ELASTICITY A concept used by economists to measure the responsiveness of people to changes in economic variables. A concept used by economists to measure

ELASTICITYELASTICITY

A concept used by economists A concept used by economists to measure the to measure the responsivenessresponsiveness of people to changes in of people to changes in economic variables.economic variables.

ELASTICITYELASTICITY If people are If people are very responsivevery responsive to to

changes in economic variables, the changes in economic variables, the measure is said to be measure is said to be elasticelastic or or highly highly elastic.elastic.

If people are If people are not very responsivenot very responsive to to changes in economic variables, the changes in economic variables, the measure is said to be measure is said to be inelastic.inelastic.

PRICE ELASTICITY OF DEMANDPRICE ELASTICITY OF DEMAND

• How much more of a product will a How much more of a product will a consumer buy when the product consumer buy when the product price decreases.price decreases.

• How much less of a product will a How much less of a product will a consumer buy when the product consumer buy when the product price increases.price increases.

• What is the responsiveness of What is the responsiveness of consumers to changes in price.consumers to changes in price.


percentage change in quantity demanded percentage change in quantity demanded EEdd= =

-------------------------------------------- --------------------------------------------

percentage change in pricepercentage change in price

• Percentage change in price equals the absolute change Percentage change in price equals the absolute change in price divided by the initial price;in price divided by the initial price;

• Percentage change in quantity equals the absolute Percentage change in quantity equals the absolute change in quantity divided by the initial quantity.change in quantity divided by the initial quantity.


• If the price of milk increases from If the price of milk increases from $2.00/quart to $2.20/quart, and$2.00/quart to $2.20/quart, and

• the resulting quantity demanded changes the resulting quantity demanded changes from 100 million gallons of milk to 85 from 100 million gallons of milk to 85 gallons of milk,gallons of milk,

• what is the elasticity of demand for milk ?what is the elasticity of demand for milk ?


% change Quantity % change Quantity E Edd = -------------------------------------- = --------------------------------------

% change Price % change Price

(New Quantity - Original Quantity) / (Original Quantity) (New Quantity - Original Quantity) / (Original Quantity) EEd d = ---------------------------------------------------------------- = ----------------------------------------------------------------

(New Price - Original Price) / (Original Price)(New Price - Original Price) / (Original Price)


• (85 -100) / 100 -15 / 100 (85 -100) / 100 -15 / 100 EEdd = ------------------------------ = ------------------------------ = ------------------------------ = ------------------------------

$2.20 -$2.00) / $2.00 $2.20 -$2.00) / $2.00 $0.20 / $2.00 $0.20 / $2.00

• EEdd = 15% / 10% = 1.50 = 15% / 10% = 1.50 Demand is elastic.Demand is elastic.

PRICEPRICEOF MILKOF MILK$$$$

Millions of Gallons of Milk per Year Millions of Gallons of Milk per Year

$2.20$2.20

$2.00$2.00

8585 100100

Market DemandMarket DemandCurveCurve

PRICE ELASTICITY OF DEMANDPRICE ELASTICITY OF DEMANDMidpoint (More Precise) ApproachMidpoint (More Precise) Approach

% change Quantity% change Quantity E Edd = =

---------------------------------------------------------- % % change Pricechange Price

(New Quantity - Original Quantity) / ((New Quantity - Original Quantity) / (AverageAverage QuantityQuantity) )

EEdd = ---------------------------------------------------------------- = ----------------------------------------------------------------

(New Price - Original Price) / (New Price - Original Price) / (Average Price(Average Price))

PRICE ELASTICITY OF DEMANDPRICE ELASTICITY OF DEMANDMidpoint (More Precise) ApproachMidpoint (More Precise) Approach

• [ (85 - 100) ÷ (85 +100) ] / 2 [ (85 - 100) ÷ (85 +100) ] / 2 E Edd = ------------------------------------- = -------------------------------------

