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PRINCIPLES OF ECONOMICS
Chapter 5 Elasticity
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ELASTICITY
Elasticity: the responsiveness of quantity to a
change in another variable (i.e., price, income,
price of other goods)
Price Elasticity of Demand: the responsiveness of
quantity demanded to a change in the price
Price Elasticity of Supply: the responsiveness of
quantity supplied to a change in the price
ELASTICITY FORMULA
ΔQ
%ΔQ
Q
Elasticity =
=
%ΔP
ΔP
P
Because the demand curve is downward sloping and
the supply curve is upward sloping the elasticity of
demand is negative and the elasticity of supply is
positive. Often these signs are ignored.
ELASTICITY FORMULA
ΔQ
%ΔQ
Q
Elasticity =
=
%ΔP
ΔP
P
Arc Elasticity =
(Q2 – Q1)/(Q2 + Q1)
(P2 – P1)/(P2 + P1)
ELASTICITY FORMULA
Q1 = 2,800, P1 = 70 and Q2 = 3,000, P2 = 60
%ΔQ = (3,000 – 2,800)/(3,000 + 2,800) =
200/5,800 = 1/29
%ΔP = (60 – 70)/(60 + 70) = -10/130 = -1/13
Elasticity coefficient = (1/29)/(-1/13) = -13/29
= -0.45
ELASTICITY TERMINOLOGY
Elastic: %ΔQ > %ΔP, elasticity coefficient > 1
Consumers show a strong reaction to a price change.
Inelastic: %ΔQ < %ΔP, elasticity coefficient < 1:
Consumers show a weak reaction to a price change.
Unitary Elastic: %ΔQ = %ΔP, elasticity coefficient = 1
Consumers reaction to a price change is neutral.
THE PRICE ELASTICITY OF DEMAND
Elasticity and the slope of the demand curve are not
the same concepts, but they are related.
With a linear demand curve, the elasticity coefficient
is greater at high prices; the upper segment of a
linear demand is price elastic
With a linear demand curve, the elasticity coefficient
is smaller at low prices; the lower segment of a
linear demand is price inelastic
PRICE ELASTICITY OF DEMAND
The mid-point of a linear demand is unitary elastic.
The upper segment of a linear demand is elastic.
The lower segment of a linear demand is inelastic.
DETERMINANTS OF ELASTICITY
Number of and Closeness of Substitutes:
The more alternatives you have, the less likely you are to pay
high prices and the more likely you are to buy a substitute
(e.g., candy bars).
Passage of Time:
The longer you take to come up with alternatives to paying
high prices, the more like you choose those alternatives (e.g.,
gasoline).
Importance in Consumer Budget:
The greater the portion of the budget an item takes up, the
greater is the elasticity coefficient (e.g., housing vs. salt).
ELASTICITY EXAMPLES
Inelastic Goods
Price Elasticity of Demand
Eggs
0.06
Food
0.21
Health Care Services
0.18
Gasoline (short-run)
0.08
Gasoline (long-run)
0.24
Highway and Bridge Tolls
0.10
Unit Elastic Good (or close to it)
Shellfish
0.89
Cars
1.14
Elastic Goods
Luxury Car
3.70
Foreign Air Travel
1.77
Restaurant Meals
2.27
PRICE ELASTICITY OF SUPPLY
The price elasticity of supply is calculated as the
percentage change in quantity divided by the
percentage change in price.
PERFECTLY ELASTIC
If %ΔP = 0, elasticity coefficient = ∞
The demand/supply is perfectly elastic, a horizontal line at
the given price,
PERFECTLY INELASTIC
If %ΔQ = 0, elasticity coefficient = 0
The demand/supply is perfectly inelastic, a vertical line at
the given quantity
UNITARY ELASTIC DEMAND
A demand curve with constant unitary elasticity will be a
curved line. Notice how price and quantity demanded
change by an identical amount in each step down the
demand curve.
UNITARY ELASTIC SUPPLY
A constant unitary elasticity supply curve is a straight line
reaching up from the origin. Between each point, the
percentage increase in quantity demanded is the same as
the percentage increase in price.
DEMAND ELASTICITY & PRICE CHANGE
Cost-saving gains cause supply to shift out to the
right from S0 to S1; that is, at any given price,
firms will be willing to supply a greater quantity.
Figure (a): The demand is inelastic, the result of
this cost-saving technology is a substantially
lower price.
Figure (b): The demand is elastic, the result of
this cost-saving technology is a substantially
larger quantity.
DEMAND ELASTICITY & PRICE CHANGE
DEMAND ELASTICITY & SALES TAX
An excise tax introduces a wedge between the price
paid by consumers (Pc) and the price received by
producers (Pp).
Figure (a): Demand is more elastic than supply, the
burden of tax is on producer as Pe – Pp > Pc – Pe
Figure (b): Demand is less elastic than supply, the
burden of tax is on consumer as Pc – Pe > Pe – Pp
DEMAND ELASTICITY & SALES TAX