Week 3, Elasticity

Supply Elasticity

-Exactly analogous to demand, but describes responsiveness of quanityt offered for sale to price changes -ex/ tickets to a baseball game, supply is fixed at number of seats available, therefore supply curve is completely vertical (inelastic) -inelastic when supply is fixed at capacity -Ex/ Ketchup: huge spike in demand around 4th of july, but price stays the same. This indicates a flat/horizontal supply curve, indicating an extremely elastic supply, meaning that they can expand and contract supply quickly based on demand. It is defined as the percentage change in quantity supplied that occurs in response to a 1 percent change in price. Determinates of supply elasticity: 1)flexibility of inputs: The more flexibility inputs have in being used for other things, the more elastic the supply curve. Ex/ something that requires minimal skills for labor means workers could easily switch to something else or switch into this. Lemonade stand vs brain surgery. If lemonade stand was in demand, could shift tons of workers to this, but if brain surgery increased in price, there would still be fixed supply due to specialized skill reqs. 2)mobility of inputs:If inputs can be easily transported from one site to another, an increase in the price of a product in one market will enable a producer in that market to summon inputs from other markets. Ex/ farmworkers willing to migrate or entertainers to hit the road makes industries elastic.For most goods, the price elasticity of supply increases each time a new highway is built, or when the telecommunications network improves, or indeed when any other development makes it easier to find and transport inputs from one place to another. 3)Ability to produce substitute inputs: If inputs could easily produce substitutes, supply is more elastic 4) time: elasticity higher in long run, since it takes time to switch resources from one product to another.

Cross Price Elasticity of Demand

-Measures the change in quantity demanded in response to change in another good's price --ex/mortgage price and home price: compliments, if mortgage rates go up, housing demand goes down -formula: E=% change in Q of item 1/ % change in Price of item 2 --mortgage ex/ % change in Q of home / % change in price of mortgage -vary depending on whether goods are substitutes or compliments --positive for substitutes (if price goes up on one, demand goes up on the other), negative for compliments (if price goes up for one, demand goes down for the other) -can be neg or pos When the cross-price elasticity of demand for one good with respect to the price of another good is positive, the two goods are substitutes; when the cross-price elasticity of demand is negative, the two goods are complements. A normal good has positive income elasticity of demand and an inferior good has negative income elasticity of demand.

Income Elasticity

-Percentage change in demand from percentage change in income --Positive: "normal" good==> buy more when income goes up --Negative: "inferior" good==>buy less when income goes up -can be negative or positive E=% change in Q / % change in Income

How Elasticity is linked to revenue

-Total Sales Revenue= TR = P x Q -Total Expenditure = Total Revenue: The dollar amount that consumers spend on a product (P × Q) is equal to the dollar amount that sellers receive. -total expenditure by buyers = total revenue earned by sellers -The level of elasticity will tell us about how sales revenue is or will be effected by a price change --Ex/if Ford cuts prices by $5,000, will that lead to more sales or will they just sell the same amount of trucks at a reduced price AKA will total revenue rise or fall? --the more elastic, the more responsive customers will be to the Ford price cut, and therefore Ford would prefer Elastic demand when cutting price, --If Ford were raising prices, they would hope demand is inelastic -the sweet spot is unit elasticity where E = 1. This is where you will maximize total revenue. It is the exact middle point on the demand curve. -The graphical interpretation of elasticity also makes it easy to see why the price elasticity of demand at the midpoint of any straight-line demand curve must always be 1.

Elasticity of demand

-pertains to the flatness/steepness (slope) of demand curve -more flat means more elastic, which means more responsive to price change -The price elasticity of demand for a good is a measure of the responsiveness of the quantity demanded of that good to changes in its price. Formally, the price elasticity of demand for a good is defined as the percentage change in the quantity demanded that results from a 1 percent change in its price. For example, if the price of beef falls by 1 percent and the quantity demanded rises by 2 percent, then the price elasticity of demand for beef has a value of −2.. -equation to calculate = Percentage change in quantity demanded / Percentage change in price -Another way to write equation is E= P/Q * 1/slope --this illustrates how elasticity is related to slope of demand. steeper demand curve means greater slope and therefor lower elasticity -slope=rise/run=change in P/change in Q

Determinants of Elasticity of Demand

1) Scope or how narrowly you define product (narrow definition such as specific brand vs overall type of product), the bigger the category the lower the elasticity, the more narrow the more elastic... cars vs honda accord 2) How expensive things are: think salt. If its super cheap, it's less elastic. 3) Time share: think gas prices changes today vs. years Other ways to describe: 1) Substitution Options: more options, more elastic 2) Budget share: large share means more elastic 3) Time: long time to adjust, more elastic Summary:The price elasticity of demand for a good or service tends to be larger when substitutes for the good are more readily available, when the good's share in the consumer's budget is larger, and when consumers have more time to adjust to a change in price.

Price Elasticity and the Steepness of the Demand Curve

Price Elasticity and the Steepness of the Demand Curve.When price and quantity are the same, price elasticity of demand is always greater for the less steep of two demand curves. general rule: If two demand curves have a point in common, the steeper curve must be the less price-elastic of the two with respect to price at that point. However, this does not mean that the steeper curve is less elastic at every point. As a glance at our elasticity formula makes clear, price elasticity has a different value at every point along a straight-line demand curve. The slope of a straight-line demand curve is constant, which means that 1/slope is also constant. But the price-quantity ratio P/Q declines as we move down the demand curve. The elasticity of demand thus declines steadily as we move downward along a straight-line demand curve.

How to use elasticity to determine the right price to maximize revenue

The general rule is that a price increase will produce an increase in total revenue whenever it is greater, in percentage terms, than the corresponding percentage reduction in quantity demanded. -To visualize this draw out a table showing the income at each P and Q point on the curve -Should be the midpoint of the curve -remember that elasticity changes at each price point

two exceptions to general rule that elasticity declines along a straight line demand curve

There are two important exceptions to the general rule that elasticity declines along straight-line demand curves. First, the horizontal demand curve in Figure 4.8(a) has a slope of zero, which means that the reciprocal of its slope is infinite. Price elasticity of demand is thus infinite at every point along a horizontal demand curve. Such demand curves are said to be perfectly elastic. Second, the demand curve in Figure 4.8(b) is vertical, which means that its slope is infinite. The reciprocal of its slope is thus equal to zero. Price elasticity of demand is thus exactly zero at every point along the curve. For this reason, vertical demand curves are said to be perfectly inelastic. The horizontal demand curve (a) is perfectly elastic, or infinitely elastic, at every point. Even the slightest increase in price leads consumers to desert the product in favor of substitutes. The vertical demand curve (b) is perfectly inelastic at every point. Consumers do not, or cannot, switch to substitutes even in the face of large increases in price.