7/21/2019 101 Chapter 3

1/60

Chapter 3: ElasticityChapter 3: Elasticity

Price elasticity

demand

supply Cross elasticity

Income elasticity

7/21/2019 101 Chapter 3

2/60

Basic ideaBasic idea

We know when P

QdQs

holding other factors constant

7/21/2019 101 Chapter 3

3/60

but how muchbut how much

if price doubles

how much does Qd fall

by !"#by $"#

by 3""#

price elasticity tells us

7/21/2019 101 Chapter 3

4/60

I% Price Elasticity of &emandI% Price Elasticity of &emand

e'ample

mocha latte at (tarbucks

price rises from )3 to )$ per cup Qd falls from !$ to $ cups per hr%

7/21/2019 101 Chapter 3

5/60

e*uatione*uation

# change in Qd

# change in P

7/21/2019 101 Chapter 3

6/60

# change in Qd# change in Qd

new Qd + initial Qda,erage Qd

' !""

midpoint method

7/21/2019 101 Chapter 3

7/60

e'amplee'ample

$ cups + !$ cups

-$.!$/01 cups' !""

+!" cups

!" cups' !"" 2 +!""#

7/21/2019 101 Chapter 3

8/60

# change in P# change in P

new P + initial Pa,erage P

' !""

midpoint method

7/21/2019 101 Chapter 3

9/60

e'amplee'ample

)$ + )3

-)$.)3/01' !""

)1

)

' !"" 2 $"#

7/21/2019 101 Chapter 3

10/60

demand elasticitydemand elasticity

# change in Qd

# change in P

+!""#

$"#2 +1

7/21/2019 101 Chapter 3

11/60

If price of latte increases !#4

Qd of latte decreases 1#

7/21/2019 101 Chapter 3

12/60

demand elasticitydemand elasticity

a unit+free measure

compare all goods 5 ser,ices

changes for different pointson the demand cur,e

7/21/2019 101 Chapter 3

13/60

if price elasticity of demandif price elasticity of demand

-absolute ,alue/-absolute ,alue/

2 !

unit elastic

# change Qd 2 # change P

6 !

elastic

# change Qd 6 #change Psensiti,e to P changes

7/21/2019 101 Chapter 3

14/60

7 !

inelastic

# change Qd 7 #change P

not sensiti,e to P changes

7/21/2019 101 Chapter 3

15/60

elastic demandelastic demand

-6!/-6!/ flatter cur,e

P

Q

&

small change in P

big change in Qd

7/21/2019 101 Chapter 3

16/60

inelastic demandinelastic demand

-7!/-7!/ steep cur,e

P

Q

&

big change in P

small change in Qd

7/21/2019 101 Chapter 3

17/60

perfectly inelastic demandperfectly inelastic demand

,ertical lineP

Q

&

change in P

no change in Qd

7/21/2019 101 Chapter 3

18/60

perfectly elastic demandperfectly elastic demand

hori8ontal lineP

Q

&

any change in P

Qd falls to 8ero

7/21/2019 101 Chapter 3

19/60

7/21/2019 101 Chapter 3

20/60

e'ample: cup of lattee'ample: cup of latte

initial P2)34 Qd 2 !$%

9 2 )3 ' !$ 2 )$

new P 2 )$4 Qd 2 $9 2 )$ ' $ 2 )1$

demand for latte is elastic

9 falls as P rises

7/21/2019 101 Chapter 3

21/60

what makes demand elastic orwhat makes demand elastic or

inelasticinelastic

!% is it a lu'ury or necessity

if lu'ury4 demand is elastic

if necessity4 demand is inelastic

7/21/2019 101 Chapter 3

22/60

e'amplee'ample

mocha latte at (tarbucks

is a lu'ury

a li,er transplant is not

7/21/2019 101 Chapter 3

23/60

1% definition of good

latte at (tarbucks4

narrow definition2 many substitutes -other brands of coffee4 tea/

demand is elastic

coffee in general4

broad definition 2 fewer substitutes

demand is less elastic

7/21/2019 101 Chapter 3

24/60

3% time since price change

short timeno time to ad;ust4

demand is inelastic

long timetime to ad;ust4

demand is elastic

7/21/2019 101 Chapter 3

25/60

e'amplee'ample

Price of gas per gallon

the day price rises

demand inelastic years later

demand much more elastic

as carpool or buy smaller car

7/21/2019 101 Chapter 3

26/60

factors !+3factors !+3

all get at same issue:

can consumers substitute a cheaper

good easily if yes4 demand is elastic

if no4 demand is inelastic

7/21/2019 101 Chapter 3

27/60

% Is item large part of your budget if yes4 then demand elastic

-forced to change beha,ior/

if no4 then demand inelastic

-no need to change beha,ior/

7/21/2019 101 Chapter 3

28/60

e'amplee'ample

soap

if price doubles4 will you buy less

rent if rent doubles

++ stay on campus

++ more roommates

7/21/2019 101 Chapter 3

29/60

II% Price Elasticity of (upplyII% Price Elasticity of (upply

# change in Qs

# change in P

7/21/2019 101 Chapter 3

30/60

e'amplee'ample

bunch of roses

P 2 )"0bunch4 Qs 2 < -million bunches/

P 2 )

