8/12/2019 Microecon Lecture Note for 23Jan.2013
1/49
ELASTICITYMicroeconomics
8/12/2019 Microecon Lecture Note for 23Jan.2013
2/49
ELASTICITY
is a measure of how much buyers and sellers
respond to changes in market conditions
8/12/2019 Microecon Lecture Note for 23Jan.2013
3/49
THE ELASTICITY OF DEMAND
Price elasticity of demandis a measure of how
much the quantity demanded of a good responds to
a change in the price of that good.
Price elasticity of demand is the percentage change
in quantity demanded given a percent change in the
price.
8/12/2019 Microecon Lecture Note for 23Jan.2013
4/49
DETERMINANTSOFPRICEELASTICITY
OFDEMAND
Availability of Close Substitutes:
More close substitutes=More elastic
Example: Butter vs Egg
Necessities versus Luxuries:
inelastic versus elastic
Example: visit a doctor vs sailboat
8/12/2019 Microecon Lecture Note for 23Jan.2013
5/49
DETERMINANTSOFPRICEELASTICITY
OFDEMAND
Definition of the Market:
Narrowly defined marketmore elastic
Broadly defined market less elastic
Example: Food vs Ice Cream
Time Horizon
Longer time horizonmore elastic
Shorter time horizonless elastic
8/12/2019 Microecon Lecture Note for 23Jan.2013
6/49
SUMMARY
Demand tends to be more elastic :
the larger the number of close substitutes.
if the good is a luxury.
the more narrowly defined the market.
the longer the time period.
8/12/2019 Microecon Lecture Note for 23Jan.2013
7/49
The (own) price elasticity of demand is computed
as the percentage change in the quantity
demanded divided by the percentage change in
price.
Price elasticity of demand =Percentage change in quantity demanded
Percentage change in price
8/12/2019 Microecon Lecture Note for 23Jan.2013
8/49
CALCULATINGELASTICITY
1.1
1.0
1.44 1.5
8/12/2019 Microecon Lecture Note for 23Jan.2013
9/49
CALCULATING ELASTICITY: POINT
ELASTICITY
Point Elasticity={[Q2-Q1]/Q1}/{[P2-P1]/P1}
Case 1: Price rises from 1 to 1.1
% change in qty = (1.44-1.5)/1.5= -4%
% change in price = (1.10-1)/1= 10%
Elasticity=-4%/10%=-0.4
8/12/2019 Microecon Lecture Note for 23Jan.2013
10/49
CALCULATINGELASTICITY: POINT
APPROACH
Case 2: Price falls from 1.1 to 1.
% change in qty = (1.5-1.44)/1.44= 4.16%% change in price = (1-1.10)/1.10= -9.09%
Elasticity=4.16%/-9.09%=-0.457
8/12/2019 Microecon Lecture Note for 23Jan.2013
11/49
POTENTIALPROBLEMOFPOINT
ELASTICITY
(Point) Elasticity level in case 1 is different from
(point) elasticity level in case 2
8/12/2019 Microecon Lecture Note for 23Jan.2013
12/49
MIDPOINT METHOD (ARC ELASTICITY
The midpoint formula is preferable when calculating
the price elasticity of demand because it gives the
same answer regardless of the direction of the
change.
8/12/2019 Microecon Lecture Note for 23Jan.2013
13/49
MIDPOINTMETHODFORMULA
Price elasticity of demand =( ) / [( ) / ]
( ) / [( ) / ]
Q Q Q Q
P P P P
2 1 2 1
2 1 2 1
2
2
8/12/2019 Microecon Lecture Note for 23Jan.2013
14/49
ARCELASTICITY
(MIDPOINTMETHOD)
Case 1: Price rises from 1 to 1.1.
% change in qty = (1.44-1.5)/1.47 = -4.1%
% change in price = (1.10-1)/1.05 = 9.5%
Elasticity=-4.1%/9.5%
=-0.432
Case 2: Price falls from 1.1 to 1.
% change in qty = (1.5-1.44)/1.47 = 4.1%
% change in price = (1-1.10)/1.05 = -9.5%
Elasticity=4.1%/-9.5%
=-0.432
8/12/2019 Microecon Lecture Note for 23Jan.2013
15/49
ELASTIC OR INELASTIC?
Inelastic Demand
Quantity demanded does not respond strongly to pricechanges.
Price elasticity of demand is less than one.
Elastic Demand Quantity demanded responds strongly to changes in
price.
Price elasticity of demand is greater than one.
8/12/2019 Microecon Lecture Note for 23Jan.2013
16/49
OTHERTYPES
Perfectly Inelastic
Quantity demanded does not respond to pricechanges.
Perfectly Elastic
Quantity demanded changes infinitely with anychange in price.
Unit Elastic
Quantity demanded changes by the samepercentage as the price.
