2 Elasticities

8/11/2019 2 Elasticities

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Demand and Supply Elasticities


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What is a demand elasticity?

A demand elasticity is the percentage change in Q that occurs from a 1%

change in another market variable, ceteris paribus

Elasticity is the sensitivity or responsiveness of your demand Common elasticities

Price elasticity of demand

Income elasticity of demand

Cross-price elasticity of demand

These elasticities allow us to precisely quantify the changes in quantity

demanded or shifts in demand curves that we discussed before

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Price Elasticity of Demand

Price elasticity of demand: the percentage change in the quantity

demanded that results from a 1 percent change in the price

Quantify movements along the demand curve (i.e., changes in quantitydemanded)

Formula:

=%

%

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Classifying Demand Elasticities

1. Perfectly inelastic demand: ep= 0

2. Inelastic demand: ep< 1

3. Unit elastic demand: ep= 1

4. Elastic demand: ep> 1

5. Perfectly elastic demand: ep= infinity

Rule of thumb: Flatter curves are more elastic

Steeper curves are more inelastic


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Factors that Affect the Elasticity of Demand

1. Availability of close substitutes

Greater availability implies more elastic

2. Luxuries vs. necessities

Luxuries are more elastic

3. Time horizon

Longer horizon implies more elastic

4. Definition of the market Narrower definition implies more elastic


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Total Revenue and Demand Elasticity

Total revenue: TR = P x Q

If ep< 1, then an increase (decrease) in P will increase (decrease) TR

If ep= 1, then a change in P will not change TR

If ep> 1, then an increase (decrease) in P will decrease (increase) TR


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Income Elasticity of Demand

Income elasticity of demand: percentage change in quantity demanded

given a 1 percent change in income

eI> 0 implies a normal good eI< 0 implies an inferior good


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Cross-Price Elasticity of Demand

Cross price elasticity of demand: percentage change in quantity

demanded of good A given a 1 percent change in the price of good B

eXP> 0 implies substitutes

eXP< 0 implies complements


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Elasticity of Supply


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Classifying Supply Elasticities

1. Perfectly inelastic supply: es= 0

2. Inelastic supply: es< 1

3. Unit elastic supply: es= 1

4. Elastic supply: es> 1

5. Perfectly elastic supply: es= infinity


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Factors that Affect the Elasticity of Supply

1. Flexibility of production

More flexible implies more elastic

2. Time horizon

Longer horizon implies more elastic


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Calculating Elasticities

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Calculating Price Elasticity of Demand

Price elasticity of demand:

=%

%

Note that % =

And that % =

Therefore:

=

=

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Calculating Price Elasticity of Demand, contd

Price elasticity of demand:

=

What is

?

is the (inverse of) the slope!

So

=

1

Elasticity is closely related to the slope of the demand curve

But it is notequivalent to the slope

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Why dont we use slope?

The slopes of the demand and supply curve tell us a lot about demand and

supply, so why use elasticities?

The slope depends upon the units that you use Example: Cans of soda vs liters of soda

Different goods have different units, so slopes are hard to compare

Example: liters of soda vs. buckets of popcorn

Elasticities make it possible to compare across goods % change in soda demand vs % change in popcorn demand

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Calculating elasticities


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The Midpoint Method

The midpoint method gives a good approximation of the elasticity:

)(2

1)(

2

112

12

12

12

PP

PP

QQ

QQep


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Total Revenue and Demand Elasticity, revisited

Total revenue: TR = P x Q

If ep< 1, then an increase (decrease) in P will increase (decrease) TR

If ep= 1, then a change in P will not change TR

If ep> 1, then an increase (decrease) in P will decrease (increase) TR

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2 Elasticities