ECON 102 Chapter 5 Slides

Chapter 5: Elasticity

Definition of Elasticity

  • Elasticity measures the responsiveness of one variable to changes in another.

  • Example: Average gas prices in Las Vegas dropped from $4.56 to $3.89, a 15% decrease.

  • Price elasticity of demand is expressed as a negative number; use absolute value for interpretation.

  • Bigger absolute values indicate greater elasticity.

Calculating Percentage Changes

Two Methods:

  1. Base Method

    • %ΔP = (Change in P / Old P)

    • %ΔQ = (Change in Q / Old Q)

  2. Midpoint Method

    • Uses average of old and new values for calculations.

Categorizing Price Elasticity of Demand

  • Ed < 1 : Inelastic

  • Ed > 1 : Elastic

  • Ed = 1 : Unit Elastic

  • Ed = 0 : Perfectly Inelastic

  • Ed = ∞ : Perfectly Elastic

Demand Curve Shapes

  • Steeper curves represent inelastic demand.

Determinants of Elasticity

  1. Availability of close substitutes

  2. Proportion of income spent on the product

  3. Luxuries vs. necessities

  4. Time period for adjustment

  • Elastic goods have more substitutes, larger budget proportions, are luxuries, and allow more time for decisions.

Examples of Demand Elasticity

  • Phones: Inelastic demand overall, but specific models (e.g., LG) might have elastic demand.

  • Price change scenarios: If diesel jeans decrease 10% with Ed of 1.2, sales increase.

Elasticity and Total Revenue

  • Inelastic Demand: Price increases lead to higher total revenue.

  • Elastic Demand: Price increases lead to lower total revenue.

  • Unit Elastic Demand: Price changes do not affect total revenue.

Types of Goods Related to Elasticity

  • Inelastic Goods: Prices of these goods increase quickly over time.

  • Office supply stores offer discounts on inelastic goods like pencils before school term starts.

Cross Elasticity of Demand

  • Measures how one good’s price affects demand for another.

  • Sign matters:

    • Positive (+): substitutes

    • Negative (−): complements

    • Zero (0): not related.

Income Elasticity of Demand

  • Measures responsiveness of quantity demanded to changes in consumer income.

  • Signs indicate type of good:

    • Normal Goods: 0 < EY < 1

    • Luxury Goods: EY > 1

    • Inferior Goods: EY < 0

Elasticity of Supply

  • Measures quantity supplied's response to price changes.

  • ES = % Change Quantity Supplied / % Change Price

  • Always positive; less than 1 is inelastic, greater than 1 is elastic.

Types of Taxes and Elasticity

  1. Progressive tax: Higher rates as income increases.

  2. Flat tax: Constant percentage regardless of income.

  3. Regressive tax: Lower percentage as income rises.

  4. Lump-sum tax: Fixed dollar amount regardless of income.

Tax Incidence

  • Who bears the economic burden of a tax depends on elasticity.

  • Elastic goods lead to less burden on consumers; inelastic goods result in more burden.