ELASTICITIES Chapter 4

Elasticities  The study of Elasticities examines the responsiveness of consumers or producers to a change in a variable in the marketplace.  Studying this has implications for businesses – so they can be aware of the effects of changes – and implications for governments – so they can decide which good to place taxes on, for example.

Elasticity of Demand  Elasticity of Demand is a measure of how much the demand for a product changes when there is a change in one of the factors that determines demand.  There are 3 elasticities of demand to consider:  Price elasticity of demand (PED)  Cross elasticity of demand (XED)  Income elasticity of demand (YED)

Price Elasticity of Demand (PED) – Elastic or Inelastic?  If a small increase in price leads to a proportionally large decrease in quantity demanded, consumers are said to be very price sensitive and demand therefore is price elastic.  If a large increase in price has little effect on the quantity of a good demanded, consumers are not very price sensitive, and demand is said to be price inelastic.

Price Elasticity of Demand (PED): PED coefficient PED= Percentage change in quantity demanded Percentage change in price PED = %ΔQ d %ΔP PED=(Q d2 -Q d1 )÷ Q d1 (P 2 -P 1 ) ÷ P 1

PED coefficient  The PED coefficient is negative because of the inverse relationship between price and quantity.  Since the law of demand applies to nearly all goods and services, we typically ignore the the negative and express PED as an absolute value.

Exercises page PED 40/50 =.8 2. First, calculate the change in price. Plug this into PED formula. Simplify(1.5x25)=37.5. % change in quantity resulting from a 25% increase in price is 37.5%. Therefore, new quantity is 200- (.375x200). An increase in price from $8 to $10 leads to a decrease in the quantity demanded from 200 to 125 units. 3. PED usually expressed as an absolute value and the PED coefficient is therefore positive. (law of demand – inverse relationship)

Cross Elasticity of Demand