the concept of elasticity. elasticity what is the concept and why do we need it? elasticity is used...
TRANSCRIPT
The Concept of Elasticity
Elasticity
What is the concept and why do we need it?
Elasticity is used to measure the effects of changes in economic variables
The Most Important Elasticity
• Price elasticity of demand
• A measure of the responsiveness of the quantity demanded of a good to a change in its price.
Demand: Gallons vs Litres Price($/g) Quant(g) Price($/L) Quant(L)
a 100 0 a' 25 0
b 50 25 b' 12.50 100
c 0 50 e' 0 200
Elasticity: A Units-Free Measure
Price elasticity ofdemand =
Percentage change in quantity demanded
Percentage change in price
Calculating Elasticity
P
Q
%
%
ave
ave
PP
/
/
Which is negative, but price elasticity ofdemand is given as a positive number
= (Q/P)(Pave/Qave)
Calculating Elasticity
• Negative sign is ignored
• The changes in price and quantity are expressed as percentages of the average price and average quantity.
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint
Newpoint
Calculating the Elasticity of Demand
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
= $20P
= 8Q
Originalpoint
Newpoint
Calculating the Elasticity of Demand
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint
Newpoint
Pave = $400
= $20P
= 8Q
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint
Newpoint
Pave = $400
Qave = 40
= $20P
= 8Q
Calculating the Elasticity of Demand
Calculating Elasticity
PavePQaveQ
//
400/2040/8 = 4
meaning, on average, each 1% price decreaseCauses a 4% increase inquantity demanded
Price elasticity
Some Interesting Characteristicsof
Linear Demand Curves(It is a straight Line)
Can be Deduced
Compute Elasticity for Gasoline (in Gallons) from Earlier Example
0 25 50 100 200
25
100
Pri
ce (
$/un
it)
Quant. (G)
Gallons: slope = -2
When:Price falls from $100/gal to $0/gal
50
|P/Q| = 100/50 = 2
Pavg = 100/2 (=50)Qavg = 50/2 (=25)Pavg/ Qavg = (100/2)/(50/2)
= 2
|P/Q| = 100/50 = 2
Pavg/ Qavg = (100/2)/(50/2)= 2
The ratio of midpoint Price and Quantity = The slope
But for elasticity we want |Q/P|, the reciprocal of demand curve slope
|Q/P| = 1/2
Elasticity = |Q/P| (Pavg/ Qavg) = (1/2)*2 =1
A Lesson: Elasticity on linear demand curves
0 25 50 100 200
25
100
Pri
ce (
$/un
it)
Quant. (G or L)
50 Elasticity = 1
For any Price-Quantity combinationElasticity > 1
Elasticity < 1
Three types of price elasticity of demand
• inelastic
• Unit elastic
• elastic
Inelastic Demand
• Inelastic demand
• The percentage change in quantity is less than the percentage change in price.
• Price elasticity of demand < 1
Extreme Case: Perfectly Inelastic Demand
6
12
Pri
ce
Quantity
D1Elasticity = 0 WHY?
(Q/P)(Pave/Qave) =
(0/P)(Pave/Qave) = 0
Because Q = 0
Elastic Demand
• Elastic demand
• The percentage change in quantity is greater than the percentage change in price.
• Price elasticity of demand > 1
Extreme Case:Perfectly Elastic Demand
6
12
Pri
ce
Quantity
D3
Elasticity =
(Q/P)(Pave/Qave) =
Because P = 0
(Q/0)(Pave/Qave) =
Unit Elastic Demand
• Unit elasticity
• The percentage change in quantity equals the percentage change in price.
• Price elasticity of demand = 1
Extreme Case:Unit Elastic Demand Everywhere
6
12
Pri
ce
Quantity
D2
1 2 3
Elasticity = 1
Unit Elasticity
Factors That Influence Elasticity
• The Closeness of Substitutes.
• The closer the substitutes, the more elastic the demand
•more elastic means a higher price elasticity (but not necessarily > 1)
Elasticity and Closeness of Substitutes
Quantity (pounds per week)
Pri
ce (d
olla
rs p
er p
ound
)
5
10
No close subs
1 2 3 4 7
Orange Roughy
Close subs
Factors That Influence Elasticity
• Proportion of Income Spent on the Good
• The greater the proportion of income spent on food, the more elastic the demand•Because of Income Effect of a price change
Factors That Influence Elasticity
• Time Elapsed Since Price Change
• The longer the time, the more elastic the demand•Short-run demand•Long-run demand
28
Factors Affecting Price Elasticity of Demand
• Availability of substitutes
• The better & more numerous the substitutes for a good, the more elastic is demand
• Percentage of consumer’s budget
• The greater the percentage of the consumer’s budget spent on the good, the more elastic is demand
• Time period of adjustment
• The longer the time period consumers have to adjust to price changes, the more elastic is demand
29
Income Elasticity
• Income elasticity (EM) measures the
responsiveness of quantity demanded to changes in income, holding the price of the good & all other demand determinants constant
• Positive for a normal good
• Negative for an inferior goodd dM
d
% Q Q ME
% M M Q
30
Cross-Price Elasticity
• Cross-price elasticity (EXY) measures the
responsiveness of quantity demanded of good X to changes in the price of related good Y, holding the price of good X & all other demand determinants for good X constant
• Positive when the two goods are substitutes
• Negative when the two goods are complementsX X Y
XYY Y X
% Q Q PE
% P P Q