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Economics Mr. Joshi Market Elasticity – A Matter of Responsiveness A common example of a question that economists and policy-makers would want to know is, “If gas prices were to go up by 20%, by what % would the demand for gasoline fall?” This ratio is called Elasticity by economists. There are a number of comparisons that economists do that are helpful in understanding the responsiveness of a given market: For example, the law of demand predicts that if the price of a good were to increase, its quantity demanded would _____________. Conversely, if the price of a good were to decrease, its quantity demanded would _______. The law of supply predicts that if the price of a good were to increase, its quantity supplied would _____________. Conversely, if the price of a good were to decrease, its quantity supplied would _________. If incomes for everyone were to go up, the quantity demanded of a good is likely to go _______. If incomes for everyone were to go down, the quantity demanded of a good is likely to go ________. If the price of a given good goes up, the demand for a complementary good would go ________. If the price of a given good goes down, the demand for a complementary good would go ________. But, economists have been interested not only in the direction of the responsiveness, but also its magnitude. Someone clever came up with the idea of looking at % change (rather than actual units or $s) so that the numbers would be easier to work with. The following are formulas for the most popular kinds of elasticity: Why might anyone want to know each of these ratios? Price Elasticity of Demand % Qd =_______ % P Price Elasticity of Supply % Qs =_______ % P Income Elasticity of Demand % Qd =_______ % I Cross-Elasticity of Demand % Qd of Good B =_______ % P of Good A What would a graph of these relationships look like? P P Qd I Qs Pa Qd Qd of b Let’s look at Price Elasticity of Demand more closely: Price Elasticity of Demand % Qd =_______ % P What would you guess is the Price Elasticity of Demand for Gasoline in the short-term? What would a graph of demand look like for gasoline? P Qd If the price elasticity of demand for a good is less than 1, economists call this inelastic. Why might this be? If the price elasticity of demand for a good is equal to 1, economists call this unit elastic. If the price elasticity of demand for a good is more than 1, economists call this elastic. Why might this be? What factors can you think of that would impact how elastic demand might be for a given good? 4 COMMON FACTORS in determining the Price Elasticity of Demand: 1. % of Budget that the Price of the Good Takes (circle) __More/Less_ Elastic Small % of Budget _More/Less_ Elastic Large % of Budget 2. Necessity vs. Luxury (circle) __More/Less_ Elastic Necessity _More/Less_ Elastic Luxury 3. Availability of Substitutes (circle) __More/Less_ Elastic Few Substitutes _More/Less_ Elastic Many Substitutes 4. Short vs. Long Term (circle) __More/Less_ Elastic Short-term _More/Less_ Elastic Long-term Now, it is time to use your experience in the economic world to guess the price elasticities of demand for the following goods: Goods and Services Salt Matches Toothpicks Airline travel, short-run Gasoline, short-run Gasoline, long-run Residential natural gas, short-run Residential natural gas, long-run Coffee Fish (cod) consumed at home Tobacco products, short-run Legal services, short-run Physician services Taxi, short-run Automobiles, long-run Movies Housing, owner occupied, long-run Shellfish, consumed at home Oysters, consumed at home Private education Tires, short-run Tires, long-run Radio and television receivers Restaurant meals Foreign travel, long-run Airline travel, long-run Fresh green peas Automobiles, short-run Chevrolet automobiles Fresh tomatoes Price Elasticity of Demand (0-5) Estimates on reverse side are from: Economics: Private and Public Choice, James D. Gwartney and Richard L. Stroup, eighth edition 1997, seventh edition 1995; primary sources: Hendrick S. Houthakker and Lester D. Taylor, Consumer Demand in the United States, 1929-1970 (Cambridge: Harvard University Press, 1966,1970); Douglas R. Bohi, Analyzing Demand Behavior (Baltimore: Johns Hopkins University Press, 1981); Hsaing-tai Cheng and Oral Capps, Jr., "Demand for Fish" American Journal of Agricultural Economics, August 1988; and U.S. Department of Agriculture. Table 5. Estimated Price Elasticities of Demand for Various Goods and Services Goods Estimated Elasticity of Demand Inelastic Salt Matches Toothpicks Airline travel, short-run Gasoline, short-run Gasoline, long-run Residential natural gas, short-run Residential natural gas, long-run Coffee Fish (cod) consumed at home Tobacco products, short-run Legal services, short-run Physician services Taxi, short-run Automobiles, long-run 0.1 0.1 0.1 0.1 0.2 0.7 0.1 0.5 0.25 0.5 0.45 0.4 0.6 0.6 0.2 Approximately Unitary Elasticity Movies Housing, owner occupied, long-run Shellfish, consumed at home Oysters, consumed at home Private education Tires, short-run Tires, long-run Radio and television receivers 0.9 1.2 0.9 1.1 1.1 0.9 1.2 1.2 Elastic Restaurant meals Foreign travel, long-run Airline travel, long-run Fresh green peas Automobiles, short-run Chevrolet automobiles Fresh tomatoes 2.3 4.0 2.4 2.8 1.2 - 1.5 4.0 4.6 What factors might you guess are the most important in determining the Elasticity of Demand for these goods?