CHAPTER 20 ELASTICITY of DEMAND & SUPPLY By: Amanda Reina & Sandra Avila

Three types of Elasticity Price Elasticity Cross Elasticity Income Elasticity

Price Elasticity Response of consumers and producers to price change Price Elasticity of Demand Price Elasticity of Supply

Price Elasticity of Demand (Formulas) E d = % change in quantity demanded of product X ____________________________ % change in price of product X

Price Elasticity of Demand (Formulas) E d = [change in quantity demanded of X / original quantity demanded of X] __________________________________ [change in price of X / original price of X]

Price Elasticity of Demand Elimination of Minus Sign Price and Quantity demanded are inversely related because of the down- sloping of the demand curve. Coefficient (first number) of demand E d will ALWAYS be negative (-). Take the absolute value. P 0 Q Down-Sloping D1D1

Price Elasticity of Demand Example Ed= % change in quantity demanded of product X __________________________ % change in price of product P↓ Q d ↑ This means that the numerator in the formula will be positive and the denominator negative.

Price Elasticity of Demand Interpretations of E d Elastic Demand: E d > 1 Inelastic Demand: E d < 1 Unit Elasticity: E d = 1 Perfectly Inelastic: E d = 0 Consumers have NO response to price change (Vertical Line) Perfectly Elastic: E d =∞ A slight price fall causes consumers to increase their purchases from 0 to all they can get (Horizontal Line) Ed= % change in quantity demanded of product X __________________________ % change in price of product

Mid-Point Formula E d = [Change in quantity /(sum of quantities/2)] [Change in price /(sum of prices/2)]

Graphical Analysis Demand is : Elastic with high prices (lower quantity) Inelastic with low prices (higher quantity)

Total Revenue Test TR = P X Q P= Price Q= Quantity

Total Revenue Test Elastic ↓P = TR↑ Inelastic ↓P = TR ↓

Example Quantity Demanded Price ($) Unit Elastic Ed = 1 Elastic Ed > 1 Inelastic Ed < 1

Determinants of Price Elasticity of Demand Substitutability: Higher # of Substitute goods = greater E d Proportion of Income: Higher price of good relative to consumer’s income = greater E d Luxuries v. Necessities: The more the good is luxury = the greater E d is Time: Longer time period = greater E d

Price Elasticity of Supply Response of consumers and producers to price change E s = % change in quantity supplied of product X ____________________________ % change in price of product X

Degree of Price Elasticity of Supply How quickly and easily producers can shift resources b/w alternative uses “The longer the time, the greater the resource “shiftability.”

Impact of time on Elasticity of Supply Immediate market period Period that occurs immediately after a change in market price, where it is too soon for producers to respond with a change in quantity supplied Perfectly inelastic supply 0 D1 D2 SmSm P0P0 Pm Q P Qo

Impact of time on Elasticity of Supply Short run Period too short to change plant capacity but long enough to use a fixed plant more or less intensively P Q 0 D1 D2 SsSs P0P0 PsPs QoQs **Supply more elastic than market period

Impact of time on Elasticity of Supply Long run Period long enough for all desired adjustments to be made P Q SLSL D2 D1 P0P0 PlPl QoQl **Supply is even more elastic

Cross Elasticity of Demand Measures how sensitive consumer purchases of product X are to a change in the price of product Y. Related products Change in income

Cross Elasticity of Demand Formula E xy = % change in quantity demanded of product X __________________________ % change in price of product Y

Cross Elasticity of Demand Substitute goods have a positive E xy Sales of X is related to price changes of Y Beef and Chicken Complementary goods have a negative E xy Increase in price X = Decrease demand in Y Milk and Chocolate powder Independent goods have zero E xy X and Y are unrelated Candy and Books

Income Elasticity of Demand Measurement of the consumers’ response to a change in their incomes by buying more/less goods E i = % change in quantity demanded % change in income

Income Elasticity of Demand Positive E i = Normal/ Superior Goods Q d & I move in the same direction Negative E i = Inferior Goods Q d & I move in opposite direction