1. Elasticity (Part 2)

2. Determinants of Price Elasticity of Demand
Four Factors determine Price Elasticity of Demand:
Number of substitutes
Necessities versus luxuries
Percentage of one’s budget spent on the good
Time

3. Determinants of Price Elasticity of Demand (Cont)
Number of Substitutes:
The more substitutes there are for a good, the higher the price elasticity of demand will be; the fewer substitutes there are for a good, the lower the price elasticity of demand will be.
The more broadly defined the goods is, the fewer the substitutes it will have; the more narrowly defined the goods is, the more the substitutes it will have
Necessities versus Luxuries: The more a good is considered luxury (a good we can go without) rather than a necessity (a good we can’t do without), the higher the price elasticity of demand will be.

4. Determinants of Price Elasticity of Demand (Cont)
Percentage of One’s Budget Spent on the Good:
The greater the percentage of one’s budget that goes to purchase a good, the higher the price elasticity of demand will be; the smaller the percentage of one’s budget that goes to purchase a good, the lowerer the price elasticity of demand will be
Time:
The more time that passes (since the price change), the higher the price elasticity of demand for the good will be; the less time that passes, the lower the price elasticity of demand for the good.

5. Cross Elasticity of Demand
Measures the responsiveness in the quantity demanded of one good to changes in the price of another good.
Defined as the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good.
𝐸 𝐶 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝐷𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑜𝑛𝑒 𝑔𝑜𝑜𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑎𝑛𝑜𝑡ℎ𝑒𝑟 𝑔𝑜𝑜𝑑

6. Cross Elasticity of Demand
This concept is often used to determine whether two goods are substitutes or complements and the degree to which one good is a complement to or substitute for another.
Substitutes: Price increases in one leads to a rise in Quantity demanded of the other good. So if 𝐸 𝐶 >0⇒ Goods are substitutes
Complements: Price increases in one leads to a fall in Quantity demanded of the other good. So if 𝐸 𝐶 <0⇒ Goods are complements
The higher (bigger positive number) the cross elasticity of demand is  greater degree of substitution

7. Income Elasticity of Demand
Measures the responsiveness of quantity demanded to changes in income.
Define as the percentage change in quantity demanded of a good divided by the percentage change in income.
𝐸 𝑌 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝐷𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐼𝑛𝑐𝑜𝑚𝑒
Since using percentage changes can at times lead to conflicting results, the following is also used:
𝐸 𝑑 = Δ 𝑄 𝑑 𝑄 𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 Δ𝑌 𝑌 𝑎𝑣𝑒𝑟𝑎𝑔𝑒

8. Income Elasticity of Demand (Cont)
If Income elasticity of demand is positive (Ey > 0)  normal good.
The demand for an inferior good decreases as income increases. So if Income elasticity of demand is negative (Ey < 0)  inferior good

9. Price Elasticity of Supply
Measures the responsiveness of quantity supplied to changes in price.
Defined as the percentage change in quantity supplied of a good divided by the percentage change in the price of the good.
𝐸 𝑌 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑆𝑢𝑝𝑝𝑙𝑖𝑒𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
Supply can be classified as elastic, inelastic, unit elastic, perfectly elastic, or perfectly inelastic.

10. Price Elasticity of Supply

11. Price Elasticity of Supply and Time
The longer the period of adjustment to a change in price, the higher the price elasticity of supply.
Additional production takes time.
Reducing production takes time.
Example: Housing market.
If price increases of houses, will we be able to increase houses in short run? No.
In long run? Yes  Dedicate more resources from production of other things to produce houses, hence increasing supply. Price Elasticity of Supply Increases