Chapter 20: Elasticity of Demand & Supply

1. Chapter 20: Elasticity of Demand & Supply • Price Elasticity: Buying & selling responses of consumers and producers to price changes • Cross Elasticity: Buying responses of consumers of one product when the price of another product changes • Income Elasticity: Buying responses of consumers when their incomes change Prof. Ana Corrales ECO 2023 Notes

2. Price Elasticity of Demand • A measure of responsiveness (or sensitivity) by consumers to a price change • Ed = [% ΔQd(x)] ÷ [% Δ P(x)] • Ed = [ΔQd(x)/Qd,0(x)] ÷ [ΔP(x)/P0(x)] • Because the Demand curve is downward sloping, Ed will always be (-). We take the absolute value. Prof. Ana Corrales ECO 2023 Notes

3. Interpretations of Ed • Elastic Demand: Ed > 1 • Inelastic Demand: Ed < 1 • Unit Elasticity: Ed = 1 • Perfectly Inelastic: Ed = 0 • Consumers are completely unresponsive to changes in price • Perfectly Elastic: Ed = ∞ • Small price reduction causes buyers to increase their purchases from zero to all they can obtain Prof. Ana Corrales ECO 2023 Notes

4. Graphical Analysis of Ed • Midpoint Formula • Ed = [ΔQ/(ΣQ/2)] ÷ [ΔP/(ΣP/2)] • Demand is typically elastic in the high-price (lower quantity) range of the demand curve • Demand is typically inelastic in the low-price (high quantity) range of the demand curve Prof. Ana Corrales ECO 2023 Notes

5. Total Revenue Test • TR = P * Q • If demand is elastic, a decrease in P will increase TR • An increase in P will reduce TR • If demand is inelastic, a decrease in P will reduce TR • An increase in P will increase TR Prof. Ana Corrales ECO 2023 Notes

6. Determinants of Ed • Substitutability • The larger the number of substitute goods that are available, the greater the price elasticity of demand • Proportion of Income • The higher the price of a good relative to consumers’ incomes, the greater the price elasticity of demand • Luxuries v. Necessities • If a good in a luxury, the greater the price elasticity of demand • Time • Demand becomes more elastic when given more time for consideration • Short-term v. long-term demand varies Prof. Ana Corrales ECO 2023 Notes

7. Price Elasticity of Supply • A measure of responsiveness (or sensitivity) by producers to a price change • Es = [% ΔQs(x)] ÷ [% Δ P(x)] • Determinant of Es: How easily and quickly producers can shift resources between alternative uses • Because often “shiftability” of a resource is time sensitive, Es is different immediately v. short-run v. long-run Prof. Ana Corrales ECO 2023 Notes

8. Es varies with Time (Fig 20.3) • The Market Period: Immediately after a change in market price occurs, it is too soon for producers to respond • Supply curve is perfectly inelastic • For durable goods, there may be no market period Prof. Ana Corrales ECO 2023 Notes

9. Es varies with Time (Fig 20.3) • The Short-run: Period of time too short to change plant capacity but just long enough to use a fixed plant more/less intensively • Supply curve is slightly more elastic than in the Market Period • The Long-Run: Factors of Production can change • Supply curve is even more elastic Prof. Ana Corrales ECO 2023 Notes

10. Cross Elasticity of Demand • A measure of consumers’ sensitivity for product X to changes in price of Y • Exy = [% ΔQd(x)] ÷ [% ΔP(y)] • Substitute goods have (+) Exy • Complementary goods have (-) Exy • Independent goods have zero Exy Prof. Ana Corrales ECO 2023 Notes

11. Income Elasticity of Demand • A measure of how consumers’ incomes affect purchases of particular goods • Ei = [% ΔQd] ÷ [% ΔI] • Normal goods have (+) Ei • Inferior goods have (-) Ei Prof. Ana Corrales ECO 2023 Notes

12. Ch. 20 Study Questions • 6 • 7 • 12 • 13 • 14 Prof. Ana Corrales ECO 2023 Notes