Chapter 5: Elasticity and Its Application

Key Concepts of Elasticity

• Elasticity Definition: Measures responsiveness of quantity demanded/supplied to price changes.

• Price Elasticity of Demand (Ep):

  • Ep = \frac{\text{Percentage change in Qd}}{\text{Percentage change in P}}

  • Elastic Demand: |Ep| > 1

  • Inelastic Demand: |Ep| < 1

  • Unit Elastic Demand: |Ep| = 1

Key Determinants of Elasticity

• Available Substitutes: More substitutes → higher elasticity.

• Market Definition: Narrow definitions → higher elasticity.

• Time Horizon: Longer time frames → higher elasticity.

• Product Price: Higher priced items tend to be more elastic.

Price Elasticity of Supply (Es)

• Price Elasticity of Supply:

  • Es = \frac{\text{Percentage change in Qs}}{\text{Percentage change in P}}

• Positive relation between price and quantity supplied.

Total Revenue (TR) and Elasticity Relationship

• Total Revenue Calculation: TR = P \times Q

• Elastic Demand: Price increase → Total Revenue decreases.

• Inelastic Demand: Price increase → Total Revenue increases.

Income Elasticity of Demand (EI)

• Income Elasticity Definition: Measures demand change in response to income changes.

  • Normal Goods: EI > 0

  • Inferior Goods: EI < 0

Cross Price Elasticity of Demand (Exy)

• Cross Price Elasticity Definition: Measures demand change for one good due to the price change of another good.

  • Substitutes: Exy > 0

  • Complements: Exy < 0

Short-Run vs. Long-Run Elasticity

• Short-run estimates are generally lower than long-run estimates, as consumers have more time to adjust behavior in the long run.