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CHAPTER 20
ELASTICITY of DEMAND &
SUPPLYBy: Amanda Reina
&
Sandra Avila
Three types of Elasticity Price Elasticity Cross Elasticity Income Elasticity
Price Elasticity Response of consumers and producers to
price change Price Elasticity of Demand Price Elasticity of Supply
Price Elasticity of Demand (Formulas)
Ed=
% change in quantity demanded
of product X
____________________________
% change in price of product X
Price Elasticity of Demand (Formulas)
Ed=
[change in quantity demanded of X /
original quantity demanded of X]
__________________________________
[change in price of X / original price of X]
Price Elasticity of DemandElimination of Minus Sign
Price and Quantity demanded are inversely related because of the down-sloping of the demand curve. Coefficient (first number) of demand Ed will
ALWAYS be negative (-). Take the absolute value. P
0 Q
Down-Sloping
D1
Price Elasticity of DemandExample
Ed= % change in quantity demanded of product X __________________________ % change in price of product
P↓ Qd ↑
This means that the numerator in the
formula will be positive and the denominator negative.
Price Elasticity of Demand Interpretations of Ed
Elastic Demand: Ed > 1 Inelastic Demand: Ed < 1 Unit Elasticity: Ed = 1 Perfectly Inelastic: Ed = 0
Consumers have NO response to price change (Vertical Line)
Perfectly Elastic: Ed =∞ A slight price fall causes consumers to increase their
purchases from 0 to all they can get (Horizontal Line)
Ed= % change in quantity demanded of product X __________________________ % change in price of product
Mid-Point Formula
Ed = [Change in quantity /(sum of quantities/2)]
[Change in price /(sum of prices/2)]
Graphical Analysis Demand is :
Elastic with high prices (lower quantity) Inelastic with low prices (higher quantity)
Total Revenue Test
TR = P X QP= PriceQ= Quantity
Total Revenue Test Elastic
↓P = TR↑
Inelastic ↓P = TR ↓
Example
5
4
4 5 Quantity Demanded
Price ($)
Unit Elastic
Ed = 1
Elastic
Ed > 1
Inelastic
Ed < 1
Determinants of Price Elasticity of Demand Substitutability:
Higher # of Substitute goods = greater Ed
Proportion of Income: Higher price of good relative to consumer’s income =
greater Ed
Luxuries v. Necessities: The more the good is luxury = the greater Ed is
Time: Longer time period = greater Ed
Price Elasticity of Supply Response of consumers and producers to
price change
Es = % change in quantity supplied
of product X
____________________________
% change in price of product X
Degree of Price Elasticity of Supply
How quickly and easily producers can shift resources b/w alternative uses “The longer the time, the greater the resource
“shiftability.”
Impact of time on Elasticity of Supply
Immediate market period Period that occurs immediately after a change in
market price, where it is too soon for producers to respond with a change in quantity supplied
Perfectly inelastic supply
0D1
D2
Sm
P0
Pm
Q
P
Qo
Impact of time on Elasticity of Supply Short run
Period too short to change plant capacity but long enough to use a fixed plant more or less intensively
P
Q 0D1
D2
Ss
P0
Ps
Qo Qs
**Supply more elastic than market period
Impact of time on Elasticity of Supply
Long run Period long enough for all desired adjustments to
be made
P
Q
SL
D2
D1
P0
Pl
Qo Ql
**Supply is even more elastic
Cross Elasticity of Demand Measures how sensitive consumer
purchases of product X are to a change in the price of product Y. Related products Change in income
Cross Elasticity of DemandFormula
Exy =
% change in quantity demanded
of product X
__________________________
% change in price of product Y
Cross Elasticity of Demand Substitute goods have a positive Exy
Sales of X is related to price changes of Y Beef and Chicken
Complementary goods have a negative Exy
Increase in price X = Decrease demand in Y Milk and Chocolate powder
Independent goods have zero Exy
X and Y are unrelated Candy and Books
Income Elasticity of Demand Measurement of the consumers’ response
to a change in their incomes by buying more/less goods
Ei = % change in quantity demanded
% change in income
Income Elasticity of Demand Positive Ei = Normal/ Superior Goods
Qd & I move in the same direction
Negative Ei = Inferior Goods Qd & I move in opposite direction