8/12/2019 Microecon Lecture Note for 23Jan.2013
17/49
SUMMARY
|E|=0, perfectly inelastic
0
8/12/2019 Microecon Lecture Note for 23Jan.2013
18/49
Product Market ElasticityAutomobiles
Chevette U.S. -3.2
Civic U.S. -4
Consumer products
music CDs Aus -1.83cigarettes U.S. -0.3
liquor U.S. -0.2
football games U.S. -0.275
Utilities
electricity (residential) Quebec -0.7telephone service Spain -0.1
water (residential) U.S. -0.25
water (industrial) U.S. -0.85
OWN-PRICEELASTICITIES
8/12/2019 Microecon Lecture Note for 23Jan.2013
19/49
SLOPEANDELASTICITY
Because the price elasticity of demand measures
how much quantity demanded responds to the price,
it is closely related to the slope of the demand
curve.
Higher slope, lower elasticity
8/12/2019 Microecon Lecture Note for 23Jan.2013
20/49Copyright2003 Southwestern/Thomson Learning
(a) Perfectly Inelastic Demand: Elasticity Equals 0
5
4
Quantity
Demand
1000
1. Anincreasein price . . .
2. . . . leaves the quantity demanded unchanged.
Price
8/12/2019 Microecon Lecture Note for 23Jan.2013
21/49
(b) Inelastic Demand: Elasticity Is Less Than 1
Quantity0
5
90
Demand1. A 22%increasein price . . .
Price
2. . . . leads to an 11% decrease in quantity demanded.
4
100
8/12/2019 Microecon Lecture Note for 23Jan.2013
22/49Copyright2003 Southwestern/Thomson Learning
2. . . . leads to a 22% decrease in quantity demanded.
(c) Unit Elastic Demand: Elasticity Equals 1
Quantity
4
1000
Price
5
80
1. A 22%increasein price . . .
Demand
8/12/2019 Microecon Lecture Note for 23Jan.2013
23/49
(d) Elastic Demand: Elasticity Is Greater Than 1
Demand
Quantity
4
1000
Price
5
50
1. A 22%increasein price . . .
2. . . . leads to a 67% decrease in quantity demanded.
8/12/2019 Microecon Lecture Note for 23Jan.2013
24/49
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Quantity0
Price
4 Demand2. At exactly P4,consumers willbuy any quantity.
1. At any priceabove P4, quantitydemanded is zero.
3. At a price below P4,quantity demanded is infinite.
8/12/2019 Microecon Lecture Note for 23Jan.2013
25/49
LINEARDEMANDCURVE
Vertical intercept: perfectly elastic
Upper segment: elastic
Middle: Unit elastic
Lower segment: inelastic Horizontal intercept: perfectly inelastic
8/12/2019 Microecon Lecture Note for 23Jan.2013
26/49
TOTALREVENUEANDELASTICITY
Total revenueis the amount paid by buyers and
received by sellers of a good.
Computed as the price of the good times the
quantity sold.
TR = P x Q
8/12/2019 Microecon Lecture Note for 23Jan.2013
27/49Copyright2003 Southwestern/Thomson Learning
Demand
QuantityQ
P
0
Price
PQ= P400(revenue)
4
100
8/12/2019 Microecon Lecture Note for 23Jan.2013
28/49
TOTALREVENUEANDELASTICITY
With an elastic demand curve, an increase in the
price leads to a decrease in quantity demanded that
is proportionately larger. Thus, total revenue
decreases.
With an inelastic demand curve, an increase in the
price leads to a decrease in quantity demanded that
is proportionately smaller. Thus, total revenue
increases.
8/12/2019 Microecon Lecture Note for 23Jan.2013
29/49
INCOMEELASTICITYOFDEMAND
Income elasticity of demandmeasures how much
the quantity demanded of a good responds to a
change in consumersincome.
It is computed as the percentage change in the
quantity demanded divided by the percentage
change in income.
8/12/2019 Microecon Lecture Note for 23Jan.2013
30/49
NORMALORINFERIOR?
Types of Goods
Normal Goods
Inferior Goods
Higher income raises the quantity demanded for
normal goods but lowers the quantity demanded for
inferior goods.
Normal goods: Positive income elasticity
Inferior goods: Negative income elasticity
8/12/2019 Microecon Lecture Note for 23Jan.2013
31/49
NECESSITYORLUXURY?
Goods consumers regard as necessities tend to beincome inelastic
Examples include food, fuel, clothing, utilities, andmedical services.
Goods consumers regard as luxuries tend to beincome elastic.
Examples include sports cars, furs, and expensivefoods.
