1. CHAPTER 5.
Elasticity

2. Chapter 5 Objectives/Key Topics
Upon completion of this chapter, you should understand and be able to answer these questions:
How is the responsiveness of consumers to changes in various demand factors measured?
Elasticities –
a. What are they?
b. How are they calculated?
c. What factors influence their values?
d. How can they be used?

3. Question
Suppose your cumulative GPA increases from 3.00 to 3.30 after this semester. What was the ‘percentage increase’ in your cumulative GPA?

4. Answer

5. Question
What is likely to happen to the quantity demanded of gasoline if it were to increase in price by 20%?

6. Elasticity of D Definition (Meaning)
= A measure of responsiveness of D to changes in a factor that influences D
Two components
Magnitude of change (number)
Direction of change (sign)
= The number shows the magnitude of how much D will change due to a 1% change in a D factor
The sign shows whether the D factor and D are changing in the same or opposite directions
+  same direction
-  opposite direction

7. Elasticities of Demand
 EQ,F = %ΔQdx/%ΔF = %ΔQ/%ΔF
Where,
Qdx = the quantity demanded of X
F = a factor that affects Qdx
Notes:
sign > 0  Qdx & F, ‘directly’ related
sign < 0  Qdx & F, ‘indirectly’ related
number > 1  %ΔQd, >%ΔF

8. Measures of Responsiveness of D to P Changes
Slope = unit ΔP/unit ΔQd
→ can be used to show unit Δ Qd caused by 1 unit ΔP
→ a problem with slope is that it depends on the ‘units’ of measurement
Elasticity = % Δ Qd/% ΔP
→ shows % Δ Qd for each 1% ΔP
→ does NOT depend on ‘units’ of measurement

9. Alternative elasticity calculation ‘formulas’:
1. Point
=> calculate % changes as % of original values
2. Midpoint
=> Calculate % changes as % of average of original values and new values, = (original value + new value) / 2

10. Elasticity Calculation (point method)

11. Types of Elasticities Type F E0 = own P PX EC cross P PY EI Income IEA
advertising A

12. Elasticity Value Meanings (e.g.)
E0 = -2  for each 1% Px,Qd for X will  by 2% in opposite direction
EC = +1/2  for each 1% PY,Qd for X will  by 1/2% in same direction
EI = +.1  for each 1% I,Qd for X will  by .1% in same direction

13. Own Price Elasticity of Demand
Negative according to the ‘law of demand’

14. Perfectly Elastic & Inelastic Demand

15. E0 Calculation (point formula)

16. E0 Calculation (example)

17. E0 and Linear D Curve P a
E0>1
E0=1
1/2a
E0<1 Q

18. Factors Affecting Own Price Elasticity
Available Substitutes
The more substitutes available for the good, the more elastic the demand.
Time
Demand tends to be more inelastic in the short term than in the long term.
Time allows consumers to seek out available substitutes.
Expenditure Share
Goods that comprise a small share of consumer’s budgets tend to be more inelastic than goods for which consumers spend a large portion of their incomes.

19. Uses of E0
Calculate % change in P needed to bring about desired % change in Q sold
Calculate % change in Q sold that will result from a given % change in P
Predict how TR will Δ due to given % ΔP

20. Elasticity Equation =>
Note: this is an equation with 3 variables => given values for 2 variables, can solve for value of 3rd variable
Example: %ΔQ = E0(%ΔP)
Example: %ΔP = (%ΔQ)/E0

21. Use of E0 (Example)
According to an FTC Report, AT&T’s own price elasticity of demand for long distance services is –8.64.
If AT&T lowered price by 3 percent, what would happen to the volume of long distance telephone calls routed through AT&T?

22. Answer
Calls would increase by percent!

23. Question
If a firm wants to increase its dollar sales of a product, should it P or P?

24. Quote of the Day
“Students of Economics need to be taught, in business, sometimes you should raise your price, and sometimes you should lower your price.”
- CEO of Casey’s

25. E0 and TR TR = P∙Q = total revenue (total $ sales)
If E0 elastic (# > 1)
 little P  BIG Q  TR
 little P  BIG Q  TR* (P)
If E0 inelastic (# < 1)
 BIG P  little Q  TR* ( P)
 BIG P  little Q  TR

26. Max TR
Maximum R will be generated at midpoint of linear, down-sloping D curve P
5.00
Max TR
2.50
P=5-.5Q Q 5 10

27. E0 and TR (Example) Recall E0 = -.25 at P=1 and Q=8 for P=5 - .5Q
Given E0 is inelastic  firm should be able to TR by P. P Qd
TR ($) 1 8
8.00 2 6
12.00
2.50 5
12.50* (= max TR)

28. Cross Price Elasticity of Demand
+ Substitutes
- Complements

29. Income Elasticity
+ Normal Good
- Inferior Good

30. Elasticity of Supply

31. Elasticity Summary
Elasticities can be used to estimate: