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Elasticity: Demand & Supply

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1 Elasticity: Demand & Supply
How Responsive is Quantity Demanded/Supplied to Changes in Prices (or Income)

2 Types of Elasticities Generally 3 categories we are concerned about
Price elasticity Own-price: How quantity demanded changes with the (own) price Cross-price How quantity demanded changes with another (cross) good’s price changes Income elasticity How quantity demanded changes with a change in your income Supply elasticity How quantity supplied changes with a change in (own/market) price

3 Elasticity Measures 3 Major Types for Demand Own-price Cross-price
Measures the change in quantity demanded with a change in the (own) good’s price Always negative (F.L.O.D) Always expressed in absolute value (as it’s always negative) Cross-price Measures the change in quantity demanded with a change in the price of a related good (e.g. complement or substitute) Complement (-) Substitute (+) Income Measures the change in quantity demanded with a change in income Normal/superiors goods (+) Inferior goods (-)

4 Demand Elasticity Economist use the (own) price elasticity of demand to summarize how responsive quantity demanded is to price Own-price (product’s price) Cross-price (related goods – substitutes, complements) Income Demand curves are not always linear; and responsiveness can change with price

5 3 Major Categories for Own-Price Demand Elasticity
Always negative First law of demand Talk about it in absolute terms Less than |1| -> inelastic Not very price responsive Equal to |1| -> unit elastic % change in Qd = % change in price More than |1| -> (highly) elastic Very price responsive

6 What Affects Own-Price Demand Elasticity?
Availability and closeness of substitutes “better/closer” substitute makes it easier to switch Results in either Greater movement along the demand curve (own) Greater shift of the demand curve (cross) Time More time to adjust, more options you can find Long-run elasticity > short-run Proportion of Income spent on the good Larger proportion -> more sensitive to changes in Income

7 What Does the Magnitude of the Elasticity Tell Us?
Own-price Larger absolute value (|e| > 1) Large changes in Qd with small changes in price Close substitutes exist (pepsi/coke) Or much consumption is discretionary (micro-brews) Cross-price Large value (e >1) Close (or good) substitute for good exists Complements Large absolute value (|e| > 1) Consumption in fixed proportions Income >1 superior (luxury?) good >0 normal < 0 inferior (Animal beer)


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