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:
    ext{Ed} = rac{(2,000-1,000)/(1,000)}{(12-15)/15} = -5

• Midpoint Method: More accurate for calculations.

  • Formula:
    ext{Ed} = rac{ ext{ extit{Percentage Change in Quantity D}}}{ ext{ extit{Percentage Change in Price}}}
  • Example:
    Ed = rac{(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.