Elasticity

Price Elasticity of Demand ε

a measure of the responsiveness of quantity demanded to changes in the price

• Always going to have a negative value

What is Demand when ε > 1?

elastic - consumers fairly responsive to a price change

a small increase in price will decrease quantity demanded by a relatively large amount

an increase in price decreases total revenue

sometimes called a luxury good

What is Demand when ε < 1?

inelastic - consumers fairly unresponsive to a price change

a large increase in price will decrease quantity demanded by a relatively small amount

an increases in price increases total revenue

What is Demand when ε = 1?

unit elastic

What determines the Elasticity of Demand?

Substitutes - if there are no substitutes there is inelastic demand 

Perfect Elastic Demand

even the slightest increase in price leads consumers to switch to substitutes

e.g. chewing gum at supermarket till

Perfect Inelastic Demand

consumers can’t switch to substitutes or stop buying when price increases

e.g. life saving drugs - no good substitute

Determinants of ε

• The availability of close substitutes

• The availability of close substitutes

• Share of the budget

  • What proportion of your budget do you spend on the good in question

• Time to adjust

  • In the short run, consumers may have a difficult time altering their behaviour, in the long run, behavioural changes are easier (e.g. responsiveness to petrol price changes)

• Addiction/Habitual

  • Goods that are addictive tend to be more inelastic

Arc and Point Price Elasticity

the price elasticity of demand between 2 points on the demand curve

Point Price Elasticity

provides a measure of the elasticity of demand at a particular point on the demand curve

PPE Formula

If we take ΔP to be very small, then the slope of the demand curve at some point is ΔP/ΔQ

So f demand at the point A is:

Cross-Price Elasticity of Demand

The percent change in quantity demanded of that good, in response to a 1% change in price of another good

Can be positive or negative:

• Positive if substitutes

• Negative if complements

Income Elasticity of Demand

The percentage change in quantity demanded associated with a 1% change in consumer income

Describes how responsive demand is the income changes

Positive for normal goods

Its negative for inferior goods

Price Elasticity of Supply

Measures sellers sensitivity to changes in price

E = price change in quantity supplied / percentage change in price 

Determinants of Supply Elasticity

• Flexibility of inputs

• Mobility of inputs

• Ability to produce with substitute=ute inputs

• Time