[ ($2.20 - $2.00) ÷ ($2.20 + $2.00) ] / 2[ ($2.20 - $2.00) ÷ ($2.20 + $2.00) ] / 2• -15 / 92.5 -15 / 92.5 16.22% 16.22%

E Edd = ---------------------------- = -------------------------- = 1.70 Demand is = ---------------------------- = -------------------------- = 1.70 Demand is

elastic.elastic. $0.20 / $2. $0.20 / $2. 9.52%9.52%

PRICEPRICEOF MILKOF MILK$$$$


$2.20$2.20

$2.00$2.00

8585 100100

Market DemandMarket DemandCurveCurve

THREE ELASTICITY GROUPS OF THREE ELASTICITY GROUPS OF CONSUMER DEMANDCONSUMER DEMAND

GROUP QUANTITY TO PRICE RELATIONSHIP VALUEGROUP QUANTITY TO PRICE RELATIONSHIP VALUE

ELASTICELASTIC Percentage change in quantityPercentage change in quantity > 1 > 1greater than percentage change in price.greater than percentage change in price.

INELASTICINELASTIC Petrcentage change in quantityPetrcentage change in quantity < 1 < 1

less than percentage change in price.less than percentage change in price.

UNIT UNIT Percentage change in quantity Percentage change in quantity =1 =1

ELASTICELASTIC equal to percentage change in price.equal to percentage change in price.

PRICE ELASTICITY AND PRICE ELASTICITY AND SUBSTITUTESSUBSTITUTES

• NO GOOD SUBSTITUTES NO GOOD SUBSTITUTES ----

Consumers are not very responsive to changes Consumers are not very responsive to changes in price;in price;

Example:Example: insulin for diabetics;insulin for diabetics;

Price elasticity of demand is Price elasticity of demand is inelasticinelastic..• MANY SUBSTITUTES MANY SUBSTITUTES ----

Consumers will readily switch to alternative Consumers will readily switch to alternative product for small price changes;product for small price changes;

Example:Example: cornflakes;cornflakes;

Price elasticity of demand is Price elasticity of demand is elasticelastic..

Estimated Price Elasticities of Demand Estimated Price Elasticities of Demand for Selected Productsfor Selected Products

PRODUCTPRODUCT ELASTICITYELASTICITY

saltsalt 0.10.1

waterwater 0.20.2

coffeecoffee 0.30.3

cigarettescigarettes 0.30.3

shoes and footwareshoes and footware 0.70.7

housinghousing 1.01.0

automobilesautomobiles 1.21.2

foreign travelforeign travel 1.81.8

restaurant mealsrestaurant meals 2.32.3

air travelair travel 2.42.4

motion picturesmotion pictures 3.73.7

specific brands of coffeespecific brands of coffee 5.65.6

Other Determinants of Demand ElasticityOther Determinants of Demand Elasticity

• TIME -TIME -

Greater timeGreater time permits finding more substitutes; permits finding more substitutes; consequently, elasticity of demand increases with consequently, elasticity of demand increases with time: Greater time -- time: Greater time -- greater elasticitygreater elasticity..

• PERCENTAGE OF BUDGET -PERCENTAGE OF BUDGET -

The The smallersmaller the the priceprice of a product with respect to of a product with respect to the size of the household budget, the the size of the household budget, the moremore inelasticinelastic will be the product demand.will be the product demand.

• NECESSITIES VERSUS LUXURIES -NECESSITIES VERSUS LUXURIES -

The The greater the needgreater the need for a product, the for a product, the moremore inelasticinelastic will be the product demand. will be the product demand.

