Chapter 5 Elasticity of Demand and Supply

What is elasticity? People respond to changes. If a price of a product goes down, more people would buy. If the weather is cold, more people would buy more ice creams than hot teas. For economists, the size of the responsiveness to changes by consumers and suppliers must be measured. This measuring concept of the responsiveness is called elasticity.

What is Price elasticity of demand? Let’s say you are selling ice creams for $5.00, and for that price 10 people bought it. The next day, you lower the price to $3.00 and 16 people bought it. Thus you conclude that by lowering the price, you received a big response - more people bought it. Economists call this elastic. On the contrary, despite that you had lowered the price to $3.00 and if only 11 people bought it, Economists call this inelastic. Elasticity of Demand

of Price elasticity of Demand 4 determinants of Price elasticity of Demand Availability of Close Substitutes How Widely or Narrowly you define a good Necessities VS. Luxuries Time Continued… (explanations) Elasticity of Demand

Availability of Close Substitutes If there were yogurts and ice creams (which are substitutes), and the price of the ice creams increase but that of yogurts stay the same, most of those people who were going to buy the ice creams would buy yogurts instead because of the cheap price. Thus people responded to the price change of the ice cream substantially (elastic) because of the decreased price of the substitute. So, products with substitutes are more elastic than those of not. Elasticity of Demand

How Widely or Narrowly you define a good The more widely you define a good, the less elastic (more inelastic) the demand for the good and vice versa. For example, when comparing “food” and “ice creams”, since food is a more broad category, which has many close substitutes as the ice cream is more specific are more narrow. The food with more substitutes are more inelastic because they have alternatives within the catagory to repsond to changes. However, the ice creams are more elastic because they have substitutes outside of their own category. Elasticity of Demand

Time The longer a price change persists through time, the more elastic (less inelastic) the demand for the good. Say for example, if the government decides to place a trash dump next to your house and your neighbors, at a short period of time you and your neighbors will bear the trash dump (which is inelastic), but as time goes by you and your neighbors will move to other places and avoid the trash dump (which is elastic). Elasticity of Demand

How to measure elasticity in numbers? *MUST BE ABSOLUTE VALUE This is the equation: (% change in Quantity demanded) / (% change in Price) Which is expressed through the simple “midpoint method”: (Q2 - Q1) / [(Q2+Q1)/2] / (P2 - P1) / [(P2+P1)/2] Ed > 1 = elastic Ed < 1 = inelastic Ed = 1 = unit elastic Elasticity of Demand

Graphs of Demand curves and its Variety, and the total revenue : If the video does not work, click here Elasticity of Demand

Elasticity of a Linear Demand Curve The slope of the graph maybe constant but the elasticity of the linear curve is not constant. The top part of point M is considered Elastic, because the quantity is low at its high price. The bottom part of point M is considered Inelastic, because the quantity is high at its low price. Think logically - at high price, for products which is elastic, people would respond by buying less and vice versa. http://instruct1.cit.cornell.edu/Courses/econ101-dl/images/l6fig3.gif Elasticity of Demand

Income elasticity of demand Remember, normal goods and inferior goods? Which the incomes determine the quantity of demand? Its theory applies to elasticity. We call this the income elasticity of demand when we measure the responsiveness affected by a person’s income. The equation is : (% change in quantity demanded) / (% change in income) Elasticity of Demand

Cross-price elasticity of demand Remember, complements and substitutes? This applies to cross-price elasticity of demand. For example, if you were selling strawberry syrups and ice creams, since they are complements if one of their prices go up, the other’s demand will change because people respond to the increased price. This effect is called the cross-price elasticity of demand. We measure this : (% change in quantity demanded of good 1) / (% change in the price of good 2) Elasticity of Demand

What is Price elasticity of supply? Because the law of supply indicates that the higher price of a product raises the quantity supplied, it subtly applies to the elasticity of supply. The elasticity of supply measures the change of the quantity affected by the price. If the quantity changes a lot, affected by the price, it is called elastic. Whereas if it is affected only slightly, it is called inelastic. Elasticity of Supply

Determinants of Elasticity of Supply Flexibility in altering the amount of a good produced. This means that the elasticity of Supply depend on the flexibility and the ability of sellers to change the quantity of products they produce. Time, like demand, also applies to the elasticity of Supply. The longer the time goes by, the more elastic it gets. Because during a short period of time, companies can not build or increase the size of the factories whereas during a long period of time, factories can expand and even shut down the old ones. Elasticity of Supply

How to measure the price elasticity of Supply? *MUST BE ABSOLUTE VALUE (% change in quantity supplied) / (% change in price) Like how we measure demand, we use the midpoint formula: (Q2 - Q1) / [(Q2+Q1)/2] / (P2 - P1) / [(P2+P1)/2] Elasticity of Supply

Supply curves If the video does not work, click here Elasticity of Supply

Quizzes 1. A good’s elasticity of demand is -0.2 what information can we know from this? Answer: This good is a necessity, because its elasticity is lower than 1. Thus it is informed that people did not really response to the change in price.

Quizzes 2. Suppose your demand schedule for ice creams are: Price ($) Qd (income = $100) (income = $200) 0.8 40 50 1 32 45 1.2 24 30 1.4 16 20 Calculate the price elasticity of demand as the price of ice creams increases from $1 to $1.2 I) if your income is $100 II) if your income is $200 Answer: I) 0.18 (inelastic) II) 2.2 (elastic)