Chapter 5: Elasticities of demand and supply

time elapsed since price changes...

as time passes after price change, it becomes easier to change production plans an supply becomes more elastic

demand for a good is elastic if....

substitutes are easy to find ex) soft drinks made in aluminum or plastic (does not matter which) so demand for aluminum is elastic

demand for a good is inelastic if...

substitutes are hard to find ex) oil has poor substitutes, so demand for oil inelastic

determining price elasticity of demand...

we compare the % change in the quantity demanded with the % change in price

in order to compare % change in price and % change in quantity demanded, we use absolute values or magnitude of the %change and....

we ignore minus signs

unit elastic demand:

when % change in the quantity demanded equals the % change in price

elastic demand:

when the % change in the quantity demanded exceeds the % change in price

inelastic demand:

when the % change in the quantity demanded is less than the % change in price

perfectly inelastic demand (an extreme case of an inelastic demand):

when the % change in the quantity demanded is zero for any change in the price

elastic supply:

when the % change in the quantity supplied exceeds the % change in price

inelastic:

when the % change in the quantity supplied is less than the % change in price

perfectly inelastic supply:

when the % change in the quantity supplied is zero for any % change in the price

unit elastic for supply:

when the % change in the quantity supplies equals the % change in price

perfectly elastic demand (extreme case of an elastic demand): when the quantity demanded changes by a very large percentage in response to an almost zero % change in price

when the quantity demanded changes by a very large percentage in response to an almost zero % change in price -consumers are willing to buy any quantity of the good at a given price but none at a higher price

perfectly elastic supply:

when the quantity supplied changes by a very large % in response to an almost zero % change in price

% change in quantity demanded using "midpoint method"

***

Determine numerical c=value for price elasticity of demand to figure if demand for a good is elastic, unit elastic, inelastic using....

***

calculating % change in price using "midpoint method..."

-> we divide the change in price by the average of the new and initial price (which is new+initial all divide by 2), then multiply all by 100 => average price at midpoint between initial and new price hence name midpoint method ***

three groups our calculations would fall into...

-all depend on the elasticity of demand 1. elastic 2. unit elastic 3. inelastic

goods that have perfectly inelastic supply...

-can be produced in only a fixed quantity ex) beachfront home in Malibu can be built only on a unique beach front lot

B/c elasticity compares the % change in quantity demand with the % change in price, we need a measure of percentage change that does not depend on the direction of the price change...

-economists use measure called "midpoint method"

Storage possibilities:

-elasticity of supply that cannot be stored depends only on production possibilities ex) perishable items like fresh strawberries -but of one that can be stored depend on decision to keep good stored or offered for sale ===small price changes make difference, so elastic ex) holding Roses for Valentines Day in late Jan, early Feb

change in price calculated is...

new price- initial price

To determine the responsiveness of anything demanded to its price, we need to compare the two % changes we calculate...

-if we collected data in the prices and quantities of a # of goods and services (and we were careful that the other things, had remained the same), we could calculate lots of % changes

Influences on the price elasticity of demand: (What makes the demand for some things elastic and the demand for others inelastic?)

-influence on price elasticity of demand are... 1. availability of substitutes 2. proportion of income spent

B/c the average price is the same regardless of whether prices rise or fall...

-the % change in price calculated by the "midpoint method" is the same (absolute value or magnitude) for a price rise and a price fall

Note.....

-when the price of a good rises, the quantity demanded of it decreases; a positive change in price brings a negative change in the quantity demanded -similarly, when the price of a good falls, the quantity demanded of it increases, this time a negative change in price brings a positive change in the quantity demanded

When price changes, total revenue can change in the same direction, opposite direction, or remain constant

-whichever were to occur, though, is dependent on price elasticity of demand

The two main influences on the price elasticity of supply are...

1) production possibilities 2) storage possibilities

Define the cross elasticity of demand and income elasticity of demand, and explain the factors that influence them...

1. Cross elasticity of demand shows how the demand for a good changes when the price of one of its substitutes or complements changes 2. cross elasticity is positive for substitutes and negative for complements 3. income elasticity of demand shows how the demand for a good changes when income changes. For a normal good, the income elasticity of demand is positive. For an inferior good, the income elasticity of demand is negative.

Along a linear demand curve....

1. demand is unit elastic at midpoint of the curve 2. demand is elastic at all points above midpoint of the curve 3. demand is inelastic at al points below midpoint of the curve

supply of a good might be....

1. elastic 2. unit elastic 3. inelastic

the relationship between the price elasticity of demand and TR is...

1. price and TR change in opp. directions demand is elastic 2. if price changes, leaves TR unchanged, demand is unit elastic 3. price and TR change in same direction, demand is inelastic

Define the price elasticity of demand, and explain the factors that influence it and how to calculate it...

1. the demand for a good is elastic if, when its price changes the percentage change in the quantity demanded exceeds the percentage change in price 2. the demand for a good is inelastic if, when its price changes, the percentage change in the quantity demanded is less than the percentage change in price 3. the price elasticity of demand for a good depends on how easy it is to finds its substitutes for the good and on the proportion of income spent on it. 4. price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in price 5. if demand is elastic, a rise in price leads to a decrease in total revenue. If demand is unit elastic, a rise in price leaves total revenue unchanged. And if demand is inelastic, a rise in price leads to an increase in total revenue.

