PRINCIPLES OF ECONOMICS Chapter 5 Elasticity PowerPoint Image Slideshow

ELASTICITY Elasticity: the responsiveness of quantity to a change in another variable (i.e., price, income, price of other goods) Price Elasticity of Demand: the responsiveness of quantity demanded to a change in the price Price Elasticity of Supply: the responsiveness of quantity supplied to a change in the price

ELASTICITY FORMULA Elasticity = %ΔQ %ΔP = ΔQ ΔP Q P Because the demand curve is downward sloping and the supply curve is upward sloping the elasticity of demand is negative and the elasticity of supply is positive. Often these signs are ignored.

ELASTICITY FORMULA Elasticity = %ΔQ %ΔP = ΔQ ΔP Q P Arc Elasticity = (Q 2 – Q 1 )/(Q 2 + Q 1 ) (P 2 – P 1 )/(P 2 + P 1 )

ELASTICITY FORMULA Q 1 = 2,800, P 1 = 70 and Q 2 = 3,000, P 2 = 60 %ΔQ = (3,000 – 2,800)/(3, ,800) = 200/5,800 = 1/29 %ΔP = (60 – 70)/( ) = -10/130 = -1/13 Elasticity coefficient = (1/29)/(-1/13) = -13/29 = -0.45

ELASTICITY TERMINOLOGY Elastic: % ΔQ > %ΔP, elasticity coefficient > 1 Consumers show a strong reaction to a price change. Inelastic: % ΔQ < %ΔP, elasticity coefficient < 1: Consumers show a weak reaction to a price change. Unitary Elastic: % ΔQ = %ΔP, elasticity coefficient = 1 Consumers reaction to a price change is neutral.

THE PRICE ELASTICITY OF DEMAND Elasticity and the slope of the demand curve are not the same concepts, but they are related. With a linear demand curve, the elasticity coefficient is greater at high prices; the upper segment of a linear demand is price elastic With a linear demand curve, the elasticity coefficient is smaller at low prices; the lower segment of a linear demand is price inelastic

PRICE ELASTICITY OF DEMAND The mid-point of a linear demand is unitary elastic. The upper segment of a linear demand is elastic. The lower segment of a linear demand is inelastic.

DETERMINANTS OF ELASTICITY Number of and Closeness of Substitutes: The more alternatives you have, the less likely you are to pay high prices and the more likely you are to buy a substitute (e.g., candy bars). Passage of Time: The longer you take to come up with alternatives to paying high prices, the more like you choose those alternatives (e.g., gasoline). Importance in Consumer Budget: The greater the portion of the budget an item takes up, the greater is the elasticity coefficient (e.g., housing vs. salt).

ELASTICITY EXAMPLES Inelastic GoodsPrice Elasticity of Demand Eggs0.06 Food0.21 Health Care Services0.18 Gasoline (short-run)0.08 Gasoline (long-run)0.24 Highway and Bridge Tolls0.10 Unit Elastic Good (or close to it) Shellfish0.89 Cars1.14 Elastic Goods Luxury Car3.70 Foreign Air Travel1.77 Restaurant Meals2.27

PRICE ELASTICITY OF SUPPLY The price elasticity of supply is calculated as the percentage change in quantity divided by the percentage change in price.

PERFECTLY ELASTIC If %ΔP = 0, elasticity coefficient = ∞ The demand/supply is perfectly elastic, a horizontal line at the given price,

PERFECTLY INELASTIC If %ΔQ = 0, elasticity coefficient = 0 The demand/supply is perfectly inelastic, a vertical line at the given quantity

UNITARY ELASTIC DEMAND A demand curve with constant unitary elasticity will be a curved line. Notice how price and quantity demanded change by an identical amount in each step down the demand curve.

UNITARY ELASTIC SUPPLY A constant unitary elasticity supply curve is a straight line reaching up from the origin. Between each point, the percentage increase in quantity demanded is the same as the percentage increase in price.

DEMAND ELASTICITY & PRICE CHANGE Cost-saving gains cause supply to shift out to the right from S 0 to S 1 ; that is, at any given price, firms will be willing to supply a greater quantity. Figure (a): The demand is inelastic, the result of this cost-saving technology is a substantially lower price. Figure (b): The demand is elastic, the result of this cost-saving technology is a substantially larger quantity.

DEMAND ELASTICITY & PRICE CHANGE

DEMAND ELASTICITY & SALES TAX An excise tax introduces a wedge between the price paid by consumers (P c ) and the price received by producers (P p ). Figure (a): Demand is more elastic than supply, the burden of tax is on producer as P e – P p > P c – P e Figure (b): Demand is less elastic than supply, the burden of tax is on consumer as P c – P e > P e – P p

DEMAND ELASTICITY & SALES TAX