price changes, demand is inelastic. The price-elasticity coefficient Ed measures the degree of elasticity or inelasticity of demand. The coefficient is found by the formula Ed =(% Change in Q demanded of x)/(% change in P of x) Economists use the averages of prices and quantities under consideration as reference points in determining percentage changes in price and quantity. If Ed is greater than 1, demand is elastic. If Ed is less than 1, demand is inelastic. Unit elasticity is the special case in which Ed equals 1. Perfectly inelastic demand is graphed as a line parallel to the vertical axis; perfectly elastic demand is shown by a line above and parallel to the horizontal axis. Elasticity varies at different price ranges on a demand curve, tending to be elastic in the upper-left segment and inelastic in the lower-right segment. Elasticity cannot be judged by the steepness or flatness of a demand curve. The number of available substitutes, the size of an item's price relative to one's budget, whether the product is a luxury or a necessity, and the length of time to adjust are all determinants of elasticity of demand.

Inelastic Demand

Product or resource demand for which the price elasticity of demand is less than 1. This means the resulting percentage change in quantity demanded is less than the percentage change in price.

perfectly inelastic demand

Product or resource demand in which price can be of any amount at a particular quantity of the product or resource demanded; quantity demanded does not respond to a change in price; graphs as a vertical demand curve.

perfectly elastic demand

Product or resource demand in which quantity demanded can be of any amount at a particular product price; graphs as a horizontal demand curve.

Elastic Demand

Product or resource demand whose price elasticity is greater than 1. This means the resulting change in quantity demanded is greater than the percentage change in price.

LO4.3 Describe price elasticity of supply and how it can be measured.

The elasticity concept also applies to supply. The coefficient of price elasticity of supply is found by the formula Es=(% change in quantity supplied of X)/(% change in price of X) The averages of the prices and quantities under consideration are used as reference points for computing percentage changes. Elasticity of supply depends on the ease of shifting resources between alternative uses, which varies directly with the time producers have to adjust to a price change.

Price Elasticity of Demand

The ratio of the percentage change in quantity demanded of a product or resource to the percentage change in its price; a measure of the responsiveness of buyers to a change in the price of a product or resource.

cross elasticity of demand

The ratio of the percentage change in quantity demanded of one good to the percentage change in the price of some other good. A positive coefficient indicates the two products are substitute goods; a negative coefficient indicates they are complementary goods.

price elasticity of supply

The ratio of the percentage change in quantity supplied of a product or resource to the percentage change in its price; a measure of the responsiveness of producers to a change in the price of a product or resource.

Income elasticity of Demand

The ratio of the percentage change in the quantity demanded of a good to a percentage change in consumer income; measures the responsiveness of consumer purchases to income changes.

Total Revenue (TR)

The total number of dollars received by a firm (or firms) from the sale of a product; equal to the total expenditures for the product produced by the firm (or firms); equal to the quantity sold (demanded) multiplied by the price at which it is sold.

LO4.2 Explain how price elasticity of demand affects total revenue.

Total revenue (TR) is the total number of dollars received by a firm from the sale of a product in a particular period. It is found by multiplying price times quantity. Graphically, TR is shown as the P × Q rectangle under a point on a demand curve. If total revenue changes in the opposite direction from price, demand is elastic. If price and total revenue change in the same direction, demand is inelastic. Where demand is of unit elasticity, a change in price leaves total revenue unchanged.