Page 1

Introduction to Elasticity

• Elasticity is a crucial concept in economics used to measure responsiveness of demand and supply to changes in price and other factors.

Page 2

Learning Objectives

• Define Price Elasticity of Demand: Understand the concept and what influences its elasticity.

• Application in Economic Policy: Analyze how long-run elasticities impact policy design.

• Calculations: Learn to calculate the price elasticity of demand from demand curves.

• Revenue Effects: Explore how price changes influence total revenue and expenditure based on elasticity.

• Elasticity Types: Understand cross-price elasticity and income elasticity of demand.

• Price Elasticity of Supply: Grasp factors affecting supply elasticity and learn to calculate it from supply curves.

Page 3

Drug Enforcement and Local Theft Analysis

• Hypothesis: Drug users may resort to theft to fund their drug purchases; enforcing drug laws could reduce theft rates.

• Analysis Findings: While increased enforcement reduces drug supply, the resulting price increase may not decrease theft unless total drug expenditure falls.

• Key Concept: Responsiveness of quantity demanded to price changes is crucial.

Page 4

Price Elasticity of Demand

• Definition: Price elasticity of demand quantifies the percentage change in quantity demanded in response to a 1% price change.

• Example Calculation:

  • If beef price decreases by 1% and demand increases by 2%, the elasticity is -2.

• Interpretation: High elasticity (|E| > 1) indicates a responsive demand to price changes.

Page 5

Calculation of Price Elasticity

• Symbol: ε (epsilon) represents elasticity.

• Formula:

  • [ ε = \frac{\text{Percentage change in quantity demanded}}{\text{Percentage change in price}} ]

• Important Note: While demand elasticity is negative due to the inverse relationship between price and quantity, it's typically expressed as a positive value for ease.

Page 6

Elastic Demand

• Condition: Demand is elastic when the elasticity is greater than 1.

• Implication: The quantity demanded responds more significantly than the price change, making the demand responsive.

Page 7

Inelastic Demand

• Condition: Demand is inelastic when elasticity is less than 1.

• Implication: In this case, the quantity demanded changes less than the price change, indicating a lower responsiveness to price shifts.

Page 8

Unit Elastic Demand

• Condition: Demand is unit elastic when elasticity equals 1.

• Implication: Price and quantity change by the same percentage, resulting in a balanced response to price shifts.

Page 9

Example of Demand Calculation: Pizza

• Old Price: $1.00, New Price: $0.97

• % Change in Price: 3%

• Old Quantity: 400, New Quantity: 404

• % Change in Quantity: 1%

• Elasticity Calculation: [ ε = \frac{1%}{3%} = 0.33 ]

• Conclusion: Demand is inelastic as elasticity < 1.

Page 10

Determinants of Price Elasticity of Demand

1. Substitution Possibilities: More options lead to more elastic demand.

2. Budget Share: A larger share of the budget spent on an item increases elasticity.

3. Time to Adjust: Longer adjustment periods increase elasticity (e.g., air conditioners vs. gasoline).

Page 11

Examples of Elasticities

• Green peas: 2.8

• Restaurant meals: 1.6

• Beer: 1.2

• Coffee: 0.3

Page 12

Unintended Effects of the Yacht Tax

• Hypothesis: Luxury tax on yachts would generate $31 million.

• Analysis Findings: High elasticity of demand led to only $16.6 million in revenue; buyers opted for yachts outside the U.S., losing jobs in the U.S. boating industry.

• Outcome: The tax was repealed after two years.

Page 13

Social Contagion and Long-Run Elasticity

• Long vs. Short Run: Price elasticity of demand tends to be higher in the long run; individuals take time to adjust to price changes.

• Impact of Social Influence: Behaviors can spread like social media memes, affecting overall demand response.

Page 14

Taxes and Teen Smoking

• Hypothesis: Teen demand for cigarettes is inelastic due to peer influence and limited income.

• Analysis Findings: Higher cigarette taxes rise prices, leading some teens to reduce smoking, impacting their peers.

Page 15

Long-Run Response to a Carbon Tax

• Effects of Social Contagion: Promotes a greater long-term response to carbon taxes, with price surges based on emissions.