Elasticity Along a Linear Demand CurveElasticity Along a Linear Demand Curve

PRICEPRICE$$$$

QUANTITY CONSUMED PER DAYQUANTITY CONSUMED PER DAY

8080

7676

1010 1212

Elasticity = 4 = (20% / 5%)Elasticity = 4 = (20% / 5%)

5050

4646

2525 2727

2020

1616

4040 4242

Elasticity = 1.0 = (8% / 8%)Elasticity = 1.0 = (8% / 8%)

Elasticity = 0.25 = Elasticity = 0.25 = (5% / 20%)(5% / 20%)

Elasticity Along a Linear Demand CurveElasticity Along a Linear Demand Curve

PRICEPRICE$$$$

QUANTITY CONSUMED PER DAYQUANTITY CONSUMED PER DAY

8080

7676

1010 1212

Elasticity = 4 : Elasticity = 4 : ELASTICELASTIC

5050

4646

2525 2727

2020

1616

4040 4242

Elasticity = 1.0 : Elasticity = 1.0 : UNIT ELASTICUNIT ELASTIC

Elasticity = 0.25 :Elasticity = 0.25 :INELASTICINELASTIC

Using Elasticity of Demand to Calculate Using Elasticity of Demand to Calculate Change in Quantity DemandedChange in Quantity Demanded

GIVEN:GIVEN:

• Elasticity of Demand;Elasticity of Demand;

• Percentage change in Price;Percentage change in Price;

• EEdd = % change Quantity ÷ % change Price; = % change Quantity ÷ % change Price;

Percentage change in quantity may be Percentage change in quantity may be calculated from the two known values:calculated from the two known values:

• % change Quantity = E% change Quantity = Edd x % change Price x % change Price

Using Elasticity of Demand to Predict Using Elasticity of Demand to Predict changes in Total Revenuechanges in Total Revenue

DEMANDDEMAND PRICEPRICE TOTAL REVENUETOTAL REVENUE

ElasticElastic IncreaseIncrease DeclinesDeclines

ElasticElastic DecreaseDecrease IncreasesIncreases(A negative relationship exists between price and total (A negative relationship exists between price and total

revenue for an elastic demand.)revenue for an elastic demand.)

InelasticInelastic IncreaseIncrease IncreasesIncreases

InelasticInelastic DecreaseDecrease DeclinesDeclines(A positive relationship exists between price and total (A positive relationship exists between price and total

revenue for an inelastic demand.)revenue for an inelastic demand.)

PRICE ELASTICITY OF SUPPLYPRICE ELASTICITY OF SUPPLY

• How much more of a product will a How much more of a product will a producer make when the product price producer make when the product price increases.increases.

• How much less of a product will a How much less of a product will a producer make when the product price producer make when the product price drops.drops.

• What is the responsiveness of producers What is the responsiveness of producers to changes in price. to changes in price.


percentage change in quantity supplied percentage change in quantity supplied

EEdd= ----------------------------------------= ----------------------------------------percentage change in pricepercentage change in price

• Percentage change in price equals the absolute Percentage change in price equals the absolute change in price divided by the initial price;change in price divided by the initial price;

• Percentage change in quantity equals the Percentage change in quantity equals the absolute change in quantity divided by the initial absolute change in quantity divided by the initial quantity.quantity.


• If the price of milk increases from If the price of milk increases from $2.00/quart to $2.20/quart, and$2.00/quart to $2.20/quart, and

• the resulting quantity supplied changes the resulting quantity supplied changes from 100 million gallons of milk to 120 from 100 million gallons of milk to 120 gallons of milk,gallons of milk,

• what is the elasticity of supply for milk ?what is the elasticity of supply for milk ?

