KRUGMAN'SMICROECONOMICS for AP*

Other Elasticities

Margaret Ray and David Anderson

Micro:

Econ:

12

48

Module

What you will learnin this Module:

• How cross-price elasticity of demand measures the responsiveness of demand for one good to changes in the price of another good.

• The meaning and importance of the income elasticity of demand, a measure of the responsiveness of demand to changes in income.

• The significance of the price elasticity of supply, which measures the responsiveness of the quantity supplied to changes in price.

• The factors that influence the size of these various elasticities.

Other Elasticities

• Cross-price elasticity of demand

• For example, suppose the For example, suppose the price of gasoline were to price of gasoline were to increase. The producers of increase. The producers of large trucks and SUVs will large trucks and SUVs will be very interested to know be very interested to know how this might affect sales how this might affect sales of these vehicles. A cross-of these vehicles. A cross-price elasticity of demand price elasticity of demand would be used to measure would be used to measure this response.this response.

Other Elasticities

• Income elasticity of demand

• Suppose the economy is Suppose the economy is suffering a recession and suffering a recession and personal incomes are lower. personal incomes are lower. The airline and hotel The airline and hotel industries would be industries would be interested to know how this interested to know how this would affect the demand for would affect the demand for air travel and hotel rooms. air travel and hotel rooms. An income elasticity of An income elasticity of demand would be used in demand would be used in this case.this case.

Other Elasticities

• Price elasticity of supply

• On the supply side of On the supply side of the market, producers the market, producers would like to increase would like to increase output if the price of output if the price of their goods was to rise. their goods was to rise. A price elasticity of A price elasticity of supply would be useful supply would be useful in measuring this in measuring this response.response.

Cross-Price Elasticity of Demand

• Measures the responsiveness of the demand for good “X” to changes in the price of good “Y”

Exy = %∆ Qd of X / %∆ P of Y

• Substitutes (positive)

• Complements (negative

Cross-Price Elasticity of Demand

•If If cross elasticity is positive, then X and Y are substitutes.cross elasticity is positive, then X and Y are substitutes.

• Example: The price of Nike shoes increases 2% and Example: The price of Nike shoes increases 2% and quantity demanded for Converse shoes increases 4%.quantity demanded for Converse shoes increases 4%.

• EEConverse, NikeConverse, Nike = 4%/2% = 2. = 4%/2% = 2.

• If cross elasticity is negative, then X and Y are If cross elasticity is negative, then X and Y are complements.complements.

• Example: The price of gasoline increases 20% and quantity Example: The price of gasoline increases 20% and quantity demanded for large SUVs decreases by 5%.demanded for large SUVs decreases by 5%.

• EESUV,gasolineSUV,gasoline = -5%/20% = - .25. = -5%/20% = - .25.

• Note: if cross elasticity is zero, then X and Y are Note: if cross elasticity is zero, then X and Y are

unrelated, independent productsunrelated, independent products..

Income Elasticity of Demand

• Measures the responsiveness of demand for a good to changes in income.

Ei = %∆ Qd / %∆ I

• Normal good (positive)

• Inferior good (negative)

Income Elasticity of Demand

• A positive income elasticity indicates a normal good.

• Example: American consumer income falls by 2% and quantity of flights to Europe declines by 8%.

• Ei = 8%/2% = 4

Income Elasticity of Demand

• A negative income elasticity indicates an inferior good.

• Example: Consumer income falls by 5% and consumers increase consumption of Spam by 4%.

• Ei = 4%/(-5%) = -.80

Price Elasticity of Supply

• Measures the responsiveness of quantity supplied to changes in price.

Es = %∆ Qs / %∆ P

• If Es >1, supply is considered elastic.

• If Es < 1, supply is considered inelastic.

• If Es = 1, supply is considered unit elastic.

Factors Influencing Price Elasticity of Supply

• Determinants of Price Elasticity of Supply

• Availability of inputs (labor, capital and raw materials.

• Time

Factors Influencing Price Elasticity of Supply

• TimeTime

• The short‑run supply elasticity is more elastic than the market period and will depend on the ability of producers to respond to price changes as to how elastic it is.

• The long‑run supply elasticity is the most elastic, because more adjustments can be made over time and quantity can be changed more relative to a small change in price.

Figure 48.1 Two Extreme Cases of Price Elasticity of SupplyRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Table 48.1 An Elasticity MenagerieRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers