(MICROECONOMICS) - Elasticity (copy)

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Why We Study Elasticities?

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1

Why We Study Elasticities?

Elasticity examines the responsiveness of consumers or producers to a change in a variable in the marketplace.

  • how much one factor changes in response to a change in a different factor.

  • Helps consumers + produces know how to set prices accordingly

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Price Elasticity of Demand (PED)

A measure of the responsiveness of the quantity of a good demanded to changes in its price.

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PED formula

PED = (Percentage change in Quantity) / (Demanded Percentage change in Price)

PED = (% ΔQuantityDemanded) / (% ΔPrice)

PED = ((Qf-Qi) / (Pf - Pi)) x (Pi / Qi)

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Signs & values of PED

Always look at absolute value of PED: IPEDI

  • PED = 0: Perfectly inelastic demand

  • 0 < PED < 1: Inelastic demand

  • PED = 1: Unit elastic demand

  • 1 < PED < ∞: Elastic demand

  • PED = ∞: Perfectly elastic demand

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5

High PED

Demand is elastic: greatly influenced by price changes (high responsiveness)

<p>Demand is elastic: greatly influenced by price changes (high responsiveness)</p>
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6

Low PED

Inelastic: demand stays the same regardless of price change (low responsiveness: consumer needs it)

<p>Inelastic: demand stays the same regardless of price change (low responsiveness: consumer needs it)</p>
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7

Shrinkflation

Producers reducing the size, quantity, or weight of a product while keeping the same price

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Elasticities on a demand curve

Elasticity varies not only between different goods, but also along the demand curve for any specific good portrayed using a straight- line demand curve.

<p><span>Elasticity varies not only between different goods, but also along the demand curve for any specific good portrayed using a straight- line demand curve.</span></p>
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Perfectly inelastic demand diagram

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Perfectly elastic demand diagram

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11

6 Determinants of PED

  • Number of Substitutes

    • Most substitutes = more elastic

    • e.g. coffee barely has good substitutes, however, any coffee shop has many substitutes

  • Complements (Joint Demand)

    • Elasticity of 1 good is influenced by elasticity of other good (both inelastic or elastic)

  • Proportion of Income

    • Change in price of car VS toothpick (for rich VS poor person)

  • Luxury or Necessity

    • Luxury not needed VS necessity needed

  • Addictive or not

    • Addicted consumers = inelastic (need that good)

  • Time to respond

    • People won’t change immediately → need time to find substitute/not immediately see price change

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Applications of PED

Revenue of a firm

Taxes imposed:

  • Flat rate tax

    • Applies same rate to all taxpayers regardless of income

  • Ad valorem tax (VAT)

    • based on value of good

    • tax is percentage of sale value of good

  • Indirect tax

    • imposed on manufacturers & service providers

<p>Revenue of a firm</p><p>Taxes imposed:</p><ul><li><p>Flat rate tax</p><ul><li><p>Applies same rate to all taxpayers regardless of income</p></li></ul></li><li><p>Ad valorem tax (VAT)</p><ul><li><p>based on value of good</p></li><li><p>tax is percentage of sale value of good</p></li></ul></li><li><p>Indirect tax</p><ul><li><p>imposed on manufacturers &amp; service providers</p></li></ul></li></ul>
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13

Cross elasticity of demand (XED)

Measures the relative sensitivity of a change in the quantity demanded of Good X with respect to a change in the price of Good Y.

Closeness of substitutes & relevance of complements

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XED formula

XED = (Percentage change in Quantity Demanded of Good X) / (Percentage change in Price of Good Y)

XED = (%ΔQuantityDemanded X) / (% ΔPrice Y)

XED = ((Qxf-Qxi) / (Pyf - Pyi)) x (Pyi / Qxi)

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XED > 0

Substitute goods:

  • proportional: price x increases = demand y increases

  • Larger value XED = greater substitutability: more similar

<p>Substitute goods: </p><ul><li><p>proportional: price x increases = demand y increases</p></li><li><p>Larger value XED = greater substitutability: more similar</p></li></ul>
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XED < 0

Compliment goods:

  • Inverse: price x increases = demand y decreases

  • Larger absolute value of XED = more complimentary

<p>Compliment goods:</p><ul><li><p>Inverse: price x increases = demand y decreases</p></li><li><p>Larger <strong>absolute</strong> value of XED = more complimentary</p></li></ul>
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XED = 0

If cross-price elasticity of demand is zero (XED = 0) or close to zero, this means that two products are unrelated or independent of each other.

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Income elasticity of demand (YED)

Measure of the responsiveness of demand to changes in income, and involves demand curve shifts.

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YED formula

YED = Percentage change in Quantity / Demanded Percentage change in Income
YED = (% ΔQuantityDemanded) / (% ΔIncome)

YED = XED = ((Qf-Qi) / (Yf - Yi)) x (Yi / Qi)

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YED > 0

The good is normal: income increases = demand increases

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YED < 0

The good is inferior: income increases = demand decreases

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Numerical value of YED

0 < YED < 1: income inelastic demand, e.g. necessities

YED > 1: Income elastic demand, e.g. luxury goods

<p>0 &lt; YED &lt; 1: income inelastic demand, e.g. necessities</p><p>YED &gt; 1: Income elastic demand, e.g. luxury goods</p>
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YED & producers

If national income increases,

  • goods/services with elastic demand will increase

  • goods/services with inelastic demand will decrease

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Price elasticity of supply (PES)

A measure of the responsiveness of the quantity of a good supplied to changes in its price.

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PES formula

PES = ((Percentage change in Quantity Supplied) / (Percentage change in Price)) × 100

PES = ((%ΔQuantitySupplied) / (% ΔPrice)) ×100

PES = ((Qf-Qi) / (Pf - Pi)) x (Pi / Qi)

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Values of PES

  • PES = 0: Perfectly inelastic supply

  • 0 < PES < 1: Inelastic supply

  • PES = 1: Unit elastic supply

  • 1 < PES < ∞: Elastic supply

  • PES = ∞: Perfectly elastic supply

<ul><li><p>PES = 0: Perfectly inelastic supply</p></li><li><p>0 &lt; PES &lt; 1: Inelastic supply</p></li><li><p>PES = 1: Unit elastic supply</p></li><li><p>1 &lt; PES &lt; ∞: Elastic supply</p></li><li><p>PES = ∞: Perfectly elastic supply</p></li></ul>
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Inelastic supply curve

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Elastic supply curve

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perfectly elastic supply curve

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perfectly inelastic supply curve

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31

Determinants of PES

  • Length of time

    • Amount of time producers have to adjust output in regards to price changes

  • Mobility of factors of production

    • Ease/speed firms can shift resources/production (easier to move capital)

  • Spare (unused) capacity of firms

    • How much a firm can produce without needing to expand inventory

  • Ability to store stocks

    • Buffer stocks

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