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Elasticity

Elasticity. Price elastisticity of Demand- measures how much the quantity demanded of a good changes when its price changes. The precise definition of price elasticity is the percentage change in quantity demanded divided by the percentage change in price.

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Elasticity

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  1. Elasticity

  2. Price elastisticity of Demand- measures how much the quantity demanded of a good changes when its price changes. • The precise definition of price elasticity is the percentage change in quantity demanded divided by the percentage change in price.

  3. Goods vary enormously in in their o=price elasticity , or sensitivity to price changes. • Price elastic is high, elastic • Price elastic is low, inelastic

  4. Food, fuel, shoes, and prescription drugs demand tends to be inelastic

  5. Italian designer clothing and 17-year-old Scotch whiskey demand tends to be elastic

  6. Goods that have ready substitutes are elastic than those that have no substitutes.

  7. The length of time that people have to respond to price changes also plays a role.

  8. Point elastitcity: dQ/dP x P/Q • Arc elasticity: Q1-Q0/Q1+Q0 – P1+P0/P1+PO

  9. Elastic = e>1 • Inelastic = e<1 • Unitary = 1

  10. OTHER DEMAND ELASTICITIES • INCOME ELASTICITY OF DEMAND- is the percentage change in Qd, resulting from 1-percent change in income (I). EI= (ΔQ/Q)/(ΔI/I) = (I/Q) (ΔQ/ΔI)

  11. A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes. • A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods.

  12. A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods.

  13. CROSS-PRICE ELASTICITY OF DEMAND- refers to the percentage change in the quantity demanded for a good that result from a 1-percent increase in the price of another good.

  14. So the elasticity of demand for butter with respect to the price of margarine would be written as: • EQbPm = (ΔQb/Qb) / (ΔPm/Pm) = • (Pm/Qb)(ΔQb/ΔPm) • Where Qb is the qty of butter and Pm is the price of margarine.

  15. In the equation, the cross-price elasticity will be positive because the goods are substitutes. • Some goods are complements, in which an increase in the price of one tends to push down the consumption of the other.

  16. ELASTICITIES OF SUPPLY- are defined in a similar manner. • The price elasticity of supply is the percentage in Qs resulting from 1-percent increase in price. • The elasticity is usually positive because higher price gives producers an incentive to increase output.

  17. We can also refer to elasticities of supply with respect to such variables as

  18. For example, for most manufactured goods, the elasticities of supply with respect to the prices of raw materials are negative. • An increase in the price of raw a material input means higher costs for the firm, other things being equal, therefore, the Qs will fall

  19. The Market for Wheat • For the statistical studies, we know that for 1981 the supply curve for wheat was approximately as follows: • Supply: Qs = 1800+240P • Demand: Qd = 3550-266P

  20. Qs= Qd • 1800+240P=3550-266P • 560P=1750 • P= 3.46

  21. Q= 1800+(240)(3.46)=2630 • Price • Market-clearing price

  22. Elasticity of Demand= (3.46/2630) (-266) = -0.35

  23. Elasticity of Supply= • (3.46/2630) (240) • = o.32

  24. Short-Run versus Long-Run Elasticities • When analyzing demand and supply, we must distinguish between the short run and the long run. • If we allow only a short time to pass-say, one year of less- then we are dealing with short run.

  25. When we refer to long run we mean that enough time is allowed for consumers and producers to adjust fully to the price change.

  26. Demand • For many goods, demand is much more price elastic in the long run than in the short run. -For one thing, it takes time for people to change their consumption habits.

  27. Example: Even if the price of coffee rises sharply, the quantity demanded will fall only gradually as consumers begin to drink less.

  28. In addition, the demand for a good might be linked to the stock of another good that changes only slowly. • For example, the demand for gasoline is much more elastic in the long run than in the short run.

  29. Demand and Durability- On the other hand, for some goods just the opposite is true- demand is elastic in the short run than in the long run.

  30. The total stock of each good owned by consumers is large relative to annual production.. • As a result, a small change in total stock that consumers want to hold can affect in large percentage of level of purchases.

  31. Income elasticities also differ from the short run to the long run. For most goods and services- foods, beverages, fuel, entertainment, etc.- the income elasticity of demand is larger in the long run than in the short run.

  32. Consider the behavior of gasoline consumption during a period of strong economic growth during which the aggregate income rises by 10%. Eventually people will increase gasoline consumption because they can afford to take more trips and perhaps own larger cars.

  33. But this consumption takes time and demand initially increases only by a small amount. • Thus, the long-run elasticity will be larger than the short-run elasticity.

  34. For a durable good, the opposite is true.

  35. Again, consider automobiles.

  36. Cyclinal industries- Industries in which sales tend to magnify cyclical changes in GDP and national income. • These industries are vulnerable to changing macroeconomic conditions and in particular to the business cycle- recessions and booms. • E.g.- demand for durable goods.

  37. Note that while both consumption series follow GDP, only durable goods series tends to magnify changes in GDP. • Changes in consumption of nondurables are roughly the same as changes in GDP, but changes in consumption of durables are usually several times larger.

  38. The Demand for Gasoline and Automobiles • Gasoline and automobiles exemplify some of the different characteristics of demand discussed above. • They are complementary goods- an increase in the price of one tends to reduce the demand for the other.

  39. In addition, their respective dynamic behaviors( long-run vs. short-run elasticities) are just the opposite of the other. • For gasoline, the long-run price and income elasticities are larger than the short-run elasticities;for automobiles, the reverse is true.

  40. Demand for Gasoline

  41. Demand for Automobiles

  42. Supply • Elasticities of supply also differ from the long run to the short run.

  43. For most products, long-run supply is mcuh more price elastic than short-run supply: Firms face capacity constraints in the short-run and need time to expand capapcity by building new production facilities and hiring workers to staff them.

  44. For some goods and services, short-run supply is completely inelastic. • E.g. rental units.

  45. For most goods, however, firms can find ways to increase outputeven in the short-run-if the price incentive is strong enough.

  46. Supply and Durability • For some goods, supply is more elastic in the short run than in the long run. Such goods are durable and can be recycled as part of supply if price goes up. • E.g. scrap metal, which is often melted down and refabricated.

  47. Supply if Copper

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