L5 Elasticity

Principles of Microeconomics: Supply and Demand

1. Introduction to Elasticity

• Aims of Lecture

  • Understand elasticity in economics.

  • Analyze price elasticity of demand (PED) and other elasticity types.

  • Assess how changes in prices affect demand and overall market behavior.

2. Key Concepts in Elasticity

• Price Elasticity of Demand (PED)

  • Measures responsiveness of quantity demanded to a change in price.

  • Leads to understanding market dynamics better than merely supply and demand curves.

• Determinants of Elasticity

  • Availability of Close Substitutes: More substitutes = more elastic demand.

  • Necessities vs Luxuries: Necessities yield inelastic demand; luxuries yield elastic demand.

  • Definition of Market: Narrow markets tend to have more elastic demand.

  • Time Horizon: Long-term adjustments mean more elastic demand.

3. Calculating Price Elasticity of Demand

• Calculating PED:

  • Formula:[ \text{PED} = \frac{\text{% Change in Quantity Demanded}}{\text{% Change in Price}} ]

  • Example: 10% rise in price leads to 2% fall in quantity demanded.[ \text{PED} = \frac{-2%}{10%} = -0.2 ]

• Special Cases:

  • Perfectly Inelastic Demand: PED = 0 (quantity doesn't change regardless of price change).

  • Perfectly Elastic Demand: PED = ∞ (small price increase drops quantity to zero).

4. Interpreting Price Elasticity of Demand

• Value Interpretation:

  • PED < 1: Inelastic, quantity changes less than price changes.

  • PED > 1: Elastic, quantity changes more than price changes.

  • Giffen goods may show unique patterns against the law of demand.

5. Other Demand Elasticities

• Income Elasticity of Demand (IED):

  • Measures quantity demanded's responsiveness to income changes.

  • Normal Goods: IED > 0; Luxury Goods: IED > 1; Necessities: 0 < IED < 1.

• Cross-Price Elasticity of Demand (CED):

  • Measures the change in quantity demanded for one good due to price changes in another good.

  • Substitutes have positive CED; complements have negative CED.

6. Price Elasticity of Supply

• Price Elasticity of Supply:

  • Measures responsiveness of quantity supplied to price changes.

  • Characteristics: More elastic when time frames are longer.

7. Conclusion and Summary

• Summary Points:

  • PED indicates responsiveness to price changes.

  • Elasticities provide insights into market behavior and buyer habits.

  • Factors affecting elasticity include substitutes, necessity, time, and market definition.