Economics 100 Lecture 8’ Elasticity II

Elasticity  Elastic and inelastic demand  Elasticity, revenue, and expenditure  Other elasticities of demand  Elasticity of supply

Elastic and inelastic demand  Perfectly elastic: infinity  Elastic: greater than one  Unit elastic: one  Inelastic: less than one  Perfectly inelastic: zero (Example) (insuline is perfectly inelastic!!!)

 We will soon see that the convention of labelling elastic those values of elasticity over 1 and inelastic those values of elasticities under 1 is not really arbitrary: it has some operational meaning...

Elastic and inelastic demand

 CAUTION: Elasticity is not the same as slope,…but they are related!

Elasticity along a linear demand curve  At a high price and small quantity, elasticity is large

Elasticity along a linear demand curve  At a low price and large quantity, elasticity is small

Elasticity along a linear demand curve  At the mid- point price and quantity, elasticity is one

Factors that influence the elasticity of demand  Substitutes (insulin versus pencils)  % of income spent on good (cars versus pencils)  Time elapsed since price change (short- run versus long-run reactions to water or gasoline or energy prices)

Elasticity, Revenue, and Expenditure  If demand is unit elastic, an increase in price results in an equal percentage decrease in the quantity demanded, so total revenue (for the seller) and total expenditure (for the consumer) remain constant

Elasticity, Revenue, and Expenditure  If demand is elastic => an increase in price results in an larger percentage decrease in the quantity demanded, so total revenue and total expenditure decrease.

 If demand is inelastic => an increase in price results in an smaller percentage decrease in the quantity demanded, so total revenue and total expenditure increase Elasticity, Revenue, and Expenditure

 As you can see, and as in the case of temperature (where we use a 0 degree C o and a 100 C o as meaningful thresholds), elasticity values range along a continuum, but the convention of establishing a borderline at value one has some operational meaning too...

More elasticities of demand  Cross elasticity of demand  Income elasticity of demand

Cross elasticity of demand  Measures the responsiveness of the demand for a good to a change in the price of another good

Cross elasticity of demand  Substitute: cross elasticity of demand is positive  Complement cross elasticity of demand is negative  Important now not to use absolute value!!!

Income elasticity of demand  Measures the sensitivity of demand to changes in income £ Normal good: positive £ Inferior good: negative £ What if it is zero???????

Income elasticity of demand £ Normal good positive (if greater than 1, we say income elastic or luxury good, if less than 1, we say income inelastic) £ Inferior good negative

Income elasticity of demand  Income elasticity can easily exhibit different values along different ranges of the consumption spectrum

Elasticity of supply  Measures the responsiveness of a change in the quantity supplied of a good to a change in its price  Ranges from zero (vertical supply curve) to infinity (horizontal supply curve)

 Longer period of adjustment, greater is the elasticity of supply  Less substitutes for the production process and/or productive resources (flower shop versus a mine)

Elasticity of supply  MS is zero elastic  SS is inelastic  LS is elastic

Next, Markets in Action