7/21/2019 101 Chapter 3

31/60

# change Qs# change Qs

!$ +

7/21/2019 101 Chapter 3

34/60

if price rises !#4

Qs rises 1%!$#

unit+free measure depends on points chosen

on the supply cur,e

7/21/2019 101 Chapter 3

35/60

if price elasticity of supplyif price elasticity of supply

2 !unit elastic

# change Qs 2 # change P

6 !

elastic

# change Qs 6 #change Psensiti,e to P changes

7/21/2019 101 Chapter 3

36/60

7 !

inelastic

# change Qs 7 #change P

not sensiti,e to P changes

7/21/2019 101 Chapter 3

37/60

inelastic supplyinelastic supply

steep cur,eP

Q

(

big change in P

small change in Qs

7/21/2019 101 Chapter 3

38/60

perfectly inelastic supplyperfectly inelastic supply

,ertical lineP

Q

(

change in P

no change in Qs

7/21/2019 101 Chapter 3

39/60

elastic supplyelastic supply

flatter cur,eP

Q

(

small change in P

big change in Qs

7/21/2019 101 Chapter 3

40/60

perfectly elastic supplyperfectly elastic supply

hori8ontal lineP

Q

(

any change in P

Qs falls to 8ero

7/21/2019 101 Chapter 3

41/60

what makes supply elastic orwhat makes supply elastic or

inelasticinelastic

!% production possibilities

Can you make more easily

?@ then supply is inelastic

AE(

then supply is elastic

7/21/2019 101 Chapter 3

42/60

e'amplee'ample

oceanfront property

cant make more

inelastic supply salt

almost an infinite amount

elastic supply

7/21/2019 101 Chapter 3

43/60

1% time since price change

it takes time to produce if a short time4

supply is inelastic

if a long timesupply is elastic

7/21/2019 101 Chapter 3

44/60

e'amplee'ample

hotel rooms

takes time to build

supply inelastic in short+run4

elastic in long+run

7/21/2019 101 Chapter 3

45/60

3% Can you store it easily0cheaply

if yes4 then elastic

if no4 then inelastic

7/21/2019 101 Chapter 3

46/60

e'amplee'ample

bananas

storage time limited

supply inelastic

7/21/2019 101 Chapter 3

47/60

III% Income Elasticity of &emandIII% Income Elasticity of &emand

impact of income changes ondemand

si8e of shiftin the demand cur,e

when income changes

7/21/2019 101 Chapter 3

48/60

e*uatione*uation

# change in Qd

# change in income

6 " normal good

7 " inferior good

7/21/2019 101 Chapter 3

49/60

e'ample: ;ewelrye'ample: ;ewelry

income increases !"#

Qd ;ewelry increases 3$#

7/21/2019 101 Chapter 3

50/60

income elasticityincome elasticity

# change in Qd ;ewelry

# change in income

3$#

!"#2 3%$

7/21/2019 101 Chapter 3

51/60

I% Cross Elasticity of &emandI% Cross Elasticity of &emand

impact of price change of

substitutes or complements

si8e of shiftin demand cur,e

when price of a related good

changes

7/21/2019 101 Chapter 3

52/60

e*uatione*uation

# change in Qd

# change in P of related good

7/21/2019 101 Chapter 3

53/60

cross elasticitycross elasticity

6 " for substitutes

7 " for complements

7/21/2019 101 Chapter 3

54/60

e'ample: Peanut buttere'ample: Peanut butter

what happens to Qd of PB4

when price of ;elly rises

PB 5 ;elly are complements

price ;elly 2 )3 ;ar4 Qd PB 2 1 ;ars per month

price ;elly 2 ) ;ar4 Qd PB 2 ! ;ar per month

7/21/2019 101 Chapter 3

55/60

# change in Qd PB# change in Qd PB

! ;ar + 1 ;ars

!%$ ;ars' !"" 2 +

7/21/2019 101 Chapter 3

56/60

cross price elasticity of PBcross price elasticity of PB

with respect to price of ;elly

# change in Qd PB

# change in P ;elly

+

7/21/2019 101 Chapter 3

57/60

e'ample: Peanut buttere'ample: Peanut butter

what happens to Qd of PB4

when price of butter rises

PB 5 butter are substitutes

P butter 2 )! stick4 Qd PB 2 1 ;ars per month

P butter 2 )3 stick4 Qd PB 2 1%1 ;ars per mo%

7/21/2019 101 Chapter 3

58/60

# change in Qd PB# change in Qd PB

1%1 ;ar + 1 ;ars

1%! ;ars' !"" 2 =%$#

# change in P of butter# change in P of butter

)3 + )!

)1

' !"" 2 !""#

7/21/2019 101 Chapter 3

59/60

cross price elasticity of PBcross price elasticity of PB

with respect to price of butter

# change in Qd PB

# change in P butter

=%$#

!""# 2 %"=$

summarysummary

7/21/2019 101 Chapter 3

60/60

summarysummary

law of demand 5 supply

direction of change in Qd0Qs

when P changes

price elasticityhow large are these Qd0Qs

changes

cross0income elasticitysi8e of shift in demand cur,e