MICRO CH5

Elasticity Overview

• Elasticity measures responsiveness of quantity demanded/supplied to market changes.

Price Elasticity of Demand (PED)

• Definition: Responsiveness of quantity demanded to price changes.

• Formula: ext{PED} = rac{ ext{% change in quantity demanded}}{ ext{% change in price}}

• Values:

  • If PED > 1: Elastic Demand

  • If PED < 1: Inelastic Demand

  • If PED = 1: Unit Elastic Demand

Total Revenue and Price Elasticity

• If demand is elastic: increasing price decreases total revenue.

• If demand is inelastic: increasing price increases total revenue.

Income Elasticity of Demand (YED)

• Definition: Responsiveness of quantity demanded to income changes.

• Normal goods: YED > 0; Inferior goods: YED < 0.

Cross-Price Elasticity of Demand (XED)

• Definition: Responsiveness of quantity demanded for one good to price changes of another good.

• Substitutes: XED > 0; Complements: XED < 0.

Price Elasticity of Supply (PES)

• Definition: Responsiveness of quantity supplied to price changes.

• Formula: ext{PES} = rac{ ext{% change in quantity supplied}}{ ext{% change in price}}

• Values:

  • If PES > 1: Elastic Supply

  • If PES < 1: Inelastic Supply

Determinants of Price Elasticity

• Demand elasticity increases with:

  • Availability of substitutes

  • Luxury vs. necessity distinction

  • Narrow market definition

  • Time for buyer response (greater over time).