Elasticity 2dix

8/8/2019 Elasticity 2dix

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SUMMARY

chapter:

6

>>

Krugman/WellsEconomics

2009 Worth Publishers

Elasticity


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WHAT YOU WILL LEARN IN THIS CHAPTER

What is the definition ofelasticity?

What is the meaning and importance of:

price elasticity of demand?

income elasticity of demand? price elasticity of supply?

What factors influence the size of these various

elasticities?

How the cross-price elasticity of demand

measures the responsiveness of demand for one

good to changes in the price of another good


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Definingand Measuring Elasticity

The priceelasticity ofdemandis the ratio ofthe percent change in the quantity demanded

to the percent change in the price as we

move along the demand curve (dropping the

minus sign).


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The Price Elasticity ofDemand


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D

10.09.9

$21

20

Price of vaccination

A

0Quantity of vaccinations (millions)

B

DemandforVaccinations

When price rises to $21per barrel, world demandfalls to 9.9 million barrels

per day (point B).


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Calculatingthe Price Elasticity ofDemand


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Usingthe Midpoint Method

The midpointmethodis a technique for calculating

the percent change.

In this approach, we calculate changes in a variable

compared with the average, or midpoint, of thestarting and final values.


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Some Estimated Price Elasticities ofDemand

Good Priceelasticity

Inelastic demand

Eggs 0.1

Beef 0.4 Stationery 0.5

Gasoline 0.5

Elastic demand

Housing 1.2

Restaurant meals 2.3

Airline travel 2.4

Foreign travel 4.1

Priceelasticity ofdemand1


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Interpretingthe Price Elasticity ofDemand

Two Extreme Cases ofPrice Elasticity of

Demand:

Demand is perfectlyinelastic when the quantity

demanded does not respond at all to changes inthe price. When demand is perfectly inelastic, thedemand curve is a vertical line.

Demand is perfectlyelasticwhen any priceincrease will cause the quantity demanded to dropto zero. When demand is perfectly elastic, thedemand curve is a horizontal line.


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Two Extreme Cases ofPrice Elasticity ofDemand

10Quantity ofshoelaces (billions ofpairsperyear)

(a) Perfectly InelasticDemand: PriceElasticity ofDemand = 0

$3

$2

Price ofshoelaces(perpair)

leaves thequantitydemanded

unchanged.

An increase inprice

D1


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Two Extreme Cases ofPrice Elasticity ofDemand

At any price above $5,quantity demanded is

zero

At exactly $5,

consumerswill buy anyquantity

At any price below$5, quantitydemanded is infinite

0

(b) Price ElasticDemand: PriceElasticity ofDemand =

$5

Price ofpinktennis balls(perdozen)

D2

Quantity oftennis balls (dozensperyear)


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Interpretingthe Price Elasticity ofDemand

Demand is elasticif the price elasticity of demand

is greater than 1.

Demand is inelasticif the price elasticity of

demand is less than 1.

Demand is unit-elasticif the price elasticity of

demand is exactly 1.


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(a) Unit-ElasticDemand: Price Elasticity ofDemand = 1

900 1,100

B

A

0

$1.10

0.90

Price of crossing

A20%increase inthe price . . .

D1

. . . generates a 20% decrease inthe quantity of crossingsdemanded.

Quantity of crossings(per day)

Unit Elasticity ofDemand


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(b) InelasticDemand: Price Elasticity ofDemand = 0.5

950 1,050

B

A

0

$1.10

0.90

D2

Price of crossing

A20% increasein the price . . .

. . . generates a 10% decrease in the

quantity of crossings demanded.


InelasticDemand


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(c) ElasticDemand: Price Elasticity ofDemand = 2

generates a 40%decrease in the quantity ofcrossings demanded.

800 1,200

B

A

0

$1.10

0.90


D3

Price of crossing

A20%increase inthe price . . .

ElasticDemand


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WhyDoes It MatterWhetherDemandis Unit-Elastic, Inelastic, orElastic?

Because this classification predicts how changes in

the price of a good will affect the total revenue

earned by producers from the sale of that good.

The totalrevenueis defined as the total value ofsales of a good or service, i.e.

Total Revenue = Price Quantity Sold


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Total Revenue by Area

1,1000

$0.90

Price ofcrossing

DTotal revenue = price xquantity = $990

Quantity ofcrossings (perday)


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Elasticityand Total Revenue

When a seller raises the price of a good, there aretwo countervailing effects in action (except in the

rare case of a good with perfectly elastic or

perfectly inelastic demand):

A price effect: After a price increase, each unit sold sells

at a higher price, which tends to raise revenue.

A quantity effect: After a price increase, fewer units are

sold, which tends to lower revenue.


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Effect ofa Price Increase on Total Revenue

B A

C

Price effect of priceincrease: higher price foreach unit sold

900 1,1000

$1.10

0.90

Quantity ofcrossings (perday)

Price ofcrossing

D

Quantity effect ofprice increase:fewer units sold


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Elasticityand Total Revenue

If demand for a good is elastic(the price elasticity of

demand is greater than 1), an increase in price reduces totalrevenue.

In this case, the quantity effect is stronger than the priceeffect.

If demand for a good is inelastic(the price elasticity of

demand is less than 1), a higher price increases totalrevenue.

In this case, the price effect is stronger than the quantity

effect.

If demand for a good is unit-elastic(the price elasticity ofdemand is 1), an increase in price does not change total

revenue.

In this case, the sales effect and the price effect exactly

offset each other.


