Download Elasticity

Elasticity
What is it and how to calculate it?
The Concept of Elasticity
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
Laugher Curve
Q. What’s the difference between an
economist and a befuddled old man with
Alzheimer’s?
A. The economist is the one with a
calculator.
The Concept of Elasticity
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
Price Elasticity
• The price elasticity of demand is the
percentage change in quantity demanded
divided by the percentage change in price.
Percentage change in quantity demanded
ED =
Percentage change in price
Price Elasticity
• The price elasticity of supply is the
proportional change in quantity demanded
relative to the proportional change in price.
Percentage change in quantity supplied
ES =
Percentage change in price
What Information Price
Elasticity Provides
• Price elasticity of demand and supply
gives the exact quantity response to a
change in price.
Classifying Demand and Supply
as Elastic or Inelastic
• Demand or supply is elastic if the
percentage change in quantity is greater
than the percentage change in price.
E>1
Classifying Demand and Supply
as Elastic or Inelastic
• Demand or supply is inelastic if the
percentage change in quantity is less than
the percentage change in price.
E<1
Elastic Demand and Supply
• Elastic supply means that quantity
changes by a greater percentage than the
percentage change in price.
• The same holds true for demand.
Inelastic Demand and Supply
• Inelastic supply means that quantity
doesn't change much with a change in
price.
• The same holds true for demand.
Elasticity Is Independent of
Units
• Percentages allow us to have a measure
of responsiveness that is independent of
units.
• This makes comparisons of
responsiveness of different goods easier.
Calculating Elasticities
• To determine elasticity divide the
percentage change in quantity by the
percentage change in price.
The End-Point Problem
• The end-point problem – the percentage
change differs depending on whether you
view the change as a rise or a decline in
price.
The End-Point Problem
• Economists use the average of the end
points to calculate the percentage change.
(Q2 - Q1)
Elasticity = (P
2
- P1)
½Q2  Q1 
½P1 + P2 
Graphs of Elasticities
B
$26
24
22
20
18
16
14
0
C (midpoint)
A
D
Elasticity of demand
between A and B = 1.27
10
12
14
Quantity of software (in hundred thousands)
Graphs of Elasticities
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
0
A
B
C (midpoint)
Elasticity of supply
between A and B = 0.18
470 480 490
Quantity of workers
Calculating Elasticity
Q 2  Q1
1
%Q 2 (Q1  Q 2 )
E

P2  P1
%P
1
(
P

P
)
1
2
2
Calculating Elasticity of Demand
Between Two Points
$26
24
22
20
18
16
Elasticity of demand
between A and B:
B
midpoint
C
A
% Q
E
% P
10  14
4
1
 .33
2 (14  10)
ED 
 12 
 1.27
26  20
6
.26
1
23
2 (26  20)
Demand
14
0
10
12
14
Quantity of software (in hundred thousands)
Calculating Elasticity of Supply
Between Two Points
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
0
A
C
Elasticity of supply
between A and B: E  %Q
B
% P
485  475
10
1
.021
480
2 ( 485  475)
ES 


 .2
5  4.50
.50
.105
1
4.75
2 (5  4.50)
470 480 490
Quantity of workers
Calculating Elasticity at a Point
• Let us now turn to a method of calculating
the elasticity at a specific point, rather than
over a range or an arc.
Calculating Elasticity at a Point
• To calculate elasticity at a point, determine
a range around that point and calculate
the arc elasticity.
Calculating Elasticity at a Point
$10
9
8
7
6
5
4
3
2
1
(28 - 20)
E
at A
=
C
½28  20 
 0.66
(5 - 3)
½5 + 3 
A
B
20 24 28
40
Quantity
Calculating Elasticity at a Point
$10
9
8
7
6
5
4
3
2
1
To calculate elasticity at a point determine
a range around that point and calculate
the arc elasticity.
C
Eat A
A
B
20 24 28
Quantity
28  20
8
1
.33
2 (28  20)
24



 .66
53
2
.5
1
4
2 (5  3)
40
Elasticity and Supply and
Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.
Calculating Elasticity at a Point
$10
9
8
7
6
5
4
3
2
1
Demand
A
Supply
EA = 2.33
D
C E = 0.75
C
6
ED = 0.86
EB = 0.11
B
12 18 24 30 36 42 48 54 60 Quantity
Elasticity and Supply and
Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.
Elasticity Is Not the Same as
Slope
• The steeper the curve at a given point, the
less elastic is supply or demand.
• There are two limiting examples of this.
Elasticity Is Not the Same as
Slope
• When the curves are flat, we call the
curves perfectly elastic.
• The quantity changes enormously in
response to a proportional change in price
(E = ).
Elasticity Is Not the Same as
Slope
• When the curves are vertical, we call the
curves perfectly inelastic.
• The quantity does not change at all in
response to an enormous proportional
change in price (E = 0).
Perfectly Inelastic Demand
Curve
Perfectly inelastic
demand curve
0
Quantity
Perfectly Elastic Demand Curve
Perfectly elastic
demand curve
0
Quantity
Elasticity Changes Along
Straight-Line Curves
• Elasticity is not the same as slope.
• Elasticity changes along straight line
supply and demand curves–slope does
not.
Elasticity Along a Demand Curve
Ed = ∞
$10
9
8
7
6
5
4
3
2
1
Elasticity declines along
demand curve as we move
toward the quantity axis
Price
Ed > 1
0
Ed = 1
Ed < 1
Ed = 0
1
2
3
4
5
6
7
8
9 10 Quantity
Elasticity Along a Supply Curve
S0
Price
$10
9
8
7
6
5
4
3
2
1
0
S1
Es declines
Es = 
Es rises
Es = 0
1
2
3
4
5
6
Quantity
7
If the supply
curve intersects
the vertical axis,
Es declines as
you go up the
supply curve.
If the supply
curve intersects
the quantity axis,
Es increases as
you go up the
supply curve.