Chapter 5
Elasticity
and Its Applications
Elasticity . . .
is
a measure of how much buyers and sellers respond to changes in market conditions
THE ELASTICITY OF DEMAND
Price
elasticity of demand is a measure
of how much the quantity demanded of a good responds to a change in the
price of that good.
Price
elasticity of demand is the percentage change in quantity demanded given
a percent change in the price.
Demand
for a good is said to be elastic if the quantity demanded responds substantially
to a change in price.
What determines the Price
Elasticity of Demand?
Availability
of Close Substitutes
Demand
will be more elastic if there are more substitutes.
Necessities
versus Luxuries
Demand
for necessities is more inelastic
Definition
of the Market
Vanilla
ice cream or ice cream in general
Time
Horizon
Over
time people reshape their preferences if prices change
Computing the Price Elasticity
of Demand
The
price elasticity of demand is computed as the percentage change
in the quantity demanded divided by the percentage change in price.
Computing the Price Elasticity
of Demand
Example:
If the price of an ice cream cone increases from $2.00 to $2.20 and the
amount you buy falls from 10 to 8 cones, then your elasticity of demand
would be calculated as:
The Variety of Demand Curves
Inelastic
Demand
Quantity
demanded does not respond strongly to price changes.
Price
elasticity of demand is less than one.
Elastic
Demand
Quantity
demanded responds strongly to changes in price.
Price
elasticity of demand is greater than one.
The Variety of Demand Curves
Perfectly
Inelastic
Quantity
demanded does not respond to price changes.
Perfectly
Elastic
Quantity
demanded changes infinitely with any change in price.
Unit
Elastic
Quantity
demanded changes by the same percentage as the price.
Total Revenue and the Price
Elasticity of Demand
Total
revenue is the amount paid by buyers and received by sellers of a good.
Computed
as the price of the good times the quantity sold.
TR = P x Q
Elasticity and Total Revenue
along a Linear Demand Curve
With
an inelastic demand curve, an increase in price leads to a decrease in
quantity that is proportionately smaller. Thus, total revenue increases.
With
an elastic demand curve, an increase in the price leads to a decrease in
quantity demanded that is proportionately larger. Thus, total revenue
decreases.
Income Elasticity of Demand
Income
elasticity of demand measures how much the quantity demanded of a good
responds to a change in consumers income.
It
is computed as the percentage change in the quantity demanded divided by
the percentage change in income.
Computing
Income Elasticity
Income Elasticity
Types
of Goods
Normal
Goods
Inferior
Goods
Higher
income raises the quantity demanded for normal goods but lowers the quantity
demanded for inferior goods.
Income Elasticity
Goods
consumers regard as necessities tend to be income inelastic
Examples
include food, fuel, clothing, utilities, and medical services.
Goods
consumers regard as luxuries tend to be income elastic.
Examples
include sports cars, furs, and expensive foods.
THE ELASTICITY OF SUPPLY
Price
elasticity of supply is a measure of how much the quantity supplied
of a good responds to a change in the price of that good.
Price elasticity of supply is the percentage change in quantity
supplied resulting from a percent change in price.
What Determines the Elasticity
of Supply
Ability
of sellers to change the amount of the good they produce.
Beach
front land is inelastic.
Books,
cars, or manufactured goods are elastic.
Time
period.
Supply
is more elastic in the long run.
Computing the Price Elasticity
of Supply
The
price elasticity of supply is computed as the percentage change in the
quantity supplied divided by the percentage change in price.
THREE APPLICATIONS OF SUPPLY,
DEMAND, AND ELASTICITY
1. Can good news for farming be bad news for farmers?
What
happens to wheat farmers and the market for wheat when university agronomists
discover a new wheat hybrid that is more productive than existing varieties?
2. Why did OPEC fail
to keep the price of oil high
Because
of elasticity of Demand
inelastic
in the short run and elastic in the long run
3. Drug interdiction
and drug education and drug related crime