Ch. 4: Elasticity.

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Ch. 4: Elasticity. Define, calculate, and explain the factors that influence the price elasticity of demand the cross elasticity of demand the income elasticity of demand the elasticity of supply. Price Elasticity of Demand.

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Ch. 4: Elasticity.

Define, calculate, and explain the factors that influence

• the price elasticity of demand
• the cross elasticity of demand
• the income elasticity of demand
• the elasticity of supply
Price Elasticity of Demand
• The slope of the demand curve affects how much equilibrium price and quantity change for a given change in supply.
Price Elasticity of Demand
• Price elasticity of demand
• units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus.
Price Elasticity of Demand

%DQ = DQ/Qavg

= 2/10

= .2

%DP = DP/Pavg

= -\$1/\$20

= -.05

e = .2/.05 =4

Price Elasticity of Demand
• By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls.
• Measuring as % changes leaves the elasticity value the same (“units free”).
• Although the formula yields a negative value for elasticity because price and quantity move in opposite directions, we report the absolute value.
Price Elasticity of Demand
• Inelastic and Elastic Demand
• if e>1: elastic
• if e=1: unit elastic
• if e<1: inelastic
• Shape of
• Perfectly inelastic demand curve (e=0)
• Perfectly elastic demand curve (e= infinite)
Price Elasticity of Demand

At prices above the mid-point of the demand curve, demand is elastic.

At prices below the mid-point of the demand curve, demand is inelastic.

Price Elasticity of Demand
• Total Revenue and Elasticity
• TR=P*QD
• When P changes, TR could rise or fall because QD moves in opposite direction.
• But a higher price doesn’t always increase total revenue.
Price Elasticity of Demand
• %D TR = % D P + % D Q

= % D P - % D P(e)

= % D P(1-e)

• If demand is elastic (e>1),

P increase  TR decreases

P decrease  TR increases

• If demand is inelastic (e<1),

P increase  TR increases

P decrease  TR decreases

• If demand is unitary elastic,

P increase or decrease  TR unchanged.

Price Elasticity of Demand
• As P falls from \$25 to \$12.50, D is elastic, and TR rises.
• At \$12.50, D is unit elastic and TR stops increasing.
• As P falls from \$12.50 to 0, D is inelastic, and TR decreases.
Price Elasticity of Demand
• The elasticity of demand for a good depends on:
• The number & closeness of substitutes
• The proportion of income spent on the good
• The time elapsed since a price change
More Elasticities of Demand
• Cross Elasticity of Demand
• measures responsiveness of demand for a good to a change in the price of another good.

exy= %D quantity demanded for x

%D change in price of y

• exy > 0  substitutes
• exy <0  complements
More Elasticities of Demand
• Income Elasticity of Demand
• measures how the quantity demanded of a good responds to a change in income, ceteris paribus. eI = %D in quantity demanded

% D in income

• eI >0  normal good
• eI >1 luxury good
• eI <0 inferior good
Price Elasticity of Supply

A change in demand causes

• A larger change in equilibrium price if supply is supply is steeper,
• A smaller change in equilibrium quantity if supply is steeper.
Elasticity of Supply

Elasticity of supply

• measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same.
Elasticity of Supply
• Factors That Influence the Elasticity of Supply
• Elasticity of supply for inputs
• Substitution possibilities for inputs
• The time frame for supply decisions
• Storage costs