Chapter 5: Elasticity Flashcards
(34 cards)
Elasticity
measures how responsive Qd or Qs is to changes in price, income or prices of related good…
-> how much buyers and sellers respond to changes in market conditions
Price elasticity of demand..
…is a measure of how much the quantity demanded of a good responds to a change in the price of that good.
-Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.
Ep = percentage change in Qd/percentage change in P Ep = coefficient of elasticity ... the size of coefficient elasticity shows how elastic a good is... aka how responsive demand is to a change in price...
Response to changes in price vary based on different factors…
of substitutes
Is good a luxury or necessary
How narrowly defined is the market
What about the time period
Inelastic demand
Qd does not respond strongly to changes in P
- -> % change in quantity demand (Qd) < % change in P
- -> change in P»_space;> change in Q
- -> Ep < 1
- -> demand curve would be fairly steep….eg. required textbook
Elastic demand
Qd responds strongly to a change in P
- -> % change in Qd > % change in P
- -> Change in Q»_space;» change in P
- -> Ep > 1
- -> demand curve will be fairly flat
- -> most manufactures
Perfectly inelastic demand
Qd does no respond to a change in P at all..
–> Q doesnt change for any size change in P
–> Ep = 0
–> Demand curve will be vertical
Eg. prescription heart medication… i.e. a necessity
Perfectly Elastic Demand
slide 15
Qd changes infinitely with any change in price…
Ep approaches infinite
–> Demand curve would be horizontal..
Eg. wheat.. agriculture
Unit elastic
Qd changes by the same % as P % change in Qd = % change in P Ep =1 demand curve would be non-linear eg. demand for win in the US (not confirmed)
The flatter the curve…. the more elastic the demand….
..
Midpoint formula measures arc elasticity
- Ep = (Q2 – Q1) / ([Q2 + Q1] / 2) / (P2 – P1) / ([P2 + P1] / 2)
preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of change…
–> used when 2 prices are given and their corresponding Qd values
Point elasticity
Measures the impact of a marginal change in price on quantity demanded
–> Ep = dQ/dP * P/Q
dQ/dP = slope of a linear demand curve when demand is in the form Q = f(P)
*Elasticity is not constant along a linear demand curve… not the same as slope… ELASTICITY MEASURES PERCENTAGE CHANGES.
Elasticity coefficient will always be…
Negative sign… since law of demand: P increases, Qd decreases..
*We drop the negative sign when calculating price elasticity
- Generalities about elasticities and their determinants.
- goods that are luxuries tend to have elastic demand
- goods that have close substitutes tend to have elastic demand
- goods tend to have more elastic demand over longer time horizons
- how you define the market makes a difference
- how much of your budget you spend on a good determines elasticity
- Goods that are necessities tend to have inelastic demand. i.e demand for insulin –> perfectly inelastic (reqd), demand to dentist visits (inelastic)
- demand for plasma tvs, vacations
- eg. coke/pepsi (elastic)….eg. egg```s (no close substitute–> demand is pretty inelastic)
- find subsitute down the road that you cant now
- Food - Perfectly inelastic
vegetables – more elastic (there are substitutes)
broccoli – even more elastic
**More generally you define the market, the more elastic the demand for that good. - If you spend a large proportion of your budget on a good, demand for that good will tend to be elastic. (Leasing your car?)
If you spend a small proportion on a good, demand tends to be inelastic. (Tim’s coffee).
Elasticity along the demand curve
Ep --> infinity (perfectly elastic) Ep >1 elastic Ep = 1 (at midpoint) = unit elastic Ep <1 inelastic Ep=0 (perfectly inelastic)
Why does elasticity change along the curve the way it does?
Recall that our point elasticity formula for a demand curve specified as Q = f(p) is
Ep = dQ/dP * P/Q
Slope dQ/dP is constant for a linear demand curve.
But P and Q are different combinations at different points on the demand curve, so elasticity changes along the demand curve.
Since dQ/dP is the slope of the demand curve, that’s why we can “see” elasticity by the steepness (slope) of the curve.
When maximizing profit… total revenue.. good to know
price elasticity
TR (Totral revenue) =
P*Q (prices times quantity traded).
Inelastic demand curve.. price increase leads to a quantity decrease (proportionally smaller)… lose sales but make up for it via higher pricers…
*TR will increase if P increase for inelastic demand…
To increase TR for inelastic demand… firm should increase price**
Elastic demand curve…increase in P leads to decrease in quantity (proportionally larger)…lose sales..less total revenue
***TR will decrease if P increases if demand is elastic…
To increase TR with elastic good, it should decrease P.
Unit elastic demand curve… the gain to TR from a P increase (or decrease) will be exactly offset by the decrease (or increase) in Q
**No change in P will increase TR …
TR must be at a maximum when Ep =1 **
Income elasticity of demand..
Measures how much the quantity demanded of a good responds to a change in consumers’ income
…. Ei = % change quantity demanded/%change in income (% change in Qd/% change in I)
or midpoint formula…
EI = (Q2 – Q1) / ([Q2 + Q1] / 2)
(I2 – I1) /([I2 + I1] / 2)
+/- matters!!!!!
+/- matters in income elasticity of demand…
If Ei > 0 (+)
- the good is a normal good - as I increases, Qd increases
If Ei < 0 (-)
- the good is an inferior good - as I decreases, Qd increases
Income inelastic…
Income elastic
Ei is between -1 and 1….. |Ei|1 or less than -1…. |Ei|>1
Goods consumers regard as necessities tend to be income inelastic.
Goods consumers regard as luxuries tend to be income elastic.
Examples: food, fuel, clothing, medicines
Examples: sports cars, jewelry, Packers seasons tickets
Cross-price elasticity of demand (Eab)
Measures the response of Qd of a good “a” to a change in price of good “b).
Eab = %r change Qd of good “a”/ % change in P of good “b”
Eab = (Q2a – Q1a) / (Q2a + Q1a) / 2
(P2b – P1b) / (P2b + P1b) / 2
+/-matters
