Elasticity

Elasticity• Measures how much buyers and

sellers respond to a change in market conditions–Price changes–Income Changes–All other market changes

Elastic Good• The change in quantity is more

than the change in the market• Quantity for a good is

substantially impacted by a change in market conditions

Inelastic Good• The change in quantity is less

than the change in the market • Quantity for a good is not

substantially impacted by a change in market conditions

Factors that determine elasticity for Demand

Amount of Substitutes

The less substitutes there are…

The more substitutes there are…

Inelastic Elastic

Necessities vs. Luxuries

Your needs

ElasticInelastic

Your luxuries or wants

Definition of the Market

Broadly Defined Market

ElasticInelastic

Narrowly Defined Market

Broadly Defined Market

ElasticInelastic

Narrowly Defined Market

Factors that determine elasticity of Supply

The type of resources that are used to produce the product play a major role in the elasticity of the good or

service

Resources and ElasticityThe harder the good or service is to produce, the more inelastic it is

The easier the good or service is to produce, the more elastic it is.

BRAIN BUSTA!Think of an apple. What is the major resource that determines whether an apple is elastic or inelastic?

TIME!

Short Run vs. Long Run Elasticity

Short Run

• Supply is usually inelastic

Long Run

• Supply is usually elastic

Also, any factors that impact the factors of production can effect

elasticity of supply

Is the supply inelastic or elastic?

Price Elasticity

• A measure of how much quantity of a good responds to a change in the price of that good. In other words, the price change is the “change in the market.”–Price Elasticity of Demand

• How quantity demanded is impacted–Price Elasticity of Supply

• How quantity supply is impacted

For example

• Since the price of gasoline changes all the time but the quantity demanded for gasoline stays almost always the same, gasoline is price inelastic.

Partner Activity• On a separate sheet of paper, write down

any good or service you can think of. • Then, specify whether the price increases

or decreases• Exchange your paper with another group• Now, identify the price elasticity of

supply and demand. Also, explain your answer. Write your names on the sheet that you answered.

Calculating Elasticity

% Change in Quantity

% Change in Price

Inelastic or Elastic?• If elasticity is greater than 1 = elastic• If elasticity is less than 1 = inelastic• If elasticity is 1 = unit elastic• If elasticity is 0 = perfectly inelastic• If elasticity is infinite = perfectly

elastic

What do they mean?

• Perfectly Inelastic– Quantity stays the same no matter the price

change.

• Perfectly Elastic– Quantity changes infinitely with any change in

price.

• Unit Elastic– The percent change in quantity = the percent

change in price

Practice

• The price of an ice cream cone increases by 40% and the amount the market buys falls by 60%

• Compute the price elasticity of ice cream cones

• What is the price elasticity?

Elasticity = 1.5, therefore ice cream is elastic

Another way to look at this…

• The price of an ice cream cone increases by 40% and the amount the market buys falls by 60%

Since the percent change in quantity is greater than the percent change in price, we

can assume the good is elastic.

Midpoint Method (arc method)

• Used to identify % change

2 1 2 1

2 1 2 1

( ) /[( ) / 2]Price elasticity of demand =

( ) /[( ) / 2]

Q Q Q Q

P P P P

Computing by looking at market graph

Price Elasticity = 3 (ignore all negatives)

Demand is price elastic.

$5

4Demand

Quantity1000 50

Price

Let’s say the price drops from $5 to $4. Is this good price elastic or price inelastic at that price change?

Worksheet Bonus Questions

1. At what price range is the good inelastic?2. At what price range is the good elastic?3. Why do you think this happens?

Elasticity and Graphing

Challenge

• Graph a typical demand curve for gasoline in the United States of America

• Graph a typical demand curve for Levi’s jeans.• Graph a typical supply curve for doctors.

The Price Elasticity of Demand(a) Perfectly Inelastic Demand: Elasticity Equals 0

$5

4

Quantity

Demand

1000

1. Anincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price

Challenge: When can this happen?

No substitutes!!

