Elasticity 2 Why are something are elastic and some inelastic?

Elasticity Review Perfectly elastic – quantity responds enormously to price changes (E =  ). Elastic – the percentage change in quantity exceeds the percentage change in price (E >1).

Elasticity Review Unit elastic – the percentage change in quantity is the same as the percentage change in price (E = 1).

Elasticity Review Inelastic – the percentage change in quantity is less than the percentage change in price (E <1). Perfectly inelastic – quantity does not respond at all to price changes (E = 0).

Substitution and Elasticity As a general rule, the more substitutes a good has, the more elastic is its supply and demand.

Substitution and Demand The larger the time interval considered, or the longer the run, the more elastic is the good’s demand curve. –There are more substitutes in the long run than in the short run. –The long run provides more options for change.

Substitution and Demand The less a good is a necessity, the more elastic its demand curve. Necessities tend to have fewer substitutes than do luxuries.

Substitution and Demand Demand becomes more elastic as the definition of a good becomes more specific. –A broadly defined good like transportation does not have many substitutes so that demand will be inelastic. –A more narrowly defined good like bus transportation will have more substitutes.

Substitution and Demand Demand for goods that represent a large proportion of one's budget are more elastic than demand for goods that represent a small proportion of one's budget.

Substitution and Demand Goods that cost very little relative to your total expenditures are not worth spending a lot of time figuring out if there is a good substitute. It is worth spending a lot of time looking for substitutes for goods that take a large portion of one’s income.

Substitution and Supply The longer the time period considered, the more elastic the supply. The reasoning is the same as for demand. –In the long run there are more options for change so it is easier (less costly) for suppliers to change into the production of another good.

Substitution and Supply Economists distinguish three time periods relevant to supply: –The instantaneous period. –The short run. –The long run.

Substitution and Supply In the instantaneous period, quantity supplied is fixed – the elasticity of supply is perfectly inelastic. This supply is sometimes called the momentary supply.

Substitution and Supply In the short run, some substitution is possible – the short-run supply curve is somewhat elastic. In the long run, significant substitution is possible – the supply curve becomes very elastic.

How Substitution Factors Affect Specific Decisions Suppose you’ve been asked to evaluate the potential impact of a 10¢ gas tax increase in Washington, D.C. and in the entire nation.

Evaluating the 10¢ Gas Tax Increase We’d expect the short run the demand curve for gasoline to be less elastic than in the long run. In the long run, motorists would switch to fuel efficient cars.

Evaluating the 10¢ Gas Tax Increase Demand is probably inelastic for the entire U.S. –Gasoline is considered a necessity –It is only a small part of what it costs to drive.

Evaluating the 10¢ Gas Tax Increase Demand for gasoline is very elastic in Washington, D.C. –Some may switch to an alternative form of transportation. –Others would go to neighboring states to buy gasoline.

Empirical Estimates of Elasticities The following table provides short- and long-term estimates of elasticities for a number of goods.

Short-Run and Long-Run Elasticities of Demand