Download econ chap 5 - mrski-apecon-2008

Chapter 5
Elasticity of
Demand and Supply
What is elasticity?
People respond to changes. If a price
of a product goes down, more people
would buy. If the weather is cold, more
people would buy more ice creams than
hot teas.
For economists, the size of the
responsiveness to changes by consumers
and suppliers must be measured. This
measuring concept of the responsiveness
is called elasticity.
What is Price elasticity of demand?
Let’s say you are selling ice creams for $5.00,
and for that price 10 people bought it. The next day,
you lower the price to $3.00 and 16 people bought it.
Thus you conclude that by lowering the price, you
received a big response - more people bought it.
Economists call this elastic.
On the contrary, despite that you had lowered
the price to $3.00 and if only 11 people bought it,
Economists call this inelastic.
Elasticity of Demand
4 determinants
of Price elasticity of Demand
1)
2)
3)
4)
Availability of Close Substitutes
How Widely or Narrowly you define a good
Necessities VS. Luxuries
Time
Continued… (explanations)
Elasticity of Demand
Availability of Close Substitutes
If there were yogurts and ice creams (which are
substitutes), and the price of the ice creams increase
but that of yogurts stay the same, most of those people
who were going to buy the ice creams would buy
yogurts instead because of the cheap price. Thus
people responded to the price change of the ice cream
substantially (elastic) because of the decreased price
of the substitute.
So, products with substitutes are more elastic
than those of not.
Elasticity of Demand
How Widely or Narrowly you define a good
The more widely you define a good, the less
elastic (more inelastic) the demand for the good and
vice versa.
For example, when comparing “food” and “ice
creams”, since food is a more broad category, which
has many close substitutes as the ice cream is more
specific are more narrow. The food with more
substitutes are more inelastic because they have
alternatives within the catagory to repsond to changes.
However, the ice creams are more elastic because
they have substitutes outside of their own category.
Elasticity of Demand
Time
The longer a price change persists through
time, the more elastic (less inelastic) the demand for
the good. Say for example, if the government
decides to place a trash dump next to your house
and your neighbors, at a short period of time you and
your neighbors will bear the trash dump (which is
inelastic), but as time goes by you and your
neighbors will move to other places and avoid the
trash dump (which is elastic).
Elasticity of Demand
How to measure elasticity in numbers?
*MUST BE ABSOLUTE VALUE
This is the equation:
(% change in Quantity demanded) / (% change in Price)
Which is expressed through the simple “midpoint
method”:
(Q2 - Q1) / [(Q2+Q1)/2] / (P2 - P1) / [(P2+P1)/2]
Ed > 1 = elastic
Ed < 1 = inelastic
Ed = 1 = unit elastic
Elasticity of Demand
Graphs of Demand curves and its Variety,
and the total revenue :
If the video does not work, click here
Elasticity of Demand
Elasticity of a Linear Demand Curve
The slope of the graph maybe constant
but the elasticity of the linear curve is
not constant. The top part of point M is
considered Elastic, because the
quantity is low at its high price. The
bottom part of point M is considered
Inelastic, because the quantity is high
at its low price. Think logically - at high
price, for products which is elastic,
people would respond by buying less
and vice versa.
http://instruct1.cit.cornell.edu/Courses/econ101-dl/images/l6fig3.gif
Elasticity of Demand
Income elasticity of demand
Remember, normal goods and inferior goods?
Which the incomes determine the quantity of
demand? Its theory applies to elasticity. We call this
the income elasticity of demand when we measure
the responsiveness affected by a person’s income.
The equation is :
(% change in quantity demanded) / (% change in
income)
Elasticity of Demand
Cross-price elasticity of demand
Remember, complements and substitutes?
This applies to cross-price elasticity of demand. For
example, if you were selling strawberry syrups and
ice creams, since they are complements if one of
their prices go up, the other’s demand will change
because people respond to the increased price. This
effect is called the cross-price elasticity of demand.
We measure this :
(% change in quantity demanded of good 1) / (%
change in the price of good 2)
Elasticity of Demand
What is Price elasticity of supply?
Because the law of supply indicates that the
higher price of a product raises the quantity supplied,
it subtly applies to the elasticity of supply. The
elasticity of supply measures the change of the
quantity affected by the price.
If the quantity changes a lot, affected by the
price, it is called elastic. Whereas if it is affected only
slightly, it is called inelastic.
Elasticity of Supply
Determinants of Elasticity of Supply
1) Flexibility in altering the amount of a good
produced. This means that the elasticity of Supply
depend on the flexibility and the ability of sellers
to change the quantity of products they produce.
2) Time, like demand, also applies to the elasticity of
Supply. The longer the time goes by, the more
elastic it gets. Because during a short period of
time, companies can not build or increase the
size of the factories whereas during a long period
of time, factories can expand and even shut down
the old ones.
Elasticity of Supply
How to measure the price elasticity of
*MUST BE ABSOLUTE VALUE
Supply?
(% change in quantity supplied) / (% change in price)
Like how we measure demand, we use the
midpoint formula:
(Q2 - Q1) / [(Q2+Q1)/2] / (P2 - P1) / [(P2+P1)/2]
Elasticity of Supply
Supply curves
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Elasticity of Supply
Quizzes
1. A good’s elasticity of demand is -0.2
what information can we know from
this?
Answer: This good is a necessity,
because its elasticity is lower than 1.
Thus it is informed that people did
not really response to the change in
price.
Quizzes
2. Suppose your demand schedule for ice
creams are: Price ($) Qd
Qd
(income = $100)
(income = $200)
0.8
40
50
1
32
45
1.2
24
30
1.4
16
20
Calculate the price elasticity of demand as the price of ice
creams increases from $1 to $1.2 I) if your income is $100 II) if
your income is $200
Answer: I) 0.18 (inelastic) II) 2.2
(elastic)