Elasticity

• Elasticity


  A measure of the responsiveness of one variable (quantity demanded or supplied) to a change in another variable
• Price elasticity of demand

  Elasticity (usually takes negative values) when price grows, quantity demanded decreases; when price decreases, quantity demanded increases
• Veblen effect


  • Some types of high-status goods, such as diamonds or luxury cars, are Veblen goods, decreasing their prices decreases people's preference for buying them because they are no longer perceived as exclusive or high status products; A price increase may increase that high status and perception of exclusivity, thereby making the good even more preferable
• Giffen good


  Staple foods of inferior quality, whose demand is driven by poverty, that makes their purchasers unable to afford superior foodstuffs; As the price of the cheap staple food rises, they can no longer afford to supplement their diet with better foods, and must consume more of the staple food
• Elastic demand


  Ed < -1
• Unit elastic demand


  Ed = -1
• Inelastic demand


  Ed >-1
• Perfectly elastic demand


  Even small change of price results decreasing of demand to zero
• Perfectly inelastic demand


  Customers buy the same amount of good, regardless of good's price
• Price increase from $1 to $2

  100% increase in price
• Price increase from $2 to $3

  50% increase in price
• Price increase from $10 to $11

  10% increase in price
• Even though the price increases by $1 in each case, the percentage change in price becomes smaller when the starting value is larger
• Elasticity measure


  ΔQ - change of quantity demanded, Q - quantity demanded before price change, ΔP - change of price, P - price before change
• In this interval, demand is inelastic (since elasticity >- 1)
• Total revenue


  Price times quantity
• If the price rises


  What happens to total revenue?
• A reduction in price will lead to: an increase in TR when demand is elastic, a decrease in TR when demand is inelastic, an unchanged level of total revenue when demand is unit elastic
• Price discrimination


  Different customers are charged different prices for the same product, due to differences in price elasticity of demand; higher prices for those customers who have the most inelastic demand (e.g. rich customers), lower prices for those customers who have a more elastic demand (e.g. poor customers)
• Examples of price discrimination


  • Theatres usually charge three different prices for a show targeting various age groups; Firms selling alcoholic beverages promote one as a prestige brand with a much higher price; Prices for flights are different for average customer and business customer (business class)
• Determinants of price elasticity (high)

  • Close substitutes are available, the good is not a necessity, the good or service is a large share of the consumer's budget, a longer time period is considered, the customers are rather poor
• Determinants of price elasticity (low)

  • There are no close substitutes, Good is necessity, Customers are rather rich, The good or service is a small share of the consumer's budget, A shorter time period is considered (no time to change habits, to look for substitutes)
• Cross-price elasticity of demand

  Cross-price elasticity is positive if and only if the goods are substitutes, cross-price elasticity is negative if and only if the goods are complements
• Normal good


  Income elasticity > 0
• Inferior good


  Income elasticity < 0
• Luxury good


  Income elasticity > 1
• Necessity good


  Income elasticity < 1
• Price elasticity of supply


  Note: it concerns the producer
• Perfectly inelastic supply


  • Example: land
• Perfectly elastic supply


  • Example: ?
• Determinants of supply elasticity

  • Short run - period of time in which capital is fixed (constant), all inputs (factors of production) are variable; in the long run supply will be more elastic in the long run than in the short run since firms can expand or contract their capital in the long run (e.g. bring employees from abroad)
• Math dictionary: równanie - equation, układ równań - simultaneous equations, ułamek - fraction, ułamek piętrowy - compound fraction, malejąca (rosnąca) funkcja - decreasing (increasing) function, funkcja liniowa - linear function, iloraz - quotient, iloczyn - product, różnica - difference, suma - sum, sumowanie - summation, dodatni - positive, ujemny - negative, licznik - numerator, mianownik - denominator
• Bibliography: Begg D. Fischer S., Dornbusch R., "Economics", 2008; Czarny B. "Podstawy Ekonomii", PWE 2010; http://www.oswego.edu/~kane/eco101.htm; www.wikipedia.org; Wood, John C. (1993). Thorstein Veblen: Critical Assessments, 352. London; Alfred Marshall, 1895. Principles of Economics Bk.III,Ch.VI in paragraph III.VI.17