CHAPTER 6: Elasticity

6-1 Introduction

• Understanding elasticity is crucial as it measures the responsiveness of buyers and sellers to changes in price.

6-2 Price Elasticity of Demand

• Definition: Price elasticity of demand measures buyers’ responsiveness to price changes.

  • Elastic demand:

  • Sensitive to price changes.

  • Results in a large change in quantity demanded.

  • Inelastic demand:

  • Insensitive to price changes.

  • Results in a small change in quantity demanded.

6-3 Price Elasticity Coefficient (Ed)

• Formula:
  $<br>Ed = rac{ ext{Percentage change in quantity demanded of product X}}{ ext{Percentage change in price of product X}} <br>$

• Represents how responsive quantity demanded is to price changes.

6-4 Midpoint Formula

• Purpose: Use the midpoint formula for determining price elasticity to ensure consistent results.

• Formula:
  $<br>Ed = rac{ ext{Change in quantity}}{ ext{Sum of quantities/2}} \bigg/ rac{ ext{Change in price}}{ ext{Sum of prices/2}} <br>$

6-5 Price Elasticity of Demand Formula

• Method: Use percentages for unit-free measure to compare elasticities across products.

• Note: Eliminate the minus sign for easier comparison of elasticities.

6-6 Interpretation of Elasticity of Demand

• Values Define Demand Type:

  • If Ed > 1: Demand is elastic.

  • If $Ed = 1$: Demand is unit elastic.

  • If Ed < 1: Demand is inelastic.

  • Extreme Cases:

  • $Ed = 0$: Demand is perfectly inelastic.

  • $Ed = ext{∞}$: Demand is perfectly elastic.

6-7 Extreme Cases: Perfectly Inelastic Demand

• Graph Representation: The demand curve is vertical indicating that quantity demanded does not change regardless of price changes.

6-8 Extreme Cases: Perfectly Elastic Demand

• Graph Representation: The demand curve is horizontal indicating that any increase in price would lead to zero quantity demanded.

6-9 Total Revenue Test Overview

• Total Revenue (TR): $TR = ext{Price} imes ext{Quantity}$

• Implications of Price Changes:

  • Inelastic Demand: Price (P) and Total Revenue (TR) move in the same direction.

  • Elastic Demand: Price (P) and Total Revenue (TR) move in opposite directions.

6-10 Total Revenue Test with Elastic Demand

• Visualize the impact of lowering price on total revenue: the gain in revenue from increased quantity sold exceeds the loss from lower price.

6-11 Total Revenue Test with Inelastic Demand

• Visualize the impact of lowering price on total revenue: the loss from lower price exceeds the gain from increased quantity sold.

6-12 Total Revenue Test with Unit-Elastic Demand

• Visualize that lowering price results in gains equaling losses, hence total revenue remains unchanged.

6-13 Total Revenue Test Example

• Graphical Representation: Shows various demand states and their corresponding price impacts on total revenue.

6-14 Summary of Price Elasticity of Demand

6-15 Determinants of Elasticity of Demand

• Substitutability: More substitutes available mean demand is more elastic.

• Proportion of Income: Higher proportion of income spent on a good increases elasticity.

6-16 Additional Determinants of Elasticity of Demand

• Luxuries vs. Necessities: Luxury goods tend to have more elastic demand than necessities.

• Time: More time allows consumers to adjust behavior, making demand more elastic.

6-17 Price Elasticity of Supply Overview

• Definition: Price elasticity of supply measures sellers’ responsiveness to price changes.

  • Elastic supply: Producers responsive to price changes.

  • Inelastic supply: Producers less responsive to price changes.

6-18 Types of Price Elasticity of Supply

• Elastic Supply: Es > 1

• Unit Elastic Supply: $Es = 1$

• Inelastic Supply: Es < 1

• Perfectly Inelastic Supply: $Es = 0$

6-19 Price Elasticity of Supply and Time

• Determinant: Time is a primary factor affecting the elasticity of supply.

• Time Periods Considered:

  • Immediate market period

  • Short run

  • Long run

6-20 The Immediate Market Period

• In this period, supply is perfectly inelastic due to fixed capacity.

6-21 The Short Run

• Short-run supply is more elastic compared to the immediate market period due to adjustments in production capacity.

6-22 The Long Run

• Long-run supply is even more elastic compared to both immediate market and short-run periods, as businesses can adjust all inputs.

6-23 Cross Elasticity of Demand Formula

• Formula:
  $<br>E_{xy} = rac{ ext{Percentage change in quantity demanded of product X}}{ ext{Percentage change in price of product Y}} <br>$

6-24 Cross Elasticity of Demand

• Definition: Measures responsiveness of purchases of one good to the price change of another good.

  • Substitute Goods: If cross elasticity is positive.

  • Complementary Goods: If cross elasticity is negative.

  • Independent Goods: If elasticity is zero or near-zero.

6-25 Formula for Income Elasticity of Demand

• Formula:
  $<br>E_i = rac{ ext{Percentage change in quantity demanded}}{ ext{Percentage change in income}} <br>$

6-26 Income Elasticity of Demand

• Definition: Measures how responsive buyers are to changes in their income.

  • Normal Goods: If elasticity is positive.

  • Inferior Goods: If elasticity is negative.

6-27 Cross and Income Elasticities