Download Price Elasticity of

Elasticity
• Price elastisticity of Demand- measures how
much the quantity demanded of a good
changes when its price changes.
• The precise definition of price elasticity is the
percentage change in quantity demanded
divided by the percentage change in price.
• Goods vary enormously in in their o=price
elasticity , or sensitivity to price changes.
• Price elastic is high, elastic
• Price elastic is low, inelastic
• Food, fuel, shoes, and prescription drugs
demand tends to be inelastic
• Italian designer clothing and 17-year-old
Scotch whiskey demand tends to be elastic
• Goods that have ready substitutes are elastic
than those that have no substitutes.
• The length of time that people have to
respond to price changes also plays a role.
• Point elastitcity: dQ/dP x P/Q
• Arc elasticity: Q1-Q0/Q1+Q0 – P1+P0/P1+PO
• Elastic = e>1
• Inelastic = e<1
• Unitary = 1
OTHER DEMAND ELASTICITIES
• INCOME ELASTICITY OF DEMAND- is the
percentage change in Qd, resulting from 1percent change in income (I).
EI= (ΔQ/Q)/(ΔI/I) = (I/Q) (ΔQ/ΔI)
• A negative income elasticity of demand is
associated with inferior goods; an increase in
income will lead to a fall in the demand and
may lead to changes to more luxurious
substitutes.
• A zero income elasticity (or inelastic) demand
occurs when an increase in income is not
associated with a change in the demand of a
good. These would be sticky goods.
• A zero income elasticity (or inelastic) demand
occurs when an increase in income is not
associated with a change in the demand of a
good. These would be sticky goods.
• CROSS-PRICE ELASTICITY OF DEMAND- refers
to the percentage change in the quantity
demanded for a good that result from a 1percent increase in the price of another good.
• So the elasticity of demand for butter with
respect to the price of margarine would be
written as:
• EQbPm = (ΔQb/Qb) / (ΔPm/Pm) =
•
•
(Pm/Qb)(ΔQb/ΔPm)
Where
Qb is the qty of butter and Pm is the price of margarine.
• In the equation, the cross-price elasticity will
be positive because the goods are substitutes.
• Some goods are complements, in which an
increase in the price of one tends to push
down the consumption of the other.
ELASTICITIES OF SUPPLY- are defined in a similar
manner.
• The price elasticity of supply is the percentage
in Qs resulting from 1-percent increase in
price.
• The elasticity is usually positive because
higher price gives producers an incentive to
increase output.
• We can also refer to elasticities of supply with
respect to such variables as
Interest rates
Wage rates
Prices of raw materials and other intermediate goods
• For example, for most manufactured goods,
the elasticities of supply with respect to the
prices of raw materials are negative.
• An increase in the price of raw a material
input means higher costs for the firm, other
things being equal, therefore, the Qs will fall
The Market for Wheat
• For the statistical studies, we know that for
1981 the supply curve for wheat was
approximately as follows:
• Supply: Qs = 1800+240P
• Demand: Qd = 3550-266P
•
•
•
•
Qs = Qd
1800+240P=3550-266P
560P=1750
P= 3.46
• Q= 1800+(240)(3.46)=2630
•
•
Price
Market-clearing price
• Elasticity of Demand=
(3.46/2630) (-266)
= -0.35
• Elasticity of Supply=
• (3.46/2630) (240)
• = o.32
Short-Run versus Long-Run Elasticities
• When analyzing demand and supply, we must
distinguish between the short run and the
long run.
• If we allow only a short time to pass-say, one
year of less- then we are dealing with short
run.
• When we refer to long run we mean that
enough time is allowed for consumers and
producers to adjust fully to the price change.
Demand
• For many goods, demand is much more price
elastic in the long run than in the short run.
-For one thing, it takes time for people to
change their consumption habits.
• Example: Even if the price of coffee rises
sharply, the quantity demanded will fall only
gradually as consumers begin to drink less.
• In addition, the demand for a good might be
linked to the stock of another good that
changes only slowly.
• For example, the demand for gasoline is much
more elastic in the long run than in the short
run.
• Demand and Durability- On the other hand,
for some goods just the opposite is truedemand is elastic in the short run than in the
long run.
• The total stock of each good owned by
consumers is large relative to annual
production..
• As a result, a small change in total stock that
consumers want to hold can affect in large
percentage of level of purchases.
• Income elasticities also differ from the short
run to the long run.
For most goods and services- foods, beverages,
fuel, entertainment, etc.- the income elasticity
of demand is larger in the long run than in the
short run.
• Consider the behavior of gasoline
consumption during a period of strong
economic growth during which the aggregate
income rises by 10%. Eventually people will
increase gasoline consumption because they
can afford to take more trips and perhaps own
larger cars.
• But this consumption takes time and demand
initially increases only by a small amount.
• Thus, the long-run elasticity will be larger than
the short-run elasticity.
• For a durable good, the opposite is true.
• Again, consider automobiles.
• Cyclinal industries- Industries in which sales
tend to magnify cyclical changes in GDP and
national income.
• These industries are vulnerable to changing
macroeconomic conditions and in particular
to the business cycle- recessions and booms.
• E.g.- demand for durable goods.
• Note that while both consumption series
follow GDP, only durable goods series tends to
magnify changes in GDP.
• Changes in consumption of nondurables are
roughly the same as changes in GDP, but
changes in consumption of durables are
usually several times larger.
The Demand for Gasoline and
Automobiles
• Gasoline and automobiles exemplify some of
the different characteristics of demand
discussed above.
• They are complementary goods- an increase in
the price of one tends to reduce the demand
for the other.
• In addition, their respective dynamic
behaviors( long-run vs. short-run elasticities)
are just the opposite of the other.
• For gasoline, the long-run price and income
elasticities are larger than the short-run
elasticities;for automobiles, the reverse is
true.
Demand for Gasoline
Number of Years Allowed to Pass Following a Price or income
change
Elasticity
1
2
3
5
10
20
Price
-0.11
-0.22
-0.32
-0.49
-0.82
-1.17
Income
0.07
0.13
0.20
0.32
0.54
0.78
Demand for Automobiles
Number of Years Allowed to Pass Following a Price or Income Change
Elasticity
1
2
3
5
10
12
Price
-1.20
-0.93
-0.75
-0.55
-0.42
-0.40
Income
3.00
2.33
1.88
1.38
1.02
1.00
Supply
• Elasticities of supply also differ from the long
run to the short run.
• For most products, long-run supply is mcuh
more price elastic than short-run supply:
Firms face capacity constraints in the shortrun and need time to expand capapcity by
building new production facilities and hiring
workers to staff them.
• For some goods and services, short-run supply
is completely inelastic.
• E.g. rental units.
• For most goods, however, firms can find ways
to increase outputeven in the short-run-if the
price incentive is strong enough.
Supply and Durability
• For some goods, supply is more elastic in the
short run than in the long run. Such goods are
durable and can be recycled as part of supply
if price goes up.
• E.g. scrap metal, which is often melted down
and refabricated.
Supply if Copper
Price Elasticity of:
Primary supply
Short-run
0.20
Long-run
1.60
Secondary supply
0.43
0.31
Total supply
0.25
1.50