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Concept of Elasticity

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Elasticity . . .

•  … allows us to analyze supply an eman

with !reater precision"

• … is a measure of how much #uyers an sellers

respon to chan!es in mar$et conitions

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T%E E&'ST(C(T) *+ ,E'.,

• The price elasticity of demand  is a measure of

how much the /uantity emane of a !oo

respons to a chan!e in the price of that !oo"

• When we tal$ a#out elasticity that responsi1eness

is always measure in percenta!e terms"

• Specifically the price elasticity of eman is the

 percenta!e chan!e in /uantity emane ue to a percenta!e chan!e in the price"

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The Price Elasticity of Demand and ItsDeterminants

• '1aila#ility of Close Su#stitutes

•  .ecessities 1ersus &uuries

• ,efinition of the ar$et

• Time %orizon

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The Price Elasticity of Demand and ItsDeterminants

• ,eman tens to #e more elastic3

• the lar!er the num#er of close su#stitutes"

• if the !oo is a luury"

• the more narrowly efine the mar$et"

• the lon!er the time perio"

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Computing the Price Elasticity of Demand

• The price elasticity of eman is compute as

the percenta!e chan!e in the /uantity

emane i1ie #y the percenta!e chan!e in

 price"

4 r i c e e l a s t i c i t y o f e m a n 54 e r c e n t a ! e c h a n ! e i n / u a n t i t y e m a n e

4 e r c e n t a ! e c h a n ! e i n p r i c e

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The Variety of Demand Curves

• (nelastic ,eman

• 6uantity emane oes not respon stron!ly to

 price chan!es"

• 4rice elasticity of eman is less than one"

• Elastic ,eman

• 6uantity emane respons stron!ly to chan!es in

 price"• 4rice elasticity of eman is !reater than one"

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The Variety of Demand Curves

• 4erfectly (nelastic

• 6uantity emane oes not respon to price

chan!es"

• 4erfectly Elastic• 6uantity emane chan!es infinitely with any

chan!e in price"

• nit Elastic• 6uantity emane chan!es #y the same percenta!e

as the price"

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The Variety of Demand Curves

• 8ecause the price elasticity of eman

measures how much /uantity emane

respons to the price it is closely relate to the

slope of the eman cur1e"• 8ut it is not the same thin! as the slope9

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Figure 1 The Price Elasticity of Demand

(a) Perfectly Inelastic Demand: Elasticity Euals !

$54

"uantity

Demand

1000

1. Anincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price

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Figure 1 The Price Elasticity of Demand

(#) Inelastic Demand: Elasticity Is $ess Than %

"uantity0

$5

90

Demand1. A 25%increasein price . . .

Price

2. . . . leads to an 11% decrease in quantity demanded.

4

100

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Figure 1 The Price Elasticity of Demand

2. . . . leads to a 22% decrease in quantity demanded.

(c) &nit Elastic Demand: Elasticity Euals %

"uantity

4

1000

Price

$5

0

1. A 25%increasein price . . .

Demand

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Figure 1 The Price Elasticity of Demand

(d) Elastic Demand: Elasticity Is 'reater Than %

Demand

"uantity

4

1000

Price

$5

50

1. A 25%increasein price . . .

2. . . . leads to a !"% decrease in quantity demanded.

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Figure 1 The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Euals Infinity

"uantity0

Price

$4 Demand

2. At e#actly $4consumers ill&uy any quantity.

1. At any pricea&ove $4 quantity

demanded is 'ero.

(. At a price &elo $4quantity demanded is in)inite.

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Total evenue and the Price Elasticity ofDemand

• Total revenue is the amount pai #y #uyers anrecei1e #y sellers of a !oo"

• Compute as the price of the !oo times the /uantity

sol"

Q P TR   ×=

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Figure 2 Total Revenue

Demand

"uantity

Q

P 

0

Price

 P  * Q + $400

,revenue-

$4

100

hen the price is *+, consumers-ill demand %!! units, and spend*+!! on this good.

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Elasticity and Total evenue along a$inear Demand Curve

• With an inelastic eman cur1e an increase in

 price leas to a ecrease in /uantity that is

 proportionately smaller" Thus total re1enue

increases"

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Figure 3 How Total Revenue Changes hen Price Changes!

"nelastic Demand

Demand

"uantity0

Price

evenue + $100

"uantity0

Price

evenue + $240

Demand$1

100

$(

0

n Increase in price from *% to */ 0

0 leads to an Increase intotal revenue from *%!! to*1+!

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Elasticity and Total evenue along a $inear DemandCurve

• With an elastic eman cur1e an increase in

the price leas to a ecrease in /uantity

emane that is proportionately lar!er" Thus

total revenue decreases.

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Figure 3 How Total Revenue Changes hen Price Changes!

Elastic Demand

Demand

"uantity0

Price

evenue + $200

$4

50

Demand

"uantity0

Price

evenue + $100

$5

20

n Increase in price from *+ to *2 0

0 leads to an decrease intotal revenue from *1!! to*%!!

3ote that -ith each price increase, the $a- of Demand still holds 4 anincrease in price leads to a decrease in the uantity demanded. It is the

change in T that varies5

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! 1 6+ %!7 %1 %+

1

%

+

/

2

6

*8

Demand is elastic/

demand is responsive tochanges in price.

Demand is inelastic/ demand isnot very responsive to changesin price.

hen price increases )rom

$4 to $5 declines )rom$24 to $20.

hen price increases )rom$2 to $( increases )rom

$20 to $24.

Elasticity is 9 % in this range.

Elasticity is % in this range.

Price

"uantity

Elasticity of a #inear Demand Curve

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;ther Demand Elasticities

• (ncome Elasticity of ,eman

•  Income elasticity of demand  measures how much

the /uantity emane of a !oo respons to a

chan!e in consumers: income"• (t is compute as the percenta!e chan!e in the

/uantity emane i1ie #y the percenta!e

chan!e in income"

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;ther Demand Elasticities

• (ncome Elasticity

• Types of ;oos

•  .ormal ;oos

• (nferior ;oos• %i!her income raises the /uantity emane for

normal !oos #ut lowers the /uantity emane for

inferior !oos"

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;ther Demand Elasticities

• (ncome Elasticity

• ;oos consumers re!ar as necessities ten to #e

income inelastic

• Eamples inclue foo fuel clothin! utilities anmeical ser1ices"

• ;oos consumers re!ar as luuries ten to #e

income elastic"

• Eamples inclue sports cars furs an epensi1e foos"

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;ther Demand Elasticities

• Cross-price elasticity of demand • ' measure of how much the /uantity emane of one !oo

respons to a chan!e in the price of another !oo compute

as the percenta!e chan!e in /uantity emane of the first

!oo i1ie #y the percenta!e chan!e in the price of thesecon !oo

2!ooof  pricein<chan!e

=!ooof emane/uantityin<chan!eemanof elasticity price-Cross   =

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$ummary

© 2007 Thomson South-Western

• 4rice elasticity of eman measures how muchthe /uantity emane respons to chan!es inthe price"

• 4rice elasticity of eman is calculate as the percenta!e chan!e in /uantity emanei1ie #y the percenta!e chan!e in price" > (f a eman cur1e is elastic total re1enue falls

when the price rises"

 > (f it is inelastic total re1enue rises as the price rises"

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$ummary

• The income elasticity of eman measureshow much the /uantity emane respons tochan!es in consumers: income"

• The cross-price elasticity of eman measureshow much the /uantity emane of one !oorespons to the price of another !oo"