Chapter Three - Elasticity 2025

Chapter Three: Elasticity (pg. 49 - 68)

Concept of Elasticity

• Definition: Elasticity measures the response of producers or consumers to changes in market conditions.

• Types of Elasticity:

  • Price Elasticity of Demand (PED): Measures consumer response to price changes.

  • Price Elasticity of Supply (PES): Measures producer response to price changes.

• Elastic vs Inelastic:

  • Elastic Products: Significant change in quantity demanded or supplied due to price changes.

  • Inelastic Products: Minor changes in quantity demanded or supplied despite price changes.

Importance of Elasticity

• For Businesses:

  • Knowledge of elasticity helps in profit generation strategies and business growth.

  • Low elasticity (inelastic demand) allows firms to increase prices with minimal drop in demand.

• For Government:

  • Understanding elasticity aids in the design of effective taxation policies.

  • Inelastic goods (e.g., cigarettes) can maximize tax revenues with little impact on demand.

Calculating Percentage Changes

• Percentage Change Formula:[% Change = \frac{New Value - Original Value}{Original Value} \times 100 ]

• Example Calculation:

  • If the price changes from $5 to $6:[% Change = \frac{6-5}{5} \times 100 = 20%]

Price Elasticity of Demand (PED)

• Formula:[PED = \frac{Percentage Change in Quantity Demanded}{Percentage Change in Price} = \frac{%\Delta QD}{%\Delta P}]

• Purpose: PED assesses the sensitivity of quantity demanded to price changes.

• Symbol Awareness: Recognize that the triangle ((\Delta)) indicates a change in value.

PED Outcomes

Determinants of Price Elasticity of Demand (PED)

• Number of Alternatives: More substitutes lead to higher elasticity.

• Percentage of Income: Goods taking up a large income portion tend to be more elastic.

• Market Breadth: Broad markets (e.g., cars) are often inelastic, while specific markets (e.g., a specific car brand) are elastic.

• Urgency of Purchase: Necessity leads to inelastic demand.

• Time: Longer time frames allow for more elastic responses.

Price Elasticity of Demand and Total Revenue

• Revenue Calculation: Total revenue is calculated as Price × Quantity.

• Revenue Implications: By understanding where price elasticity lies, firms can optimize pricing strategies for revenue maximization.

Midpoint Formula for PED

• Midpoint Method: Provides consistency in calculating PED by using averages.

Elasticity along a Linear Demand Curve

• Elasticity Variation:

  • At the top (low quantity), demand is elastic; at the bottom (high quantity), it is inelastic.

  • Elasticity is equal to one at the midpoint.

Price Elasticity of Supply (PES)

• Formula:[PES = \frac{Percentage Change in Quantity Supplied}{Percentage Change in Price} = \frac{%\Delta QS}{%\Delta P}]

• Purpose: Measures the reactivity of producers to price changes.

PES Outcomes and Factors

Factors Influencing Price Elasticity of Supply (PES)

• Time: Short-term inelasticity versus long-term elasticity based on responsiveness of producers.

• Industry Nature: Certain industries like agriculture have rigid supply responses due to growth cycles.

• Storage: Ability to store goods increases elasticity.

Application of Elasticity in Markets

• Agricultural Products: Demand is inelastic; increasing supply decreases price while revenue decreases due to inelastic demand.

• Housing Market: Supply is inelastic; increased demand raises prices significantly with only modest quantity increases.

Taxes and Price Elasticity

• Tax Implementation: Taxes shift supply curves and affect demand and pricing. The burden of taxes differs based on demand elasticity.

• Consumer vs. Producer Burden: Recognizes how tax impacts both buyers and suppliers.

• Revenue Maximization: Governments benefit from taxing inelastic goods, enhancing revenue while minimally impacting demand.

Conclusion

• The understanding of price elasticity is essential for making informed decisions in economics, influencing both market behavior and policymaking.