Download ELASTICITY

ELASTICITY
Elasticity is the concept economists use to
describe the steepness or flatness of curves
or functions.
In general, elasticity measures the
responsiveness of one variable to changes in
another variable.
Elasticity
slide 1
PRICE ELASTICITY OF
DEMAND
Measures the responsiveness of quantity
demanded to changes in a good’s own price.
The price elasticity of demand is the percent
change in quantity demanded divided by the
percent change in price that caused the
change in quantity demanded.
Elasticity
slide 2
LOTS OF ELASTICITIES!
THERE ARE LOTS OF WAYS TO COMPUTE
ELASTICITIES. SO BEWARE! THE DEVIL IS
IN THE DETAILS.
MOST OF THE AMBIGUITY IS DUE TO THE
MANY WAYS YOU CAN COMPUTE A
PERCENTAGE CHANGE. BE ALERT HERE.
IT’S NOT DIFFICULT, BUT CARE IS NEEDED.
Elasticity
slide 3
What’s the percent increase in price here
because of the shift in supply?
S'
price
S
pE = $.30
pE = $.20
D
QE
Q
CANDY MARKET
Elasticity
slide 4
IS IT:
A) [.10/.20] times 100?
B) [.10/.30] times 100?
C) [.10/.25] times 100?
D) Something else?
Elasticity
slide 5
From time to time economists have used ALL of
these measures of percentage change -including the “Something else”!
Notice that the numerical values of the percentage
change in price is different for each case:
Go to hidden slide
Elasticity
slide 6
Economists usually use the “midpoint”
formula (option C), above) to compute
elasticity in cases like this in order to
eliminate the ambiguity that arises if we
don’t know whether price increased or
decreased.
Elasticity
slide 8
Using the Midpoint Formula
Elasticity =
% change in Q
% change in P
% change in p =
% change in p =
change in P
average P
times 100.
P
(
)  100
PMEAN
For the prices $.20 and $.30, the % change in p is 40
percent.
Elasticity
slide 9
What’s the percent change in Q due to the
shift in supply?
S'
price
S
pE’ = $.30
pE = $.20
D
QE’ = 17 QE = 25
Q
CANDY MARKET
Elasticity
slide 10
Use the midpoint formula again.
% change in Q
Elasticity =
% change in P
% change in Q = change in Q
% change in Q =
average Q
Q
(
)  100
Q MEAN
For the quantities of 25 and 17, the % change in Q is
38 percent. (8/21 times 100)
Elasticity
slide 11
NOW COMPUTE ELASTICITY
% change in Q = 38 percent
% change in P= -40 percent
E = -(-38 / 40.0) = 0.95
Elasticity
slide 12
Use the midpoint formula again.
% change in Q
Elasticity =
% change in P
% change in Q = change in Q
average Q
% change in Q =
Q
(
)  100
Q MEAN
For the quantities of 26 and 18, the % change in Q is
36 percent. (8/22 times 100)
Elasticity
slide 13
NOW COMPUTE ELASTICITY
% change in Q = 36.0 percent
% change in P = -40percent
E = -(-36 / 40) = 0.90
Elasticity
slide 14
TERMS TO LEARN
Demand is ELASTIC when the numerical value of
elasticity is greater than 1.
Demand is INELASTIC when the numerical value of
elasticity is less than 1.
Demand is UNIT ELASTIC when the numerical
value of elasticity equals 1.
NOTE: Numerical value here means “absolute
value.”
Elasticity
slide 15
FACTS ABOUT ELASTICITY
It’s always a ratio of percentage changes.
That means it is a pure number -- there are no units
of measurement on elasticity.
Price elasticity of demand is computed along a
demand curve.
Elasticity is not the same as slope.
Elasticity
slide 16
DETERMINANTS OF DEMAND
ELASTICITY
The more substitutes there are available for a good,
the more elastic the demand for it will tend to be.
[Related to the idea of necessities and luxuries.
Necessities tend to have few substitutes.]
The smaller (narrower) the market boundaries, the
more elastic the demand will tend to be.
The longer the time period involved, the more elastic
the demand will tend to be.
Elasticity
slide 17
OTHER ELASTICITY MEASURES
In principle, you can compute the elasticity
between any two variables.
Income elasticity of demand
Cross price elasticity of demand
Elasticity of supply
Elasticity
slide 18
Each of these concepts has the expected definition.
For example, income elasticity of demand is the
percent change in quantity demand divided by a
percent change income:
EINCOME =
% change in Q
% change in I
Income elasticity of demand will be positive for
normal goods, negative for inferior ones.
Elasticity
slide 19
There is an important relationship between what
happens to consumers’ spending on a good and
elasticity when there is a change in price.
Spending on a good = P Q.
Because demand curves are negatively sloped, a
reduction in P causes Q to rise and the net effect
on PQ is uncertain, and depends on the elasticity
of demand.
Elasticity
slide 20
Candy example
Price
$.50
$.40
$.30
$.20
$.10
Elasticity
Quantity
4
10
17
25
56
Total revenue
$2.00
$4.00
$5.10
$5.00
$5.60
slide 21
The Demand for Candy
Demand is inelastic in this
price range!
TR = $5.10
when price is
$.30
0.60
P
0.50
Demand
0.40
0.30
0.20
TR = $5.00 when
price is $.20
0.10
0.00
0
Elasticity
10
20
30
40
Q
50
slide 22
Here’s a convenient way to think of the
relative elasticity of demand curves.
p
relatively more elastic
at p*
p*
relatively more inelastic
at p*
Q
Q*
Elasticity
slide 23
Candy example
Price
$.50
$.40
$.30
$.20
$.10
Elasticity
Quantity
3
10
18
26
39
Total revenue
$1.50
$4.00
$5.40
$5.20
$3.90
slide 24
The Demand for Candy
Demand is inelastic in this
price range!
TR = $5.40
when price is
$.30
0.60
P
0.50
Demand
0.40
0.30
0.20
TR = $5.20 when
price is $.20
0.10
0.00
0
Elasticity
10
20
30
40
Q
50
slide 25