Elasticity and its application

Elasticity and its Application

Elasticity•A measure of how much buyers and sellers respond to changes in market conditions

•A measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants

Price Elasticity of Demand•Measures how much the quantity demanded responds to a change in price.

Factors Influencing PED

•Availability of Close Substitute

• Necessities vs. Luxuries

• Definition of Market

• Time Horizon

Computing the PED

Price Elasticity of Demand = % ∆ Qd

% ∆P

PED = 20% / 10% = 2

Midpoint Method• Price elasticity between two points on a demand curve

Ex. Point A: P=$4 Q=120

Point B: P=$6 Q=80

$6

$5

$4

80 100 120

B

A

A (6-4)/ 5 X 100 = /40%/

B (4-6)/ 5 X 100 = /40%/

Variety of Demand Curves

• Elastic- when elasticity is greater than 1.

• Inelastic-when elasticity is less than 1.

•Unit Elastic- when elasticity is equal to 1.

• Perfectly elastic- when elasticity is infinite.

• Perfectly inelastic- when elasticity is 0.

PERFECTLY INELASTIC DEMAND: ELASTICITY EQUALS 0

demand

Inelastic Demand: Elasticity Is Less Than 1

demand

Unit Elastic Demand: Elasticity Equals 1

demand

Elastic Demand: Elasticity Is Greater Than 1

demand

Perfectly elastic demand: Elasticity equals infinity

demand

Total Revenue and the PED

• amount paid by the buyers and received by the sellers. (PxQ)

a. The Case of Inelastic Demand

Ex. Consider rice as an inelastic demand. An increase in price leads to a decrease in quantity demanded that is proportionately smaller

$5

$4

90 100

$5

$4

70 100

b. The Case of Elastic Demand

The increase in price leads to a decrease in quantity demanded that is proportionately larger.

Elasticity and TR along a linear demand curve

•The slope of a linear demand curve is constant but its elasticity is not.

Price Quantity TR(PxQ)

%Change in Price

% Change in Quantity

ElasticityDescription

7 0 0 15 200 13.0 Elastic

6 2 12 18 67 3.7 Elastic

5 4 20 22 40 1.8 Elastic

4 6 24 29 29 1.0 Unit elastic

3 8 24 40 22 0.6 Inelastic

2 10 20 67 18 0.3 Inelastic

1 12 12 200 15 0.1 Inelastic

0 14 0 Inelastic

Price

Quantity

Elasticity is larger than 1

Elasticity is smaller than 1

Income Elasticity of demand• Measures how the quantity demanded changes as

consumer income changes.

• = %∆Qd/%∆Y

Cross Price Elasticity of Demand

-- measures how the quantity demanded of one good respond to a change in the price of another good.

= %∆Qd of good 1

%∆P of good 2

The Elasticity of Supply

DETERMINANTS

Flexibility of Sellers

Time Period

Price Elasticity of Supply

•Measures how much the quantity supplied responds to changes in the price

•= %∆ Quantity Supplied

%∆ in Price

(a) Perfectly Inelastic Supply: Elasticity Equals 0

supply

Supply

(b) Inelastic Supply: Elasticity Is Less Than 1

supply

c) Unit Elastic Supply: Elasticity Equals 1

(d) Elastic Supply: Elasticity Is Greater Than 1

supply

Supply

Perfectly Elastic Supply

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