Lecture3a-elasticiy

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Elasticity and Its Application

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Summary

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THE ELASTICITY OF DEMAND

THE ELASTICITY OF SUPPLY

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The Elasticity of Demand

The price elasticity of demand and its determinants

 Necessities versus luxuries

 Availability of close substitutes

 Definition of the marketing: Narrowly defined markets tend to have more elastic demand than broadly defined market (easy to find close substitutes)

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The Concept of Elasticity

 Elasticity is a measure of the responsiveness of one variable to another.

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Price Elasticity

 The price elasticity of demand is the

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Sign of Price Elasticity

 According to the law of demand, whenever the price rises, the quantity demanded falls. Thus the price elasticity of demand is always negative.

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What Information Price

Elasticity Provides

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Classifying Demand and Supply

as Elastic or Inelastic

 Demand is elastic if the percentage change in quantity is greater than the percentage change in price.

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Classifying Demand and Supply

as Elastic or Inelastic

 Demand is inelastic if the percentage change in quantity is less than the percentage change in price.

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Elastic Demand

 Elastic Demand means that quantity changes by a greater percentage than the percentage change in price.

Inelastic Demand

Inelastic Demand means that percentage change in quantity causes less percentage change in in price .

Unit elastic Demand

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Total revenue and the price

elasticity

R = P X Q

R: Revenue

P: Price

Q: Quantity

Quantity Price

100 $4

Q P

Demand

.

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Graphs of Elasticities

P

ric

e

Quantity of software (in hundred thousands) $26

24 22 20 18 16 14

0

D B

A

10 12 14

C (midpoint)

Elasticity of demand

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Calculating Elasticities: Price elasticity of Demand

D

P

Q

What is the price elasticity of demand between A and B?

$20 10 $26 14 Midpoint B A

E

_D

=

_%ΔP%ΔQ

Q2–Q1 ½(Q2+Q1)

P2–P1 ½(P2+P1)

=

C 12 $23

=

10–14 ½(10+14) 26–20 ½(26+20) -.33 .26

=

1.27

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Calculating Elasticity of Demand Between

Two Points

27 . 1 26 . 33 . 23 6 12 4 ) 20 26 ( 20 26 ) 10 14 ( 14 10 E 21 21 D           P ri c e

Quantity of software (in hundred thousands) $26 24 22 20 18 16 14 0 Demand B A

10 12 14 C

midpoint

Elasticity of demand

between A and B: E %_% Q_P

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THE ELASTICITY OF DEMAND

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Zero elasticity: demand is perfectly inelastic, and the demand curve is vertical:

• Regardless of the price, the quantity demanded stays the same. As the elasticity rises, the demand curve gets flatter and flatter.

Perfectly elastic demand:

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THE ELASTICITY OF DEMAND

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(d) Quantity moves proportionately more than the price

(b) Quantity moves proportionately less than the price

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Elasticity and Demand Curves

 Two important points to consider:

 Elasticity is related (but is not the same as) slope.

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Elasticity Along a Demand Curve

P

ri

c

e

$10 9 8 7 6 5 4 3 2 1

0 1 2 3 4 5 6 7 8 9 10 Quantity

Elasticity declines along demand curve as we move toward the quantity axis

E_d = 1

E_d = 0 E_d < 1

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Price Quantity Revenue Percent change in price

Percent change in

quantity

Elasticity Description

7 0 ?

6 2

5 4

4 6

3 8

2 10

1 12

0 14

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Price Elasticity: Supply

 Price elasticity of supply is the percentage change in quantity supplied divided by the percentage

change in price

• This tells us exactly how quantity supplied responds to a change in price

E

_S

=

• Elasticity is independent of units

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Price Elasticity: Supply

 Supply is elastic if the percentage change in quantity is

greater than the percentage change in price

Elastic supply is when

E

_S

> 1

• Supply is inelastic if the percentage change in quantity is less than the percentage change in price

Inelastic supply is when

E

_S

< 1

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Calculating Elasticities: Price elasticity of Supply

P

Q

What is the price elasticity of supply between A and B?

$4.50 476 $5.00 485 B A

E

_S

=

_%ΔP%ΔQ

Q2–Q1 ½(Q2+Q1)

P2–P1 ½(P2+P1)

=

485–476 ½(485+476) 5–4.50 ½(5+4.50) Midpoint C 480.5 $4.75 0.0187 0.105

=

0.18

S

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Calculating Elasticity of Supply

Between Two Points

P

%

Q

%

E





W a g e p er h o u r

Quantity of workers $6.00 5.50 5.00 4.50 4.00 3.50 3.00 0 C B A

470 480 490

Elasticity of supply between A and B:

2 . 105 . 021 . 75 . 4 50 . 480 10 ) 50 . 4 5 ( 50 . 4 5 ) 475 485 ( 475 485 E 2 1 21

S   

 

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 Let’s consider a case in which there exists new technology that leads to more productive of the farming industry.

CAN GOOD NEWS FOR FARMING BE BAD NEWS FOR FARMERS?

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Initial condition: •Price : $3

•Quantity : 100

With an more advanced technology:

•Price : $2

•Quantity : 110

Question: 1. Can you find the farmer’s revenues in the two cases above?

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WHY DID OPEC FAIL TO KEEP THE PRICE OF OIL HIGH?

 Short-run is different to long-run demand due to “elasticity”

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DOES DRUG INTERDICTION INCREASE OR DECREASE DRUG-RELATED CRIME?

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A B

A

B