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Elasticity

ELASTICITY (price elasticity ofdemand) What is it

How do we compute it

What aects it

! dierent "raphs

How it is related to re#enue

ELASTICITY A$% ITSA&&LICATI'$

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You desi"n wesites for local usinesses*You char"e +,, per wesite-and currently sell . wesites per month*

Your costs are risin"

(includin" the opportunity cost of yourtime)-so you consider raisin" the price to +!,*

The law of demand says that you won/t sell

as many wesites if you raise your price*How many fewer wesites0 How much willyour re#enue fall- or mi"ht it increase0

You desi"n wesites for local usinesses*

You char"e +,, per wesite-and currently sell . wesites per month*

Your costs are risin"

(includin" the opportunity cost of yourtime)-so you consider raisin" the price to +!,*

The law of demand says that you won/t sell

as many wesites if you raise your price*How many fewer wesites0 How much willyour re#enue fall- or mi"ht it increase0

A scenario

1

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2

Elasticity 3asic idea4

Elasticity measures how much one#ariale responds to chan"es inanother #ariale*

'ne type of elasticity measures howmuch demand for your wesites will fall

if you raise your price*

%e5nition4Elasticityis a numerical measure ofthe responsi#eness of Qd or Qs to

one of its determinants*

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!

&rice Elasticity of %emand

Price elasticity of demandmeasures how much Qdresponds toa chan"e in P*

&riceelasticity ofdemand

6

&ercenta"e chan"e in

Qd

&ercenta"e chan"e inP

Loosely spea7in"- it measures the price8

sensiti#ity of uyers/ demand*

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9

&rice Elasticity of %emand

&riceelasticityof demand

e:uals

P

Q

D

Q2

P2

P1

Q

1

Prisesy

.,;

Q fallsy

.!;

.!;

.,;6 .*!

&riceelasticity ofdemand

6


Qd

&ercenta"e chan"e inP

E

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=

Calculatin" &ercenta"e Chan"es

P

Q

D

+!,

>

3

+,

,

.

A

%emand foryour

wesites

Standard method

of computin" the

percenta"e (;)

chan"e4end #alue ? start

#aluestart#alue

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>

Calculatin" &ercenta"e Chan"es

P

Q

D

+!,

>

3

+,

,

.

A

%emand foryour

wesites

Problem:

The standard method"i#es dierent answers

dependin" on where you

start*Brom A to 3-

Prises !;- Qfalls

11;-

elasticity 6 11! 6

.*11

Brom 3 to A-

Pfalls ,;- Qrises

!,;- elasticity 6 !,,6

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Calculatin" &ercenta"e Chan"es So- we instead use the midpoint

method4end #alue ? start

#aluemidpoint

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The %eterminants of &rice Elasticity4A Summary

The price elasticity of demanddepends on4

the e

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Price Elasticity and %otal&e'enue


1,

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1.

&rice Elasticity and Total Je#enue Continuin" our scenario- if you raise your

pricefrom +,, to +!,- would your re#enue riseor fall0

Je#enue 6 P< Q

A price increase has two eects on re#enue4

Hi"her Pmeans more re#enue on each

unit

you sell* 3ut you sell fewer units (lower Q)-

due to Law of %emand*

Which of these two eects is i""er0It depends on the price elasticity of demand*

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1

&rice Elasticity and Total Je#enue

If demand is elastic- thenprice elast* of demand N .

; chan"e in Q N ; chan"e in P

The fall in re#enue from lower Q is "reaterthan the increase in re#enue from hi"her

P-so re#enue falls*

Je#enue 6 P

*) As a result of a fare war- the price of alu

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Elasticity

ELASTICITY (price elasticity of supply) What is it

How do we compute it What aects it

! dierent "raphs

How it is related to re#enue


1

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2,

&rice Elasticity of Supply

Price elasticity of supply

measures how much Qs

responds toa chan"e in P*

&riceelasticity of

supply

6


Qs&ercenta"e chan"e inP

Loosely spea7in"- it measures sellers/

price8sensiti#ity*

A"ain- use the midpoint method tocompute the percenta"e chan"es*

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2.

Q

2

&rice Elasticity of Supply

&riceelasticityof supplye:uals

P

Q

S

P2

Q1

P1

Prises

y >;

Qrises

y

.9;

>;6 *,

&riceelasticity of

supply

6


Qs&ercenta"e chan"e inP

E

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ELASTICITY A$% ITSA&&LICATI'$ 2

The ariety of SupplyCur#es The slope of the supply cur#e is

closely related to price elasticity ofsupply*

Jule of thum4The Katter the cur#e- the i""er theelasticity*

The steeper the cur#e- the smallerthe elasticity*

Bi#e dierent classi5cations*

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S

&erfectly inelasticF (one e

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S

InelasticF

P

QQ1

P1

Q

2

P2

Q rises lessthan .,;

M.,;.,;

M

.

&rice

elasticityof supply

6; chan"e in

Q; chan"e in

P

6

Prisesy

.,;

Sellers/

price sensiti#ity4

S

cur#e4

Elasticit

y4

relati#ely steep

relati#ely low

M .

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ELASTICITY A$% ITSA&&LICATI'$ 2!

S

nit elasticF

P

QQ1

P1

Q

2

P2

Q rises

y .,;

.,;

.,;

6

.

&rice

elasticityof supply

6; chan"e in

Q; chan"e in

P

6

Prisesy

.,;

Sellers/

price sensiti#ity4

S

cur#e4

Elasticit

y4

intermediate

slope

intermediate

6 .

