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Elasticities

Elasticities. In economics we use the concept of elasticity to compare percentage changes in pieces and quantities.

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Elasticities

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  1. Elasticities

  2. In economics we use the concept of elasticity to compare percentage changes in pieces and quantities. The price elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in the price of the output. If greater than 1 in absolute value we say demand is elastic. It less than 1 in absolute value the demand is inelastic. There is an elasticity of product supply, labor supply and labor demand. It is thought that the longer the time frame under consideration the more elastic a measure will be because we have more options in the longer term.

  3. The Cross-Elasticity of Labor Demand Often you hear the phrases skilled labor and unskilled labor. The phrases are just an indication of the type of labor involved. We have also said that maybe capital can be substituted for labor. When we focus on a certain type of labor (say skilled), the cross-elasticity of demand is the ratio of The % change in the quantity of the labor demanded divided by the percentage change in the price of another input, where the price is a wage or cost of capital. Now, depending on the production process, some inputs are called gross substitutes and some inputs are called gross complements. If the cross elasticity is a positive number, then the inputs or factors of production are gross substitutes. An increase (decrease) in the price of one would make you use more (less) of the other. Both percentage changes are positive (negative).

  4. If the cross elasticity is a negative number, then the inputs or factors of production are gross complements. An increase (decrease) in the price of one would make you use less (more) of the other. One percentage change is positive and one is negative. When you are moving soil shovels and unskilled workers are gross complements, right? But big earth mover machines and skilled operators are gross complements, right? Are unskilled workers and big earth mover machines gross complements? I think not. Let’s returns to our isoquant idea. There we had a situation where along an isoquant we had various combinations of labor and capital that lead to the same amount of output. We also talked about changes in the wage leading to substitution effects and scale effects. Let’s return to the substitution effect.

  5. The Elasticity of Substitution Yet another elasticity concept is the elasticity of substitution. It is also a measure along a given isoquant when the level of output is fixed. It is defined as the percentage change in the capital labor ratio divided by the percentage change in wage to cost of capital ratio. The capital labor ratio is K/E and the wage to cost of capital ratio is w/r. You may recall we said to have a firm produce an output level at minimum cost if had to have the ratio of marginal products equal to w/r. The elasticity of substitution is related in that it looks at the K/E ratio at this point.

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