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ECN 3100 PRINCIPLES OF ECONOMICS. Elasticity (cont.). Elasticity. Price Elasticity of Demand %∆Qd %∆P Demand tends to be more elastic : the larger the number of close substitutes. if the good is a luxury. the more narrowly defined the market. the longer the time period.
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ECN 3100 PRINCIPLES OF ECONOMICS • Elasticity (cont.) Chapter 5
Elasticity Price Elasticity of Demand %∆Qd %∆P • Demand tends to be more elastic : • the larger the number of close substitutes. • if the good is a luxury. • the more narrowly defined the market. • the longer the time period. Income Elasticity of Demand %∆Qd %∆Y • Normal goods tend to have +ive income elasticity • Inferior goods tend to have –ive income elasticity • Demand for luxury goods tend to be more elastic than demand for necessities Price Elasticity of Supply %∆Qs %∆P • Supply tends to be more elastic : • producers have more ability to change the amount of goods produced (land vs cars) • the longer the time period. Cross-price Elasticity of Demand %∆Qdx %∆Py • Substitutes tend to have +ive cross-price elasticity • Complements tend to have –ive cross-price elasticity • Unrelated goods tend have “0” cross-price elasticity Chapter 5
Mid-point formula If the price of an ice cream cone increases from $2.00 to $4.00 and the amount you buyfalls from 10 to 6 cones, then your elasticity of demand, using the midpoint formula, would be calculated as: (6-10) / [(6+10)/2] = -4 / [16/2] = -4 / 8 = -0.5 ---------------------- --------------- --------- ------- = -0.75 (4-2) / [(4+2)/2] = 2 / [6/2] = 2 / 3 = 0.67 elastic or inelastic ??? Chapter 5
Mid-point formula supply If the price of an ice cream cone increases from $2.00 to $4.00 and the amount you sellincreases from 10 to 14 cones, then your elasticity of supply, using the midpoint formula, would be calculated as: (14-10) / [(14+10)/2] = 2 / [24/2] = 2 / 12 = 0.16 ---------------------- --------------- --------- ------- = 0.23 (4-2) / [(4+2)/2] = 2 / [6/2] = 2 / 3 = 0.67 elastic or inelastic ??? Chapter 5
Price Elasticity of Supply • Perfectly Inelastic %∆Qs = 0 vertical • Inelastic %∆Qs < %∆P steep • Unit Elastic %∆Qs = %∆P 45 degree • Elastic %∆Qs > %∆P flatter • Perfectly Elastic %∆P = 0 horizontal Price Elasticity of Demand • Perfectly Inelastic %∆Qd = 0 vertical • Inelastic %∆Qd < %∆P steep • Unit Elastic %∆Qd = %∆P parabola • Elastic %∆Qd > %∆P flatter • Perfectly Elastic %∆P = 0 horizontal Chapter 5
Price Elasticity of Supply Eds <1 Inelastic Price Elasticity of Demand IEdI =1 Unit elastic IEdI >1 Elastic Eds >1 Elastic IEdI <1 Inelastic Chapter 5
Price Elasticity of Demand & Total Revenue (TR = P x Q) Inelastic Demand: Large increase in price can increase total revenue because %∆Qd < %∆P! Elastic Demand: Small increase in price can decrease total revenue because %∆Qd > %∆P! Chapter 5