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S

ElasticF

P

QQ1

P1

Q

2

P2

Q risesmore than

.,;

N.,;.,;

N

.

&rice

elasticityof supply

6; chan"e in

Q; chan"e in

P

6

Prisesy

.,;

Sellers/

price sensiti#ity4

S

cur#e4

Elasticit

y4

relati#ely Kat

relati#ely hi"h

N .

&erfectly elasticF (the other

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ELASTICITY A$% ITSA&&LICATI'$ 2=

S

&erfectly elastic (the othere

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ELASTICITY A$% ITSA&&LICATI'$ 2>

The %eterminants of SupplyElasticity The more easily sellers can chan"e

the :uantity they produce- the"reater the price elasticity of supply*

E

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A C T I E L E A J $ I $ @ 3

Elasticity and chan"es in e:uilirium

2

The supply of eachfront property isinelastic* The supply of new cars is elastic*

Suppose population "rowth causesdemand for oth "oods to doule

(at each price- Qddoules)*

Bor which product will Pchan"e the most0 Bor which product will Qchan"e the most0

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A C T I E L E A J $ I $ @ 3

Answers

!,

3eachfrontproperty (inelastic

supply)4P

Q

D1 S

Q.

P. A

When supply

is inelastic-

an increasein demand

has a i""er

impact on

price than on:uantity*

D2

3

Q

P

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A C T I E L E A J $ I $ @ 3

Answers

!.

$ew cars(elastic supply)4

P

Q

D1

S

Q.

P. A

When supply

is elastic-

an increase

in demandhas a i""er

impact on

:uantity than

on price*

D2

Q

P

3

How the &rice Elasticity of Supply Can

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ELASTICITY A$% ITSA&&LICATI'$ !

S

How the &rice Elasticity of Supply Canary

P

Q

Supplyoftenecomesless elastic

as Qrises-due tocapacitylimits*

Supplyoftenecomesless elastic

as Qrises-due tocapacitylimits*

+.!

!!

.

!,,

+1

.,,

2

,,

elasticity N .

elasticity M .

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'ther Elasticities

ELASTICITY A$% ITSA&&LICATI'$ !1

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'ther Elasticities Income elasticity of demand4 measures

the response of Qdto a chan"e in consumerincome

Incomeelasticity of

demand

6&ercent chan"e in Qd

&ercent chan"e inincome

Jecall from Chapter 24 An increase in

income causes an increase in demand for a

normal"ood* Hence- for normal "oods- income elasticity N

,*

Bor inferior"oods- income elasticity M ,*

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ELASTICITY A$% ITSA&&LICATI'$ !!

'ther Elasticities Cross+price elasticity of demand4

measures the response of demand for one"ood to chan"es in the price of another "ood

Cross8price

elast*of demand

6; chan"e in Qd for

"ood .; chan"e in price of

"ood Bor sustitutes- cross8price elasticity N ,

(e.g*- an increase in price of eef causes an

increase in demand for chic7en) Bor complements- cross8price elasticity M ,

(e.g*- an increase in price of computers

causes decrease in demand for software)

A&&LICATI'$4 %oes %ru" Interdiction Increase or

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A&&LICATI'$4 %oes %ru" Interdiction Increase or

%ecrease %ru"8Jelated Crime0

'ne side eect of ille"al dru" use is crime4sers often turn to crime to 5nance their hait*

We e

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ELASTICITY A$% ITSA&&LICATI'$ !=

D1

&olicy .4 Interdiction

&rice of

%ru"s

Uuantity

of %ru"s

S1

S2

P1

Q

1

P2

Q2

Interdiction reduces

thesupply ofdru"s*Sincedemand for

dru"s isinelastic-Prisespropor8

tionally morethan Qfalls*Jesult4 an increase intotal spendin" ondru"s- and in dru"8

related crime

new #alue ofdru"8related

crime

initial#alue ofdru"8related

crime

&olicy 4 Education

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ELASTICITY A$% ITSA&&LICATI'$ !>

&olicy 4 Education

&rice of

%ru"s

Uuantity

of %ru"s

D1S

P1

Q

1

D2

P2

Q2

Education

reducesthedemandfor dru"s*

Pand Qfall*

Jesult4A decrease intotal

spendin" ondru"s- and indru"8relatedcrime*

initial#alue ofdru"8related

crime

new #alue ofdru"8related

crime

CHA&TEJ SQQAJY

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CHA&TEJ SQQAJY

Elasticity measures the responsi#eness of

Qdor Qsto one of its determinants*

&rice elasticity of demand e:uals percenta"echan"e in Qddi#ided y percenta"e chan"e inP*When it/s less than one- demand is inelastic*FWhen "reater than one- demand is elastic*F

When demand is inelastic- total re#enue riseswhen price rises* When demand is elastic-total re#enue falls when price rises*

!

CHA&TEJ SQQAJY

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CHA&TEJ SQQAJY

%emand is less elastic in the short run-for necessities- for roadly de5ned "oods-or for "oods with few close sustitutes*

&rice elasticity of supply e:uals percenta"echan"e in Qsdi#ided y percenta"e chan"ein P*When it/s less than one- supply is inelastic*FWhen "reater than one- supply is elastic*F

&rice elasticity of supply is "reater in thelon" run than in the short run*

9,

CHA&TEJ SQQAJY

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CHA&TEJ SQQAJY

The income elasticity of demandmeasures how much :uantity

demanded responds to chan"es inuyers/ incomes*

The cross8price elasticity of demand

measures how much demand for one"ood responds to chan"es in theprice of another "ood*

econ 102 ch 5

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