Econ 402 Chapter 4

elasticity of demand, income, supply

elasticity

-ratio of 2 percentage changes

-proportionate change

P inc → DQ dec = elasticity is neg

-magnitude/absolute value of price elasticity that tells us how responsive it is

-use the magnitude to compare (ignore the ±)

inelastic/elastic demand

perfectly inelastic demand (=0)

-QD is constant when price changes

-verticle line

Unit elastic demand (=1)

-change in price is exactly proportional to change in QD

-negative linear line

Inelastic demand (0>1)

-change in QD is less than change in price

-necessary goods (insulin, housing, food, gas, alc)

-very steep slope

Perfectly elastic demand (=infinity)

-change change in price leads to infinte change in demand

-horizontal line

elastic price (>1)

-change in demand is bigger than change in price

-b/c of substitutes (beer)

-wide slope

Influence in elasticity

Closeness of substitutes

-closer a substitute = more elastic b/c easier to switch to cheaper substitute

-degree of subsitute depend on how narrowly we define a good

• no sub for phone, but can swap iphone for android

-necessary goods=inelastic, luxury goods=elastic

Income portion spent on good

-greater income spent on good → more elastic demand

-do not notice higher prices for small cost items compared to high cost items

time since price change

-more time since price change → more elastic

-ppl have more time to search for a subsitute

subsitutes

necessary goods:

-not a lot/poor subsitutes (food/shelter)

-inelastic

Luxury goods:

-many subsitutes, one of which is not buying it (travel)

-elastic

total revenue and elastiticty

total revenue: price of good mult by Q sold

-elastic demand (>1) = price inc → TR inc

-inelastic demand (0>1) = price inc → TR dec

-Unit elastic demand (=1) = price inc → no change on TR

on graph:

-elastic top to midpt, midpt = unit elastic, inelastic midpt to bottom

-on TR hump graph, midpt (unit elastic/ max totoal revenue) is top of hump

income elasticity of demand

-measure of responsiveness of demand to change in income

- ((QD1 - QD 2)/ av QD ) / ((Y1 - Y2)/ av Y )

Pos. + >1 = normal good, income elastic

-foreign travel

-% of income spent on g/s inc as income inc

Pos. + 0>1 = normal good, income inelastic

-clothing, food

-% of income spent on g/s dec as income inc

-in low-income places, more elastic b/b larger portion of income

Neg. = inferior good

-QD and amount spent on g/s dec as income inc

cross elasticity of demand

-price of sub rises → demand for other sub inc

-price of complement inc → demand dec for complements

-measure of responsiveness of demand for change in price of substitute/compliment

-((Q1-Q2) / av Q ) / ((P1-P2) / av P ) substitute/complement

-cross elasticity is pos → demand + price of other g/s change in same direction → substitutes

-cross elasticity is neg → demand + price of other g/s change in opposite directions → complements

elasticity of supply

-measure of responsiveness of QS to change in price of g/s

-((QS1-QS2) / av QS ) / ((P1-P2) / av P ) usually pos

- > 1 → elastic

-0>1 → inelastic

- =0 → perfectly inelastic supply

-vertical line

- =1 → unit elastic

- =infinite → perfectly elastic supply

-horizontal line

influence elasticity of supply

Resource substitution possibilites

-rare productive resources needed to supply → more inelastic (painting)

-produced with common/avalible resources that can be allocated toward other things → higher elasticity (farm land for corn/wheat )

Time frame

-Momentary supply

-when price of g/s changes → immediate response in QS determined by momentary supply

veggies (perfect inelastic momentary supply)- vertical supply curve

-can not change supply output when price changes

phone calls (perfect elastic momentary supply)- horz supply curve

-more ppl call → QS inc → no change in price

Short run supply

-response of QS to price change when only some of possible adjustments to production can be made is determined by short run supply

-most g/s have inelastic short run supply

-inc output → overtime, dec output → layoff

-with more time could get new tools, etc.

Long run supply

-response of QS to price change after all tech possible ways to adjust supply have happened is determined by long run supply

-most g/s have elastic long run supply

-time to plan out what you want to do