Elasticity

• Price elasticity of demand is defined as the responsiveness of quantity demanded to a change in the price of a good or service.
• Ed = >1 demand is price elastic and buyers are sensitive to a price change. Law of demand.
• Ed = <1 demand is price inelastic and buyers are not sensitive to a price change. Law of demand is weak.
• Ed = 1 demand is unitary elastic. Price and quantity change in exactly the same proportion
• Percentage Change Mathod = (% change qty/% change in price)
• Midpoint method: (change in qty/avg qty) x (avg p/change in price)
• inelastic and elastic curves

  
• Determinants of price elasticity of demand:

  • Availability of Substitutes
  • Necessity or Luxury
  • Definition of the Market
  • Proportion of Income Spent
  • Time
• Availability of substitutes: The greater number of close substitutes a good has, the more price elastic its demand. Consumers are sensitive to change since they can easily switch to another product.
• Whether the good is a necessity or a luxury: Necessarily goods like food are more price inelastic (need). Luxury goods like a TV or jewellery are elastic (not needed)
• Definition of the market: Demand for a good in a broadly defined market will be more inelastic than the demand for a good in a narrowly defined market. Eg - petrol is a broadly defined market. Demand for a specific brand such as BP, Coles Express, or Shell is a narrowly defined market.
• Proportion of income spent: Expensive goods are more likely to be price elastic as they take up a larger proportion of consumer's income. Cheaper goods are more price inelastic. Coffee increase from $4 to $5 (25% increase) unlikely to cause significant decrease. TV increase from $2000 to $2500 (25% increase) cause great effect in quantity.
• Time: If consumers have time respond to a price change, demand is more price elastic. In very short run, demand for most commodities is relatively inelastic as they don't have time to adjust consumption or find substitutes. When oil prices increased in 2008, causing petrol prices to rise, consumers could do little except pay extra. As time progressed, they could alter their consumption by using public transport, or switching to diesel/electric.
• Perfectly elastic and inelastic demand

  
• P x Q = total revenue
• elastic demand and total revenue

  
• Total revenue has increased because change in quantity demanded is greater than change in price. If price rises for an elastic good, total revenue will fall because change in quantity demanded will be greater than change in price.
• Quantity bigger = revenue lost

  Price bigger = revenue gained
• inelastic demand and total revenue

  
• Total revenue will decrease because the change in quantity demanded is smaller than the change in price. If price rises for an inelastic good, total revenue will increase because the fall in quantity demanded is smaller than the rise in price.
• If demand is elastic, price and TR move in opposite directions
• If D is inelastic, price and TR move in same direction
• Unitary: doesn't change
• Price discrimination: different consumer groups have different price elasticity of demand - firms use this information to change different prices and increase total revenue. Firms can boost their revenue by segmenting their customers into separate groups according to their elasticity. Eg. students and seniors have a more elastic demand as they have lower income than adults (cinemas)
• elasticity along a linear demand curve

  
• Price elasticity of supply: responsiveness of quantity supplied to a change in price
• % change in qty/% change in price
• Es = (change in qs/qs) x (p/change in p)
• If % change in qtys is greater than % change in $, supply is price elastic and coefficient greater than one.
• Steeper supply curve will be relatively more inelastic. When price rises from P1 to P2, quantity supplied rises for both supply curves but by different amounts. Quantity change for Si is much smaller than the change for Se. Si is said to be less responsive or elastic.
• Determinants of price elasticity:

  • Time
  • Nature of the Industry
  • Ability to Store Inventory
• Time: If the producer can respond quickly to a price change than supply will be price elastic. In the very short run, may be difficult for producer to suddenly increase output, therefore supply will tend to be more price inelastic. As time increases, supply becomes more elastic. Oil - short run, supply of oil is relatively fixed (there is a known quantity) so it is relatively inelastic. As time progresses, exploration and discovery of oil can increase quantity and supply relatively elastic.
• Nature of the industry: The supply of agricultural products tends to be relatively price inelastic while the supply of manufactured goods is more price elastic. Produce such as wheat, wool, and meat require a reasonable amount of time to produce. If price suddenly increases, farmers cannot quickly respond - must wait for next growing season. Manufactured goods are relatively easy to produce. Firms can expand supply of computers in response to an increase in price.
• Ability to store inventory: Inventions refer to stocks kept for future sale. If a producer has the ability to store or warehouse goods, it can respond fairly quickly to changes in demand and so supply is relatively elastic. Supermarkets are able to store non-perishable goods in large warehouses and ship them whenever a store runs out of product. Goods that are perishable, like fruit, cannot be stored and therefore supply is relatively inelastic.
• Agricultural market: Demand is relatively inelastic. Over time, supply will increase due to improvement in technology and productivity. An increase in supply will result in price falling and quantity increasing but because demand is inelastic, total income received by the agriculture sector falls. The reason is that when demand is inelastic, an increase in production results in a large fall in price, but only a small increase in quantity sold. Farming tends to be contract work due to the nature of elasticity.
• Housing market: Supply curve for housing is very inelastic because it takes time to constuct new houses. Over time, demand increases due to rising incomes and population. An increase in demand leads to a large rise in price and a increase in quantity, but when supply is inelastic, most of the effect is concentrated on price. Price of housing increases substantially while the quantity only increases modestly.
• GST: Goods and Services Tax, a broadly applied value added tax. Set at 10%.
• Excise taxes are taxes much larger and directed at good with very inelastic demand (petrol, alcohol, tobacco)
• Taxes are an important source of government. Negative impact on an industry.
• Demand is inelastic, tax is effective in raising revenue. Taxes on inelastic goods have a marginal impact on quantity - effects in industry output and employment is not as great as a tax on a good with elastic demand.