ElasticityElasticitychapter 20chapter 20How do I know how much quantity How do I know how much quantity demanded changes when price demanded changes when price changes???????changes???????

ElasticityElasticity

Def-responsiveness to changeDef-responsiveness to change How responsive is demand to a change in price?How responsive is demand to a change in price? How responsive is supply to a change in price?How responsive is supply to a change in price?

Depends on:Depends on: Number of substitutesNumber of substitutes

More substitutes---more elasticMore substitutes---more elastic IncomeIncome

Larger % of budget---more elasticLarger % of budget---more elastic Necessity vs. luxuryNecessity vs. luxury

Bread/milk--inelasticBread/milk--inelastic TimeTime

Short term—inelasticShort term—inelastic Long term-elastic—find substitutesLong term-elastic—find substitutes

How to figure out How to figure out Elasticity?Elasticity?

Midpoint FormulaMidpoint Formula Change in QdChange in Qd (Q1 +Q2) divided by 2(Q1 +Q2) divided by 2

Divided byDivided by Change in priceChange in price (p1 + p2) divided by 2(p1 + p2) divided by 2

Ed =

Percentage change in quantitydemanded of product X

Percentage change in priceof product X

Perfectly InelasticPerfectly Inelastic

Perfectly ElasticPerfectly Elastic

Elasticity as a RangeElasticity as a Range

The higher the price-The higher the price- the more elasticthe more elastic The lower theThe lower the price—price— the less elasticthe less elastic

Total Revenue TestTotal Revenue Test

Elastic-if price increases—total revenue decreasesInelastic-If price increases—total revenue increases

Income Elasticity of Income Elasticity of DemandDemand

% change in Qd% change in Qd % change in Income% change in Income

Income increases----causes increase in Income increases----causes increase in Qd---normal goodQd---normal good

Income increases—causes a decrease in Income increases—causes a decrease in Qd—inferior goodsQd—inferior goods

Cross Elasticity Of Cross Elasticity Of DemandDemand

% change in Qd of product X% change in Qd of product X %change in Qd of product Y%change in Qd of product Y

If complements—negative #If complements—negative # If substitutes—positive #If substitutes—positive #

Price Elasticity of SupplyPrice Elasticity of Supply

%change in Qs%change in Qs %change in price%change in price

Key issue-timeKey issue-time Market periodMarket period Short runShort run Long runLong run

Po

Pm

P

Q

D1

Qo

D2

An increase indemand withoutenough time tochange supplycauses… anincrease in price

Sm

Immediate Market period

PRICE ELASTICITY OF SUPPLY

Po

P

Q

D1

Qo

D2

Short RunPRICE ELASTICITY OF SUPPLY

Ps

An increase indemand withless intensitysupply usecauses...a lowerincrease in price

Ss

Qs

Po

P

Q

D1

Qo

D2

Long RunPRICE ELASTICITY OF SUPPLY

PL

An increase indemand in thelong run allowsgreater changecausing...

SL

QL

Even more elasticresponse - lessprice increase