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Price Elasticity ofDemandand Total Revenue


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Demand Scheduleand Total Revenue

D

00 1 2 3 4 5 6 7 1098

$252421

16

9

Quantity

Totalrevenue

0 1 2 3 4 5 6 7 1098

$10987654321

Quantity

Price

Demand is elastic: ahigher price reducestotal revenue

Elastic

Inelastic

Unit-elastic

Demand is inelastic: ahigher price increasestotal revenue

$0

1

2

34

5

67

8

9

10

$0

9

16

21

24

25

2421

16

9

0

10

9

8

76

5

43

2

1

0

TotalRevenue

Quantitydemanded

Demand Scheduleand Total Revenuefora LinearDemand Curve

Price

The price elasticityof demand changesalong the demandcurve


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What FactorsDeterminethe Price Elasticity ofDemand?

Price Elasticity ofDemand is determined by:

WhetherClose Substitutes Are Available

Whether the Good Is a Necessity or a Luxury

Share ofIncome Spent on the Good Time


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OtherDemand Elasticities: Cross-Price Elasticity

The cross-priceelasticity ofdemandbetween two

goods measures the effect of the change in one goodsprice on the quantity demanded of the other good.

It is equal to the percent change in the quantity demanded

of one good divided by the percent change in the other

goods price.

The Cross-Price Elasticity ofDemand

between Goods A and B


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Cross-Price Elasticity

Goods are substitutes when the cross-price

elasticity of demandis positive.

Goods are complements when the cross-price

elasticity of demand is negative.


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The Income Elasticity ofDemand

The incomeelasticity ofdemandis the percent

change in the quantity of a good demanded when a

consumers income changes divided by the percent

change in the consumers income.


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NormalGoodsand InferiorGoods

When the income elasticity of demand is positive,

the good is a normal good- that is, the quantity

demanded at any given price increases as income

increases.

When the income elasticity of demand is negative,

the good is an inferior good- that is, the quantity

demanded at any given price decreases as income

increases.


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Measuringthe Price Elasticity ofSupply

The priceelasticity ofsupplyis a measure of the

responsiveness of the quantity of a good supplied to

the price of that good. It is the ratio of the percent

change in the quantity supplied to the percent

change in the price as we move along the supply

curve.


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Two Extreme Cases ofPrice Elasticity ofSupply

(a) Perfectly Inelastic Supply:

Price Elasticity ofSupply = 0

1000

Quantity of cellphone frequencies

$3,000

2,000

Price of cell phonefrequency

S1

leavesthe quantitysuppliedunchanged

An increasein price

(b) PerfectlyElastic Supply:

Price Elasticity ofSupply =

0Quantity of

pizzas

$12

Price ofpizza

S2

At any price above$12, quantity

supplied is infinite.

At exactly $12,producers will

produce anyquantity

At any pricebelow $12,quantitysupplied is

zero.


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Two Extreme Cases ofPrice Elasticity ofSupply

There is perfectlyinelasticsupplywhen the price

elasticity of supply is zero, so that changes in the

price of the good have no effect on the quantity

supplied. A perfectly inelastic supply curve is a

vertical line.

There is perfectlyelasticsupplywhen even a tiny

increase or reduction in the price will lead to very

large changes in the quantity supplied, so that theprice elasticity of supply is infinite. A perfectly

elastic supply curve is a horizontal line.


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What FactorsDeterminethe Price Elasticity ofSupply?

The Availability ofInputs: The price elasticity of

supply tends to be large when inputs are readily

available and can be shifted into and out of

production at a relatively low cost. It tends to be

small when inputs are difficult to obtain.

Time: The price elasticity of supply tends to grow

larger as producers have more time to respond to a

price change. This means that the long-run priceelasticity of supply is often higher than the short-

run elasticity.


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An Elasticity Menagerie


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An Elasticity Menagerie


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SUMMARY

1. Elasticityis a general measure ofresponsiveness that

can be used to answer such questions.2. The priceelasticity ofdemandthe percent change in

the quantity demanded divided by the percent change in

the price (dropping the minus sign)is a measure of the

responsiveness of the quantity demanded to changes in

the price.

3. The responsiveness of the quantity demanded to price can

range from perfectlyinelasticdemand,where the

quantity demanded is unaffected by the price, to perfectly

elasticdemand,where there is a unique price at whichconsumers will buy as much or as little as they are offered.

When demand is perfectly inelastic, the demand curve is a

vertical line; when it is perfectly elastic, the demand curve

is a horizontal line.


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SUMMARY

4. The price elasticity of demand is classified according to

whether it is more or less than 1.If it is greater than 1,demand is elastic;if it is less than 1, demand is inelastic;

if it is exactly 1, demand is unit-elastic. This classification

determines how totalrevenue,the total value of sales,

changes when the price changes.

5. The price elasticity of demand depends on whether thereare close substitutes for the good, whether the good is a

necessity or a luxury, the share of income spent on the

good, and the length of time that has elapsed since the

price change.6. The cross-priceelasticity ofdemandmeasures the

effect of a change in one goods price on the quantity of

another good demanded.


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SUMMARY

7. The incomeelasticity ofdemandis the percent change

in the quantity of a good demanded when a consumersincome changes divided by the percent change in income.

If the income elasticity is greater than 1, a good is income

elastic;if it is positive and less than 1, the good is

income-inelastic.

8. The priceelasticity ofsupplyis the percent change inthe quantity of a good supplied divided by the percent

change in the price. If the quantity supplied does not

change at all, we have an instance ofperfectlyinelastic

supply;the supply curve is a vertical line.If the quantitysupplied is zero below some price but infinite above that

price, we have an instance ofperfectlyelasticsupply;

the supply curve is a horizontal line.


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SUMMARY

9. The price elasticity of supply depends on the availability ofresources to expand production and on time. It is higherwhen inputs are available at relatively low cost and thelonger the time elapsed since the price change.

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Elasticity 2dix

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