Economics 03

• Elasticity


  Measures how much buyers and sellers respond to changes in market conditions
• Coefficient of elasticity


  The number obtained when the percentage change in demand is divided by the percentage change in determinant
• Demand elasticity


  A measure of the degree of responsiveness of quantity demanded of a product to a given change in one of the independent variables that affect demand for that product
• Price elasticity of demand (Ed)

  The responsiveness of consumers' demand to the change in the price of goods sold
• Arc elasticity


  Computed by choosing two points on the demand curve and comparing the percentage changes in the quantity and the price on those two points
• Illustration: Price and quantity demanded schedule for a 250ml soda

  • Price: 9, Quantity Demanded: 0

  Price: 6, Quantity Demanded: 5
• Inelastic demand


  The change in quantity demanded is less than the price change. Consumers will pay almost any price for it.
• Inelastic demand curve


  • Steeper than the typical demand curve - a large price change results in a smaller quantity demanded
• Elastic demand


  The change in quantity demanded is greater than the price change. Consumers are price sensitive.
• Elastic demand curve


  • Flatter than the typical demand curve - a small price change results in a greater percentage change in quantity demanded
• Unitary elastic demand


  The change in quantity demanded is equal to the price change
• Absolute value of the coefficient of elasticity (Ep)

  If inelastic, less than 1

  If elastic, greater than 1

  If unitary elastic, equal to 1
• Income elasticity of demand (Ei)

  The responsiveness of consumers' demand to the change in their income
• Normal good


  An increase in income brings a rise in demand for the good. A decrease in income brings a fall in the demand for the good.
• Illustration: Peter's income increased by 15%, his demand for new clothes increased by 30%

  • Ei = 30% / 15% = 2.0
• Inferior good


  An increase in income brings a fall in the demand for the good. A decrease in income brings a rise in the demand for the good.
• Illustration: Josie's income decreased by 5%, her demand for thrift clothes increased by 10%

  • Ei = -10% / -5% = 2.0
• Cross-price elasticity of demand (Exy)


  The responsiveness of demand for a good concerning the changes in the price of related goods
• Substitute good


  Two goods that have a positive relationship between the quantity demanded of one good, and the price of the other
• Illustration: The price of apples and oranges fall by 25% and 10%, respectively

  • Exy = -10% / -25% = 0.40
• Complementary good


  Two goods that have a negative relationship between the quantity demanded of one good and the price of the other
• Illustration: The price of breakfast cereals rises by 5%, and milk prices fall by 15%

  • Exy = 5% / -15% = -0.33
• For pricing decisions, retailers find estimates of cross-price elasticity of demand useful
• Perfectly price inelastic demand


  Price changes do not affect the quantity demanded
• Perfectly price inelastic demand curve

  • Vertical
• Perfectly price elastic demand

  Any quantity will be demanded only at a prevailing price. If the price rises by a very small percentage, consumers will no longer buy the product.
• Perfectly price elastic demand curve

  • Horizontal
• Determinants of demand elasticity

  Availability of substitutes, share of consumer's budget spent on the good, duration of the adjustment period
• Supply elasticity


  Measures the degree of supply's responsiveness to a given price change
• Inelastic supply


  A price change generates a less than proportionate change in the quantity supplied. Suppliers are not that receptive to price changes.
• Inelastic supply curve


  • More vertical than the typical supply curve - any price change results in a smaller change in quantity supplied
• Elastic supply


  A percentage price change leads to a more than proportionate change in the quantity supplied. The supplier's response to small price changes is to increase the quantity supplied in the market rather than further price increase.
• Elastic supply curve


  • Flatter than the typical supply curve - a small price change results in a greater change in quantity supplied
• Unitary elastic supply


  The change in quantity supplied is equal to the price change
• Inelastic supply


  Supply curve is more vertical than the typical supply curve - any price change results in a smaller change in quantity supplied
• Elastic supply


  Supply curve is flatter than the typical supply curve - a small price change results in a greater change in quantity supplied
• Unitary elastic supply


  Change in quantity supplied is equal to the price change
• Perfectly price inelastic supply


  • Price changes do not affect the quantity supplied
• Perfectly price elastic supply


  • Any quantity will be supplied only at a prevailing price
• Determinants of supply elasticity

  • Time
  • Time horizon