AP Economics Mr. Bernstein Module 48: Other Elasticities October 20, 2014

AP Economics Mr. Bernstein Elasticity can measure responsiveness of other consumer and producer activities Cross-price elasticity of demand Income elasticity of demand Price elasticity of supply 2

AP Economics Mr. Bernstein Who is interested in these elasticities? Economists Governments Firms Example of cross-price elasticity: How do changes in the price of gas affect car sales? GM and Ford care. Example of income elasticity: In a recession, how do declining incomes affect hotel occupancy? Holiday Inn and Priceline care. 3

AP Economics Mr. Bernstein Cross-Price Elasticity of Demand Measures the responsiveness of the demand for good “X” to changes in the price of good “Y” Aka %  D x / %  P y Demand curve for X shifts due to a change in P y Substitutes have positive cross-elasticity A 2% rise in the price of Nikes causes a 4% increase in demand for Adidas; E Adidas, Nikes = 4% / 2% = 2 Compliments have negative cross-elasticity A 20% rise in the price of gasoline causes a 5% fall in demand for SUVs; E SUVs, gasoline = 20% / -5% = -4 Independent products have zero cross-elasticity A 10% rise in the price of peanut butter has no effect on demand for SUVs 4

AP Economics Mr. Bernstein Income Elasticity of Demand Measures the responsiveness of demand for a good to changes in income Aka %  D x / %  I Demand curve shifts due to change in income; elasticity measures the responsiveness or how much the curve shifts Normal goods have positive income elasticity American income declines 2% and purchases of airline tickets to Italy decline 8%; E i = 8% / 2% = 4 (a high income elasticity typical of luxury items) American income increases 4% and purchases of fresh vegetables increase 1%; E i = 1% / 4% =.25 (an income-inelastic response typical of necessity items) 5

AP Economics Mr. Bernstein Income Elasticity of Demand, cont. Inferior goods have negative income elasticity American income declines 5% and purchases of SPAM increase 4%; E i = 4% / -5% = -.8 6

AP Economics Mr. Bernstein Price Elasticity of Supply Law of Supply: When price increases, firms increase quantity supplied Price Elasticity of Supply follows same formula as Price Elasticity of Demand: Es = %  Q s / %  P Elastic and Inelastic definitions are the same also: If E s >1, supply is considered elastic If E s <1, supply is considered inelastic If E s = 1, supply is considered unit elastic Elastic is flatter and perfectly elastic is horizontal Inelastic is steeper and perfectly inelastic is vertical 7

AP Economics Mr. Bernstein Price Elasticity of Supply What might cause a perfectly inelastic supply curve? Even at absurdly high prices, firms will not increase supply Limits to production, perhaps due to technology limits, resource constraints or in the case of farming, seasonal impossibilities 8

AP Economics Mr. Bernstein Factors Influencing Elasticity of Supply Availability of inputs Example: If coal shipments only arrive monthly, a factory cannot quickly increase production when prices increase Time “Market period” is so short that supply is perfectly inelastic Short-run elasticity of supply is greater than zero Long-run elasticity of supply is greater than short-run elasticity Example: Farmers cannot react to rising soybean prices until the next growing season. 9