Elasticity: Economics: Chapter 6

Price elasticity of demand

• responsiveness of consumers to a price change of products 

• Some people may buy more or buy less 

Elasticity formula

Change in quantity/sum of quantity/2/change in price/sum of quantity/2

Elastic vs Inelastic

• if the coefficient is >1 than demand is elastic

• If the coefficient is <1 than demand is inelastic

• If the coefficient is =0 than demand is unit elastic

• Elastic goods quantity demand changes largely with price functions

  • Inelastic goods quantity demanded changes little despite price changes

Perfectly elastic vs Perfectly inelastic

• Perfectly elastic means small price reduction or increase causes buyers to buy all or the least amount of product they can

• Perfectly inelastic means no change in quality demanded despite price change

Total Revenue

• The total amount the seller receives of a product in a certain time period

• Formula: TR = Price x quantity

• Elastic: Total revenue changes in the opposite direction

• Inelastic: Total revenue changes in the same direction

• Unit Elastic: Total revenue doesn’t change even if price does

• Graph wise —> For TR as more quantity is demanded, price decreases, yet TR continues to rise so ED>1

• Graph wise —> Once TR reaches the maximum, and quantity keeps rising, the price will keep decreasing and so will the TR so ED<1

• * Changes when price changes

Determinants for Price Elasticity : Substitution 

• If more variety if goods ( more substitutions), the higher elasticity since people can turn to those other substitutes 

• If no substitutes such as organ transplants the organ is inelastic 

Determinants for price elasticity: Proportion to income

• The higher the price of a good relative/proportional to a person’s income the higher the elasticity

• If the good takes up a lot of a person’s income than it is elastic ( health insurance, housing)

Determinant for price elasticity: time

• Product demand is inelastic when consumers have less time to adjust to price changes ( short run→ inelastic) such as gas prices

• Product demand is elastic when consumers have more time to adjust and find alternatives to goods when they have a price change ( long run=elastic) such as switching to electric cars/

Determinant for price elastic: Luxury good vs necessity

• Inelastic goods may be necessities such as foods or medications ( in the short run)

• Elastic goods may be designer clothes or very expensive meals

Examples of inelastic goods:

• Farm products such as milk are highly inelastic

• Goods such as alcohol, cigarettes are inelastic because of addiction/use

Price elasticity in general:

• How much the quantity of a product or service/ supply demanded/given is changed due to a change in price

Price elasticity of Supply:

• If the quantity supplied by producers is changed a lot supply is elastic

• if the quantity supplied by producers doesn’t really change relative to price change supply is inelastic

• ** The easier/quicker a producer can shift resources between alternative uses/new pricing the more elastic

Formula of Price Elasticity of Supply

Es= Change in quantity supplied/sum of quantity/2/change in price of product/sum of price change/2

Income Elasticity

How responsive are consumers to change in income

• if inferior good change is negative

• If normal goods change is positive

• Formula: Change % of Qd/ Change % of income

• Shows us what types of goods they are —> Inferior people lean towards more when they have a lower income —> Normal good people leans towards more as they’re income rises.

The Market Period:

• When the time is too short for a producer to change the quantity supplied after a price change

• Supply can be constant/vertical for example for farmers who grow their products in advance or restaurant owners who order supplies in advance.

• * The more amount of time producers have to adjust to price changes/demand, the greater the amount they output.

Short run:

too short to change a factor of production, so the business cannot fully adjust

• However this time period is long enough to change capacity

• Some of these fixed costs include capital, costs tied to labor/raw materials or costs of rent —> more dramatic price change

Long run:

• A time long enough where firms/companies can change all factors of production —> cause a smaller price change

• Things that can be change are capital to produce level of output. This causes things such as new firms to enter the market/leave the market

Cross Elasticity of Demand:

• How sensitive/ how much consumers purchases change of one product if the price of another product rises

• Applies to both substitution goods and complementary goods

• Formula: % Change in quantity x/ % change in price of product y

Cross Price Elasticity: Substitue goods:

• Can only have a positive cross elasticity because as price of coffee for example increases, the demand of Trea increases

• The larger the positive cross elasticity the more they are close substitutes.

Cross Price Elasticity: Complementary goods

• Can only be negative 

• An increase in the price of one products would decrease the demand of another good.

• The larger the negative cross elasticity the more they are complementary goods

Independent goods:

• Zero elasticity/approximate means the goods are unrelated

Productive efficiency:

• Achieved because producers have to use the best combination of resources/ techniques because of competition

• Production costs are minimized

Allocative efficiency:

• The correct quantity of output is produced relative to other goods and services

• MB=MC, maximum willingness to pay equals minimum acceptable price

• If quantity is less than or greater than the equilibrium quantity there are efficiency losses

Consumer Surplus:

• When consumers receive benefit because they are willing to pay more for a good compared to its equilibrium price

• * Price and consumer surplus have an inverse relationship

Producer Surplus:

• When producers receive benefit because they can produce a product at a low price and receive more

• Price and producer surplus are directly related

Dead Weight loss

• An efficiency loss to society either underproduction or overproduction of a good ( that causes a reduction in consumer and producer surplus.)