Elasticity of SupplyElasticity of Supply

% change Quantity % change Quantity EEss = ------------------------------- = -------------------------------

% change Price ;% change Price ;

(New Quantity - Original Quantity) / (Average Quantity) (New Quantity - Original Quantity) / (Average Quantity)

EEss = --------------------------------------------- = --------------------------------------------- (New Price - Original Price) / (Average Price)(New Price - Original Price) / (Average Price)

Elasticity of SupplyElasticity of Supply

(20 /110) (20 /110) E Ess = =

------------------------- = 20% /10% = 2.0 ------------------------- = 20% /10% = 2.0 ( $0.20 / $2.10)( $0.20 / $2.10)

Supply is elastic;Supply is elastic;

PRICEPRICEOF OF MILKMILK$$$$


$2.20$2.20

$2.00$2.00

Market Supply Market Supply CurveCurve

100100 120120


• Increases with time;Increases with time;

• Limitations of production facilities in the Limitations of production facilities in the short run prevent firms from responding short run prevent firms from responding with as much output increase as price with as much output increase as price increases;increases;

• As firms can increase production facilities, As firms can increase production facilities, in the longer run, the larger will be the in the longer run, the larger will be the increase in quantity supplied. increase in quantity supplied.

Predicting Price Changes Using Predicting Price Changes Using ElasticitiesElasticities

An increase in demand (i.e., rightward shift):An increase in demand (i.e., rightward shift):• results in shortage at original price results in shortage at original price

(demand exceeds supply);(demand exceeds supply);• establishes market equilibrium at higher establishes market equilibrium at higher

price, and quantity between original price, and quantity between original equilibrium quantity and quantity consumers equilibrium quantity and quantity consumers now willing to buy at original price;now willing to buy at original price;

• encourages producers to supply more and encourages producers to supply more and consumers to buy less.consumers to buy less.



$2.00$2.00

100100

Demand DDemand D11

Supply SSupply S11

150150

shortageshortage

Demand DDemand D22


With an increase in demand, the resulting With an increase in demand, the resulting equilibrium price increase will be:equilibrium price increase will be:

• small if consumers and producers are very small if consumers and producers are very responsive to price changes (elastic responsive to price changes (elastic demand and elastic supply) ;demand and elastic supply) ;

• larger if either is not very responsive (i.e., larger if either is not very responsive (i.e., inelastic);inelastic);



$2.00$2.00

100100

Demand DDemand D11

Supply SSupply S11

130130

$2.05$2.05Demand DDemand D22

originaloriginalequilibriumequilibrium newnew

equilibriumequilibrium


With an increase in demand, the resulting With an increase in demand, the resulting percentage change in price can be found percentage change in price can be found by:by:

• Percentage change in price = Percentage change in price = Percentage change in demandPercentage change in demand------------------------------------------- -------------------------------------------

(E (Ess + E + Edd))


With an increase in supply, the resulting With an increase in supply, the resulting percentage change in price can be found percentage change in price can be found by:by:

• Percentage change in price = Percentage change in price = Percentage change in supplyPercentage change in supply------------------------------------------- -------------------------------------------

(E(Ess + E + Edd))


An increase in supply (i.e., rightward shift):An increase in supply (i.e., rightward shift):

• results in excess at original price (supply results in excess at original price (supply exceeds demand);exceeds demand);

• establishes market equilibrium at lower establishes market equilibrium at lower price, and quantity between original price, and quantity between original equilibrium quantity and quantity producers equilibrium quantity and quantity producers now willing to supply at original price;now willing to supply at original price;

• encourages producers to supply less and encourages producers to supply less and consumers to buy more.consumers to buy more.



$2.00$2.00

100100

Demand DDemand D11

Supply SSupply S11

Supply SSupply S22


With an increase in supply, the resulting With an increase in supply, the resulting equilibrium price decrease will be:equilibrium price decrease will be:

• small if consumers and producers are small if consumers and producers are responsive to price changes (elastic responsive to price changes (elastic demand and elastic supply) ;demand and elastic supply) ;

• larger if either is not very responsive (i.e., larger if either is not very responsive (i.e., inelastic);inelastic);



$2.00$2.00

100100

Demand DDemand D11

Supply SSupply S11

110110

Supply SSupply S22$1.80$1.80

original original equilibriumequilibrium

newnewequilibriumequilibrium

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ELASTICITY A concept used by economists to measure the responsiveness of people to changes in economic variables. A concept used by economists to measure