How Responsive is Quantity Demanded/Supplied to Lecture 2.4 Summer 2009 7/15/2009 Elasticity How Responsive is Quantity Demanded/Supplied to Changes in Price

Types of Elasticities Generally 3 categories we are concerned about Price elasticity Own-price: How quantity demanded changes with the (own) price Cross-price How quantity demanded changes with another (cross) good’s price changes Income How quantity demanded changes with a change in your income Supply elasticity How quantity supplied changes with a change in (own/market) price

Own-Price (Demand) Elasiticity Economist use the (own) price elasticity of demand to summarize how responsive quantity demanded is to price Demand curves are not always linear; and responsiveness can change with price

Demand Elasticity Own-Price Always negative First law of demand Talk about it in absolute terms Less than |1| -> inelastic Not very price responsive Equal to |1| -> unit elastic % change in Qd = % change in price More than |1| -> (highly) elastic Very price responsive

Elasticity Measures 3 Major Types for Demand Own-price Cross-price Measures the change in quantity demanded with a change in the (own) good’s price Always negative (F.L.O.D) Always expressed in absolute value (as it’s always negative) Cross-price Measures the change in quantity demanded with a change in the price of a related good (e.g. complement or substitute) Complement (-) Substitute (+) Income Measures the change in quantity demanded with a change in income Normal/superiors goods (+) Inferior goods (-)

What Affects the Magnitude of the Demand Elasticity Availability and closeness of substitutes “better/closer” substitute makes it to switch Results in either Greater movement along the demand curve (own) Greater shift of the demand curve (cross) Time More time to adjust, more options you can find Long-run elasticity > short-run Proportion of Income spent on the good Larger proportion -> more sensitive to changes in Income

What Does the Magnitude of the Elasticity Tell Us? Own-price Larger absolute value (|e| > 1) Large changes in Qd with small changes in price Close substitutes exist (pepsi/coke) Or much consumption is discretionary (micro-brews) Cross-price Large value (e >1) Close (or good) substitute for good exists Complements Large absolute value (|e| > 1) Consumption in fixed proportions Income >1 superior (luxury?) good >0 normal < 0 inferior (Animal beer)