Elasticity and its Application How much do buyers and sellers respond to a change in price

Elasticity measures the change in quantity against another variable. On the demand side: 1.Price elasticity of demand %  quantity % vs. %  price 2. Income elasticity of demand %  quantity vs. %  income 3. Cross price elasticity of demand %  quantity vs. %  price of another product

Price elasticity of demand Three ways to measure price elasticity of demand Determinants Total revenue test Midpoint formula

Determinants of price elasticity of demand Availability of close substitutes Necessity or luxury Definition of market Time horizon

Please Note Elasticity is actually measured between prices Elasticity is the % change in quantity measured against the % change in the other variable No linear demand curve is either elastic or inelastic Higher prices tend to be more elastic than lower prices

Total Revenue Test Total Revenue = Price x Quantity or TR = P x Q If price and total revenue change in the same direction demand is inelastic If price and total revenue change in opposite directions demand is elastic If a change in price causes no change in total revenue demand is unit elastic

Midpoint Formula The midpoint formula eliminates the problem of end points and start points Midpoint formula:  Q  P Sum of Qs/2 ÷ Sum of P’s/2 If coefficient > 1: Elastic If coefficient < 1: Inelastic If coefficient = 1: unit elastic

Income Elasticity of Demand Formula %  in quantity %  in income Positive coefficient = Normal Good Negative coefficient = Inferior Good

Cross-Price Elasticity of Demand Formula %  in quantity of good 1 %  in the price of good 2 Positive coefficient = Substitute Negative coefficient = Complement

Determinants of price elasticity of Supply A) Depends on the flexibility of sellers to change the amount of good they produce 1)Textbooks: highly elastic 2) Land: highly inelastic B)Time horizon

MIDPOINT FORMULA The midpoint formula eliminates the problem of end points and start points Midpoint formula:  Q  P Sum of Qs/2 ÷ Sum of P’s/2 If coefficient > 1: Elastic If coefficient < 1: Inelastic If coefficient = 1: unit elastic

Perfectly Elastic

Perfectly Inelastic