Elasticity: A Measure of Responsiveness

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# Elasticity: A Measure of Responsiveness - PowerPoint PPT Presentation

Elasticity: A Measure of Responsiveness. The Price Elasticity of Demand. The price elasticity of demand ( E d ) measures the responsiveness of consumers to changes in price. The Price Elasticity of Demand.

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### Elasticity: A Measureof Responsiveness

The Price Elasticity of Demand
• The price elasticity of demand (Ed) measures the responsiveness of consumers to changes in price.
The Price Elasticity of Demand
• For example, if the price of milk increases by 10% (from \$2 to \$2.20) and the quantity demanded decreases by 15% (from 100 to 85), the price elasticity of demand is:
• We compute the price elasticity of demand as follows:
When demand is perfectly inelastic, the quantity demanded is the same at every price, so the price elasticity of demand is zero.

When demand is perfectly elastic, the quantity demanded is infinitely responsive to changes in price, so the price elasticity of demand is infinite.

Price Elasticity andthe Demand Curve
What Determines thePrice Elasticity of Demand?
• The price elasticity of demand for a particular product depends on the availability of substitutes.
• Products with relatively inelastic demand have few good substitutes.
• The demand for a specific brand of a product is typically elastic.
What Determines thePrice Elasticity of Demand?
• The short-run price elasticity of demand is typically smaller than the long-run elasticity.
• Elasticity is larger for goods that take a relatively large part of a consumer’s budget.
• The price elasticity of demand for some products varies with the age of the consumer.
Computing Price Elasticity:Initial Value versus Midpoint

The midpoint method measures the percentage changes more precisely, so we get a more precise measure of price elasticity.

Elasticity Along aLinear Demand Curve
• The price elasticity of demand decreases as we move downward along a linear demand curve.
• Demand is elastic on the upper half of the demand curve and inelastic on the lower half.
Using the Price Elasticityof Demand to Make Predictions
• Predicting changes in quantity demanded:
• We can rearrange the elasticity formula to predict changes in quantity demanded as a result of price changes.
• For example:
Predicting Changes in Total Revenue
• An increase in the ticket price brings good news and bad news:
• Good news. You get more money for each ticket sold.
• Bad news. You sell fewer tickets.
Predicting Changes in Total Revenue
• Demand is elastic along the upper half of a linear demand curve, so an increase in quantity increases total revenue.
• Demand is inelastic along the lower half of a linear demand curve, so a decrease in price decreases total revenue.
• Total revenue reaches its maximum at the midpoint of the demand curve, where demand is unitary elastic.
Other Elasticities of Demand
• The income elasticity of demand measures of the responsiveness of demand to changes in income, indicating how much more or less of a particular product is purchased as income changes.
Other Elasticities of Demand
• The cross elasticity of demand measures the responsiveness of demand to changes in the price of other goods.
The Price Elasticity of Supply
• The price elasticity of supply measures the responsiveness of producers to changes in price.
The Price Elasticity of Supply
• A 10% increase in the price of milk (from \$2 to \$2.20) increases the quantity supplied by 20% (from 100 million gallons to 120 million), so the price elasticity of supply is 2.0 = 20%/10%.
Predicting Changesin Quantity Supplied
• Predicting changes in quantity supplied:
• We can rearrange the elasticity formula to predict changes in quantity supplied as a result of price changes.
• For example:
When supply is perfectly elastic, the quantity supplied is infinitely responsive to changes in price, so the price elasticity of supply is infinite.

When supply is perfectly inelastic, the quantity supplied is the same at every price, so the price elasticity of supply is zero.

Extreme Cases: Perfectly Inelastic Supply and Perfectly Elastic Supply
• The price-change formula shows the percentage change in equilibrium price resulting from a change in demand or supply, given values for the price elasticity of supply and price elasticity of demand.
• In this example, an increase in demand shifts the demand curve to the right, increasing the equilibrium price. In this case, a 35% increase in demand increases the price by 10%.
The Price Effects ofa Change in Supply
• A slight variation of theprice-change formula is used to predict the change in price resulting from a change in supply.
• For example, when the price elasticities of demand and supply are 0.6 and 1.4 respectively, an increase in the supply of milk by 10% will decrease equilibrium price by 5%.