Prof. Ana Corrales ECO 2023 Notes Chapter 20: Elasticity of Demand & Supply Price Elasticity: Buying & selling responses of consumers and producers to price changes Cross Elasticity: Buying responses of consumers of one product when the price of another product changes Income Elasticity: Buying responses of consumers when their incomes change

Prof. Ana Corrales ECO 2023 Notes Price Elasticity of Demand A measure of responsiveness (or sensitivity) by consumers to a price change E d = [% ΔQ d (x)] ÷ [% Δ P(x)] E d = [ΔQ d (x)/Q d,0 (x)] ÷ [ΔP(x)/P 0 (x)] Because the Demand curve is downward sloping, E d will always be (-). We take the absolute value.

Prof. Ana Corrales ECO 2023 Notes 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 are completely unresponsive to changes in price Perfectly Elastic: E d = ∞  Small price reduction causes buyers to increase their purchases from zero to all they can obtain

Prof. Ana Corrales ECO 2023 Notes Graphical Analysis of E d Midpoint Formula  Ed = [ΔQ/(ΣQ/2)] ÷ [ΔP/(ΣP/2)] Demand is typically elastic in the high-price (lower quantity) range of the demand curve Demand is typically inelastic in the low-price (high quantity) range of the demand curve

Prof. Ana Corrales ECO 2023 Notes Total Revenue Test TR = P * Q If demand is elastic, a decrease in P will increase TR  An increase in P will reduce TR If demand is inelastic, a decrease in P will reduce TR  An increase in P will increase TR

Prof. Ana Corrales ECO 2023 Notes Determinants of E d Substitutability  The larger the number of substitute goods that are available, the greater the price elasticity of demand Proportion of Income  The higher the price of a good relative to consumers’ incomes, the greater the price elasticity of demand Luxuries v. Necessities  If a good in a luxury, the greater the price elasticity of demand Time  Demand becomes more elastic when given more time for consideration  Short-term v. long-term demand varies

Prof. Ana Corrales ECO 2023 Notes Price Elasticity of Supply A measure of responsiveness (or sensitivity) by producers to a price change E s = [% ΔQ s (x)] ÷ [% Δ P(x)] Determinant of E s : How easily and quickly producers can shift resources between alternative uses Because often “shiftability” of a resource is time sensitive, E s is different immediately v. short-run v. long- run

Prof. Ana Corrales ECO 2023 Notes E s varies with Time (Fig 20.3) The Market Period: Immediately after a change in market price occurs, it is too soon for producers to respond  Supply curve is perfectly inelastic  For durable goods, there may be no market period

Prof. Ana Corrales ECO 2023 Notes E s varies with Time (Fig 20.3) The Short-run: Period of time too short to change plant capacity but just long enough to use a fixed plant more/less intensively  Supply curve is slightly more elastic than in the Market Period The Long-Run: Factors of Production can change  Supply curve is even more elastic

Prof. Ana Corrales ECO 2023 Notes Cross Elasticity of Demand A measure of consumers’ sensitivity for product X to changes in price of Y E xy = [% ΔQ d (x)] ÷ [% ΔP(y)] Substitute goods have (+) E xy Complementary goods have (-) E xy Independent goods have zero E xy

Prof. Ana Corrales ECO 2023 Notes Income Elasticity of Demand A measure of how consumers’ incomes affect purchases of particular goods E i = [% ΔQ d ] ÷ [% ΔI] Normal goods have (+) E i Inferior goods have (-) E i

Prof. Ana Corrales ECO 2023 Notes Ch. 20 Study Questions