Elasticity and Public Goods in Economics

Week 4 - Elasticity and Public Goods

Discussion for the Day
  • Group Activity: Discuss how price changes impact purchasing behavior.
    • Questions to consider:
    • How does a sudden price increase or decrease affect your spending habits?
    • How about for goods/services you typically don't buy?
    • What factors cause your behavior to change for some products but not for others?
The Main Points This Week
  • Key Topics:
    • Elasticity
    • Price Elasticity of Demand
      • Definition and calculation
      • Elastic vs Inelastic demand
    • Price Elasticity of Supply
    • Different Types of Elasticity
    • Tax Incidence
    • Government Interventions
    • Public Goods
    • Externalities
      • Social vs Private Costs and Benefits
    • Free-Rider Problem
Understanding Elasticity
  • Major Types of Elasticity:
    • Price Elasticity of Demand:
    • Measures how quantity demanded changes with price changes.
    • Price Elasticity of Supply:
    • Measures how quantity supplied changes with price changes.
    • Income Elasticity:
    • Measures how quantity demanded changes with income changes.
    • Cross-Price Elasticity:
    • Measures how quantity demanded of one good changes when the price of another good changes.
Price Elasticity of Demand
  • Definition: Speed of adjustment in purchasing decisions based on price changes.
    • Elastic Demand:
    • Percentage change in quantity demanded is greater than percentage change in price (highly responsive).
    • Example: A rise in airline ticket prices leads to a significant drop in purchases.
    • Inelastic Demand:
    • Percentage change in quantity demanded is less than percentage change in price (low responsiveness).
    • Example: A rise in gasoline prices has little effect on habitual buyers.
Graphing Elasticity
  • Elastic Demand: Flat curve (small price changes lead to large quantity changes).
  • Inelastic Demand: Steep curve (large price changes lead to small quantity changes).
  • Perfectly Elastic Demand: Horizontal curve (any price leads to infinite demand).
  • Perfectly Inelastic Demand: Vertical curve (quantity does not change regardless of price).
Factors Determining Elasticity
  • Availability of substitutes increases elasticity.
  • Necessities tend to be inelastic.
  • Goods that occupy a smaller share of the budget are typically more elastic.
  • Longer time frames allow more market entry, potentially increasing elasticity.
  • Competitive dynamics affect substitute availability.
  • Narrowly defined markets tend to be more elastic.
Examples of Elastic vs Inelastic
  • Gasoline: Inelastic
  • Specific Gasoline Brands (e.g., Wawa): Elastic
  • Food: Inelastic
  • Big Macs: Elastic
  • Sugar: Inelastic for non-professionals
Calculating Elasticity

  • Point Elasticity: The formula involves changes in price and quantity using initial points.

    • Example Calculation:
      extEd=(2,000−1,000)/(1,000)(12−15)/15=−5ext{Ed} = \frac{(2,000-1,000)/(1,000)}{(12-15)/15} = -5

  • Midpoint Method: More accurate for calculations.

    • Formula:
      extEd=extextitPercentageChangeinQuantityDextextitPercentageChangeinPriceext{Ed} = \frac{ ext{ extit{Percentage Change in Quantity D}}}{ ext{ extit{Percentage Change in Price}}}
    • Example:
      Ed=(1,000)/(1,500)(−3)/(13.5)=−3Ed = \frac{(1,000)/(1,500)}{(-3)/(13.5)} = -3
Interpreting Elasticities
  • Inelastic Demand: Quantity change < Price change
  • Elastic Demand: Quantity change > Price change
  • Unit Elastic: Quantity change = Price change
  • Elasticity is NOT slope; it varies across different points.
Price Elasticity of Supply
  • Elastic Supply:
    • Quantity supplied responds strongly to price changes.
    • Example: Increased wages attract more workers.
  • Inelastic Supply:
    • Quantity supplied responds weakly to price increases.
    • Example: Time needed to increase parking supply in response to price increases.
Different Types of Elasticity

  • Income Elasticity:

    • Ey < 0: Inferior goods (demand decreases as income increases).
    • 0 < Ey < 1: Necessities (demand remains stable with income changes).
    • Ey > 1: Luxuries (demand increases more than income).

  • Cross-Price Elasticity:

    • Exy < 0: Complements (price increase of one reduces demand for another).
    • Exy > 0: Substitutes (price increase of one increases demand for another).
Public Goods and Externalities

  • Public Goods:

    • Non-excludable and non-rival goods that benefit society (e.g., national defense).
    • Often require government intervention as they may not be profitable for private companies.

  • Externalities:

    • Occur when third parties are affected by market transactions.
    • Types:
      • Positive Externalities (benefit others, e.g., flu vaccines).
      • Negative Externalities (harm others, e.g., pollution).
Economics of Reducing Pollution
  • Government policies must balance the marginal benefits and costs of pollution reduction.
  • Pollution should be reduced until marginal benefits equal marginal costs.
  • The Free-Rider Problem: Individuals benefit from public goods without contributing to costs, leading to underprovision of these goods.