Ch. 4: Elasticity.

1. Ch. 4: Elasticity. • Define, calculate, and explain the factors that influence • the price elasticity of demand • the cross elasticity of demand • the income elasticity of demand • the elasticity of supply

2. Price Elasticity of Demand • If Demand is “steep”, a change in supply brings a small increase in the quantity demanded and a large fall in price.

3. Price Elasticity of Demand • The slope of the demand curve affects how much equilibrium price and quantity change for a given change in supply. • If supply increases, • the decrease in price is greater if demand is steeper • The increase in quantity is smaller if demand is steeper

4. Price Elasticity of Demand • Price elasticity of demand • units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus.

5. Price Elasticity of Demand %DQ = DQ/Qavg = 2/10 = .2 %DP = DP/Pavg = -$1/$20 = -.05 e = .2/.05 =4

6. Price Elasticity of Demand • By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls. • Changing the units of measurement of price or quantity leaves the elasticity value the same (“units free”). • Although the formula yields a negative value for elasticity because price and quantity move in opposite directions, we report the absolute value.

7. Price Elasticity of Demand • Inelastic and Elastic Demand • if e>1: elastic • if e=1: unit elastic • if e<1: inelastic • Shape of • Perfectly inelastic demand curve (e=0) • Perfectly elastic demand curve (e= infinite)

8. Price Elasticity of Demand At prices above the mid-point of the demand curve, demand is elastic. At prices below the mid-point of the demand curve, demand is inelastic.

9. Price Elasticity of Demand • Total Revenue and Elasticity • TR=P*QD • When P changes, TR could rise or fall because QD moves in opposite direction. • But a higher price doesn’t always increase total revenue.

10. Price Elasticity of Demand • %D TR = % D P + % D Q = % D P - % D P(e) = % D P(1-e) • If demand is elastic (e>1), P increase  TR decreases P decrease  TR increases • If demand is inelastic (e<1), P increase  TR increases P decrease  TR decreases • If demand is unitary elastic, P increase or decrease  TR unchanged.

11. Price Elasticity of Demand • As P falls from $25 to $12.50, D is elastic, and TR rises. • At $12.50, D is unit elastic and TR stops increasing. • As P falls from $12.50 to 0, D is inelastic, and TR decreases.

12. Price Elasticity of Demand

13. Price Elasticity of Demand • The elasticity of demand for a good depends on: • The number & closeness of substitutes • The proportion of income spent on the good • The time elapsed since a price change

14. More Elasticities of Demand • Cross Elasticity of Demand • measures responsiveness of demand for a good to a change in the price of another good. exy= %D quantity demanded for x %D change in price of y • exy > 0  substitutes • exy <0  complements

15. More Elasticities of Demand • Income Elasticity of Demand • measures how the quantity demanded of a good responds to a change in income, ceteris paribus. eI = %D in quantity demanded % D in income • eI >0  normal good • eI >1 luxury good • eI <0 inferior good

16. Price Elasticity of Supply A change in demand causes • A larger change in equilibrium price if supply is supply is steeper, • A smaller change in equilibrium quantity if supply is steeper.

17. Elasticity of Supply Elasticity of supply • measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same.

18. Elasticity of Supply

19. Elasticity of Supply • Factors That Influence the Elasticity of Supply • Resource substitution possibilities • The time frame for supply decisions • Storage costs