• Example: Solar panels.

Page 16

Price Elasticity Notation

• Change in Quantity (ΔQ): Percentage change in quantity.

• Change in Price (ΔP): Percentage change in price.

• Formula Reiteration: [ ε = \frac{\Delta Q}{Q} \div \frac{\Delta P}{P} ]

Page 17

Graphical Representation of Price Elasticity

• Scenarios: Examining price and quantity changes using specific points (A & B) on a demand curve.

• Elasticity Example: Elasticity can be calculated using changes in quantity and price graphically illustrated.

Page 18

Demand Curve Intersections

• Crossing Curves: At crossed demand curves, the price (P/Q) is identical, leading to varying elastocities.

• Steep Curve Implications: Less price elasticity at steeper curves.

Page 19

Price Elasticity Variability

• Demand Curve Behavior:

  • Varies along with different prices and quantities on a straight-line demand curve.

  • Elasticity differs due to proportionate changes at varying quantities.

• Elasticity Changes Systematically: Influences consumer behavior based on the price range.

Page 20

Special Elasticity Cases

• Perfectly Elastic: Demand responds infinitely to price changes.

• Perfectly Inelastic: Demand shows no response to changes in price.

Page 21

Elasticity and Total Expenditure

• Total Expenditure (Total Revenue): Calculated as Price x Quantity.

• Graphical Analysis: Changes in price impact total expenditure differently based on elasticity levels.

Page 22

Price Increases and Total Revenue

• Price Changes: Inelastic demand (below midpoint) will increase total revenue if price increases.

• Example: Movie ticket increasing from $2 to $4 shows an increase in revenue due to inelastic demand.

Page 23

Price Decrease and Total Revenue

• Elastic Demand Impact: A price increase (above midpoint) leads to a decrease in total revenue, demonstrating elasticity.

• Example: Movie tickets price increasing from $8 to $10 leads to decreased revenue.

Page 24

Total Expenditure Impact

• Graphical Interpretation: Tracking expenditure across quantity sold, showing how expenditure reacts to price fluctuations over different demand elasticity conditions.

Page 25

Elasticity and Demand Changes

• Effects on Total Expenditure: Demand type (elastic vs inelastic) determines how price increases or decreases will affect total expenditure on goods.

Page 26

Cross-Price Elasticity of Demand

• Definition: The percentage change in quantity demanded of good A raises from a price change in good B.

• Interpretation: Positive values indicate substitutes; negative values indicate complements.

Page 27

Income Elasticity of Demand

• Definition: Measures % change in quantity demanded due to a % change in income.

• Interpretations: Positive = normal goods; negative = inferior goods.

Page 28

Price Elasticity of Supply

• Explanation: Measures responsiveness in quantity supplied due to price change.

• Calculation Methods: Similar to demand, using change in quantity and price.

Page 29

Price Elasticity of Supply Graphs

• Effect of Positive Intercept: A supply curve can indicate decreasing elasticity as quantity increases.

• Calculations: Examples of price elasticity at different points on the supply curve.

Page 30

Special Supply Elasticity Cases

• Perfectly Inelastic Supply: Zero elasticity signifying no changes to price variations (ex. unique land).

• Perfectly Elastic Supply: Infinite elasticity where producers supply at a fixed price.

Page 31

Determinants of Supply Elasticity

1. Input Flexibility: More adaptable inputs lead to more elastic supply.

2. Resource Mobility: Greater elasticity when inputs can move freely.

3. Time Impact: More time results in more elastic supply responses.

Page 32

Real-World Applications: Prices and Elasticities

• Gas Prices vs. Car Prices Example: Differences in short-run elasticity highlighting specifics on consumer behavior and supply/price changes.

Page 33

Supply Bottleneck Effects

• Effects of relying solely on unique inputs and how it impacts supply elasticity over time.

Page 34

The Midpoint Formula: Introduced

• Need for Consistency: Using the midpoint formula standardizes elasticity calculations across varying points.

Page 35

Applying the Midpoint Formula

• Methodology: Uses averages in calculus for finding stability in elasticity throughout various price and quantity changes.