The Price Elasticity of Demand(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

$4 Demand

2. At exactly $4,consumers willbuy any quantity.

1. At any priceabove $4, quantitydemanded is zero.

3. At a price below $4,quantity demanded is infinite.

Challenge: When can this happen?

(immeasurable)

Super Duper Paper Clip Company

• Many other companies that sell the exact same product

• If price is raised by the smallest amount, than buyers buy from another company

• If price is slightly lowered, than all buyers will buy from Super Duper Paper Clip Company.

ALL of the same rules apply when looking at supply!

Owner Challenge!!!

Looking at the information on the next slide, at what price would you

earn the most revenue?

Price Demand for Beef Jerky

Purse

Total Revenue

$1 15

$2 10

$3 8

$4 4

$5 1

Do this!

Total Revenue

Quantity DemandedPrice

Price Demand for Beef Jerky

Purse

Total Revenue

$1 15

$2 10

$3 8

$4 4

$5 1

$15

Price Demand for Beef Jerky

Purse

Total Revenue

$1 15 $15

$2 10 $20

$3 8 $24

$4 4 $16

$5 1 $5

Graphing Total Revenue

Demand

Quantity

Q

P

0

Price

P × Q = $400(revenue)

$4

100

When the price is $4, consumers will demand 100 units, and spend $400 on this good.

Inelastic Goods and Total Revenue

• With an inelastic demand curve, total revenue usually increases as price increases.

How Total Revenue Changes When Price Changes: Inelastic Demand

Demand

Quantity0

Price

Revenue = $100

Quantity0

Price

Revenue = $240

Demand$1

100

$3

80

An Increase in price from $1 to $3 …

… leads to an Increase in total revenue from $100 to $240

Elastic Goods and Total Revenue

• With an elastic demand curve, total revenue usually decreases as price increases.

How Total Revenue Changes When Price Changes: Elastic Demand

Demand

Quantity0

Price

Revenue = $200

$4

50

Demand

Quantity0

Price

Revenue = $100

$5

20

An Increase in price from $4 to $5 …

… leads to an decrease in total revenue from $200 to $100

0 2 64 108 12 14

2

1

4

3

5

6

$7

Demand is elastic; demand is responsive to changes in price.

Demand is inelastic; demand is not very responsive to changes in price.

When price increases from $4 to $5, TR declines from $24 to $20.

When price increases from $2 to $3, TR increases from $20 to $24.

Elasticity is > 1 in this range.

Elasticity is < 1 in this range.

Price

Quantity

Price Range and Elasticity

The higher the price, the more elastic the good is. The lower the price, the

more inelastic the good is.

Other Demand Elasticities

• Income Elasticity of Demand – Income elasticity of demand measures how much

the quantity demanded of a good responds to a change in consumers’ income.

Other Demand Elasticities

In co m e e la stic ity o f d em an d =

P ercen tag e ch an g e in q u an tity d em an d ed

P ercen tag e ch an g e in in co m e

Remember, all elasticities are measured by dividing one percentage change by another

Income Elasticity differences

• Income Elasticity– Necessities, such as food and clothing, tend to

have small income elasticities.– Luxuries, such as fur coats and diamonds, tend to

have large income elasticities.

Other Demand Elasticities

• Cross-price elasticity of demand– A measure of how much the quantity

demanded of one good responds to a change in the price of another good

2 good of pricein %change

1 good of demandedquantity in %changedemand of elasticity price-Cross

Compares the elasticities of compliment and substitute goods

• Price elasticity of demand measures how much the quantity demanded responds to changes in the price.

• Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price.– If a demand curve is elastic, total revenue falls

when the price rises. – If it is inelastic, total revenue rises as the price

rises.

ELASTICITY REVIEW

• The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income.

• The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good.

• The price elasticity of supply measures how much the quantity supplied responds to changes in the price.

ELASTICITY REVIEW

• In most markets, supply is more elastic in the long run than in the short run.

• The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price.

• The tools of supply and demand can be applied in many different types of markets.

ELASTICITY REVIEW