Elasticity Price elasticity demand supply Cross elasticity Income elasticity Price elasticity ...

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Elasticity Price elasticity demand supply Cross elasticity Income elasticity

Transcript of Elasticity Price elasticity demand supply Cross elasticity Income elasticity Price elasticity ...

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ElasticityElasticity

Price elasticity demand supply

Cross elasticity Income elasticity

Price elasticity demand supply

Cross elasticity Income elasticity

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Basic ideaWe know when P

Qd

Qs

holding other factors constant

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but how much? if price doubles

how much does Qd fall? by 10% by 50% by 300%?

price elasticity tells us

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equation

% change in Qd

% change in P

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% change in Qd

new Qd - initial Qd

average Qdx 100

midpoint method

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% change in P

new P - initial P

average Px 100

midpoint method

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demand elasticity% change in Qd

% change in P

-100%

50%= -2

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If price of latte increases 1%,

Qd of latte decreases 2%

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demand elasticitya unit-free measure

compare all goods & serviceschanges for different points

on the demand curve

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if price elasticity of demand(absolute value)

= 1unit elastic

% change Qd = % change P> 1

elastic

% change Qd > %change P

sensitive to P changes

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< 1 inelastic

% change Qd < %change P

not sensitive to P changes

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perfectly inelastic demandvertical line

P

Q

D

change in Pno change in Qd

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perfectly elastic demandhorizontal line

P

Q

D

any change in P

Qd falls to zero

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effect on total revenue total revenue (TR)

= P x Q if demand is elastic,

TR falls as price rises if demand is inelastic,

TR rises as price rises

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what makes demand elastic or inelastic?

1. is it a luxury or necessity if luxury, demand is elastic if necessity, demand is inelastic

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3. time since price change short time

no time to adjust,

demand is inelastic long time

time to adjust,

demand is elastic

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factors 1-3

all get at same issue: can consumers substitute a cheaper

good easily? if yes, demand is elastic if no, demand is inelastic

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4. Is item large part of your budget? if yes, then demand elastic

(forced to change behavior) if no, then demand inelastic

(no need to change behavior)

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II. Price Elasticity of Supply

% change in Qs

% change in P

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if price elasticity of supply= 1

unit elastic

% change Qs = % change P> 1

elastic

% change Qs > %change P

sensitive to P changes

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< 1 inelastic

% change Qs < %change P

not sensitive to P changes

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perfectly inelastic supplyvertical line

P

Q

S

change in Pno change in Qs

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perfectly elastic supplyhorizontal line

P

Q

S

any change in P

Qs falls to zero

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what makes supply elastic or inelastic?

1. production possibilitiesCan you make more easily?

NO

then supply is inelastic

YES

then supply is elastic

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III. Income Elasticity of Demand impact of income changes on demandsize of shift

in the demand curve

when income changes

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equation

% change in Qd

% change in income

> 0 normal good< 0 inferior good

> 0 normal good< 0 inferior good

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IV. 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

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equation

% change in Qd

% change in P of related good

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cross elasticity> 0 for substitutes< 0 for complements

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summary law of demand & supply

direction of change in Qd/Qs

when P changesprice elasticity

how large are these Qd/Qs changes?cross/income elasticity

size of shift in demand curve