Define the price elasticity of supply, and explain the factors that influence it and how to calculate it...

1. the supply of a good is elastic if, when its price changes, the percentage change in the quantity supplied exceeds the percentage change in price. 2. the supply of a good is inelastic if, when its price changes, the percentage change in quantity supplied is less than the percentage change in price 3. the main influences on the price elasticity of supply are the flexibility of production possibilities and storage possibilities

Three factors influence the ability to find substitutes for a good....

1. whether the good is a luxury or a necessity -> necessity= food, house, etc.(has poor substitutes b/c must eat) -> luxury= exotic vacations (has many substitutes) 2. how narrowly it is defined -> demand for narrowly defined good is elastic ex) Starbucks latte for New World latte are good substitutes for each other -> demand for broadly defined good is inelastic ex) coffee is inelastic b/c tea is a poor substitute for it 3. the amount of time available to find a substitute for it -> the longer the time that has elapsed since the price of a good changed, the more elastic is the demand for that good ex) has prices increase in the 1970-1980's, quantity of gas demanded didn't change much b/c many owned gas-guzzling auto mobiles, so demand for gas was inelastic. But now ppl have fuel-efficient cars that replaced the gas-guzzling cars, so quantity demanded for gas decreased and gas demand became more elastic

Total revenue test:

A method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change (w/ all other influences on the quantity sold remaining unchanged)

compute numerical value for price elasticity of supply to determine if good is elastic, unit elastic or inelastic...

Price elasticity of supply: ***

If demand is elastic....

a given % rise in price brings a larger % decrease in quantity demanded, so total revenue- price multiplied by quantity decreases

If demand is inelastic....

a given % rise in price brings a smaller % decrease in the quantity demand, so total revenue increases

price elasticity of demand:

a measure of the responsiveness of the quantity demanded of a good to change in its price when all other influences on buyers' plans remain the same

Price elasticity of supply:

a measure of the responsiveness of the quantity supplied of a good to change in its price when all other influences on sellers' plans remain the same

goods that have an elastic supply....

can be produced at a constant (or very gently rising) opp. cost ex) silicon in your computer chip ===b/c silicon is extracted from sand at a tiny and almost constant opp. cost

% change in price calculated as...

change in price divided by the initial price, all multiplied by 100 ***

price elasticity of supply...

determined by company % change in quantity supplied w/ % change in price

5.1 Price elasticity of demand By knowing how sensitive or responsive buying plans are to price changes, we can predict how a given change in supply will change price quantity

ex) decrease in gas supply brings large rise in price and a small decrease in quantity - b/c buying plans for gas are not responsive to change in price BUT... ex) increase in airplane services supply brings a small decrease in price and a large increase in quantity of air travel -b/c airplane services are highly sensitive to change in price

examples of goods that are perfectly inelastic supplies on the day of a price change...

ex) fruits and vegetable -b/c hard to change quantity supplied immediately after prices change -planting decisions have to be made in advance of crop being available, especially oranges

inelastic examples:

ex) hotel rooms in NY b/c cant easily be transformed to offices and vise versa

examples of goods that are inelastic...

ex)supply of Wii -b/c before launched they made forecast of price and demand w/ quantity expected that ppl were willing to buy -but price of Wii increase on different sites to bring market equilibrium, so would have liked to ship more, but could do nothing to increase quantity supplied in the near term -> as time passes, elasticity of supply increases ===b/c extremely elastic, perhaps perfectly elastic, when technology allows for an adjustment of production to be exploited ===later, Nintendo increases production rate of Wii and site decrease price, so became more elastic as production continued to expand

Elasticity provides info of...

how responsive quantity demanded is to price changes

inelastic:

if price elasticity of demand <1

unit elastic:

if price elasticity of demand =1

elastic:

if price elasticity of demand >1

supply is inelastic:

if price elasticity of supply <1

supply is unit elastic:

if price elasticity of supply =1

supply is elastic:

if price elasticity of supply >

elastic examples:

paper and printing presses to produce textbooks or magazines, so these supplies of these goods are elastic

slope measures...

responsiveness -elasticity, not the same as slope b/c slope constant but elasticity varies

example for interpreting the price elasticity of demand #:

say E_PQ is 2, tells us... 1. Starbucks latte is elastic, -many substitutes -take small proportion of buyers income 2. Starbucks must be careful of charging to much b/c.... -price increase may bring more revenue per cup but wipe out a lot of potential business 3. flip side; price decrease could bring more business, thus bring in more revenue

5.2 The price elasticity of supply We know....

that when demand increases, the equilibrium price rises and the equilibrium quantity increases -but does price increase by large amounts, while quantity by little or vise versa? === know this by knowing price elasticity supply

Total Revenue:

the amount spent of a good and recieved by its seller and equals the price of the good multiplied by the quantity sold ex) Starbucks latte is $3, 15 an hour are sold, so total revenue= $45 ($3X 15) -figure 5.4

Portion of income spent...

the greater the proportion of income spent on a good, the greater is the impact of a rise in its price on the quantity of that good that ppl can afford to buy and the more elastic is the demand for the good ex) -toothpaste= tiny portion of budget housing= large portion of budget -toothpaste price increases, still buy same amount of toothpaste as before (inelastic) -apartment rent increase, look for roomates (elastic moreso than toothpaste)