8/12/2019 Microecon Lecture Note for 23Jan.2013
32/49
INCOMEELASTICITY
I >0, Normal good
I
8/12/2019 Microecon Lecture Note for 23Jan.2013
33/49
Item Market ElasticityConsumer products
cigarettes U.S. 0.1
liquor U.S. 0.2
food U.S. 0.8
clothing U.S. 1
newspapers U.S. 0.9
Utilitieselectricity (residential) Quebec 0.1
telephone service Spain 0.5
INCOMEELASTICITY
8/12/2019 Microecon Lecture Note for 23Jan.2013
34/49
PRICEELASTICITYOFSUPPLY
Price elasticity of supplyis a measure of how much
the quantity supplied of a good responds to a
change in the price of that good.
Price elasticity of supply is the percentage change
in quantity supplied resulting from a percent changein price.
8/12/2019 Microecon Lecture Note for 23Jan.2013
35/49
FORMULA
The price elasticity of supply is computed as the
percentage change in the quantity supplied divided
by the percentage change in price.
Price elasticity of supply =
Percentage changein quantity supplied
Percentage change in price
8/12/2019 Microecon Lecture Note for 23Jan.2013
36/49
SUMMARY
S=0, perfectly inelastic
0
8/12/2019 Microecon Lecture Note for 23Jan.2013
37/49
SLOPEANDELASTICITY
Because the price elasticity of supply measures
how much quantity supplied responds to the price,
it is closely related to the slope of the supply curve.
Higher slope, lower elasticity
8/12/2019 Microecon Lecture Note for 23Jan.2013
38/49
Copyright2003 Southwestern/Thomson Learning
(a) Perfectly Inelastic Supply: Elasticity Equals
0
54
Supply
Quantity1000
1. Anincreasein price . . .
2. . . . leaves the quantity supplied unchanged.
Price
8/12/2019 Microecon Lecture Note for 23Jan.2013
39/49
Copyright2003 Southwestern/Thomson Learning
(b) Inelastic Supply: Elasticity Is Less Than 1
110
5
100
4
Quantity0
1. A 22%increasein price . . .
Price
2. . . . leads to a 10% increase in quantity supplied.
Supply
8/12/2019 Microecon Lecture Note for 23Jan.2013
40/49
Copyright2003 Southwestern/Thomson Learning
(c) Unit Elastic Supply: Elasticity Equals
1
125
5
100
4
Quantity0
Price
2. . . . leads to a 22% increase in quantity supplied.
1. A 22%increasein price . . .
Supply
8/12/2019 Microecon Lecture Note for 23Jan.2013
41/49
Copyright2003 Southwestern/Thomson Learning
(d) Elastic Supply: Elasticity Is Greater Than 1
Quantity0
Price
1. A 22%increasein price . . .
2. . . . leads to a 67% increase in quantity supplied.
4
100
5
200
Supply
8/12/2019 Microecon Lecture Note for 23Jan.2013
42/49
Copyright2003 Southwestern/Thomson Learning
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Quantity0
Price
4 Supply
3. At a price below P4,quantity supplied is zero.
2. At exactly P4,producers willsupply any quantity.
1. At any priceabove P4, quantitysupplied is infinite.
8/12/2019 Microecon Lecture Note for 23Jan.2013
43/49
DETERMINANTSOFPRICEELASTICITY
OFSUPPLY
Ability of sellers to change the amount of the good
they produce.
Beach-front land is inelastic.
Books, cars, or manufactured goods are elastic.
Time period.
Supply is more elastic in the long run.
8/12/2019 Microecon Lecture Note for 23Jan.2013
44/49
Item Horizon Price Elasticity
distillate short run 1.57
gasoline short run 1.61
pork long run 0.23
tobacco long run 7
housing long run 1.6 - 3.7
PRICEELASTICITIESOFSUPPLY
8/12/2019 Microecon Lecture Note for 23Jan.2013
45/49
APPLICATIONOFELASTICITY
Can good news for farming be bad news for
farmers?
What happens to wheat farmers and the market for
wheat when university agronomists discover a new
wheat hybrid that is more productive than existingvarieties?
8/12/2019 Microecon Lecture Note for 23Jan.2013
46/49
8/12/2019 Microecon Lecture Note for 23Jan.2013
47/49
OTHERAPPLICATIONS
A reduction in supply in the world market for oil: the
response depends on the time horizon.
Policies to Reduce the Use of Illegal Drugs:
Drug interdiction
Drug education
8/12/2019 Microecon Lecture Note for 23Jan.2013
48/49
QUIZ1
Beachfront resorts: inelastic supply
Automobile: elastic supply
Suppose a rise in population doubles the demand
for both products.
Price? Quantity? Consumer spending?
8/12/2019 Microecon Lecture Note for 23Jan.2013
49/49
QUIZ2
Why? Why?
A drought around the world:
Total revenue that farmers received from sale of
grain rises. However, a drought in Kansas reduces
total revenue that Kansas farmers receive.
Top Related