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The Concept of ElasticityThe Concept of ElasticityThe Concept of ElasticityThe Concept of Elasticity
How large is the response of producers and consumers to changes in price?changes in price? Before business firms and the government decide to change prices and taxes, they must anticipate the magnitude of response by those affected.
ElasticityElasticity is a measure of the responsiveness of people to changes in economic variables.
Popular Elasticity MeasuresPopular Elasticity MeasuresPopular Elasticity MeasuresPopular Elasticity Measures
Price elasticity of demand ( Ed )Price elasticity of demand ( Ed ) Price elasticity of supply ( Es )Price elasticity of supply ( Es ) Income elasticity of demand Cross elasticity of demand for
Using the Midpoint Formula to Compute Using the Midpoint Formula to Compute Price Elasticity (Appendix )Price Elasticity (Appendix )Using the Midpoint Formula to Compute Using the Midpoint Formula to Compute Price Elasticity (Appendix )Price Elasticity (Appendix )
The midpoint formula is a more accurate measure of percentage changes.
Interpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of Elasticity
Response to Price Changes
Responsive
Unresponsive
Proportional
Value of
Elasticity
Ed > 1
Ed < 1
Ed = 1
Demand Elasticity
Elastic
Inelastic
Unitary elastic
Magnitudes of Change
%QD > %P
%QD < %P
%QD = %P
Type of Elasticity
Elastic
Inelastic
Substitutes Available
Many
Few
The main determinant The main determinant of demand elasticity is of demand elasticity is the availability of the availability of substitutes for the substitutes for the good in question.good in question.
Interpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of ElasticityInterpreting the Value of Elasticity
The price elasticity for water (0.20) suggests that a 10% increase in the price of water would decrease the quantity demanded by only 2%.
The elasticity for specific brands of coffee (5.6) suggests that a 10% increase in the price of a specific brand would decrease its quantity demanded by 56%.
Estimated price elasticities of demand for selected products
Using the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demand
Applications: College EducationApplications: College Education Suppose a university increases tuition
from $4,000 to $4,400 (a 10% increase in price) and wants to predict how many fewer students will enroll as a result of the high price. The Ed of higher education
Using the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demand
Predicting Changes in Quantity demandedPredicting Changes in Quantity demanded Suppose you run a campus film series,
and you know that Ed is 2.0. If you decide to increase price by 15%, you can use the following rearranged formula to predict Changes in Quantity demanded
Using the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demandUsing the Price Elasticity of demand
Predicting Changes in Quantity demandedPredicting Changes in Quantity demanded How would a tax on beer affect highway
deaths? The Ed for beer among adults is 1.3. If a state imposes a beer tax that increases beer price by 20%, what would happen to the number of highway deaths among young adults?
Elasticity and Total Revenue (TR)Elasticity and Total Revenue (TR)Elasticity and Total Revenue (TR)Elasticity and Total Revenue (TR) Elasticity of demand determines if an
increase in price will cause the firm’s revenue to increase or decrease.
Total Revenue = Price x Quantity sold
Total Revenue = Price x Quantity sold An increase in the price have two opposing effects
The good news about an increase in price is that a higher price will increase the revenue obtained from each unit sold.
The bad news is that at a higher price, fewer units are sold. Elasticity of demand tells us whether Elasticity of demand tells us whether the good news dominates over the bad news.the good news dominates over the bad news.
Supply Elasticity and TimeSupply Elasticity and TimeSupply Elasticity and TimeSupply Elasticity and Time
Supply becomes more elastic over time.
The increase in quantity supplied as a response to an increase in price is greater when supply is more elastic.
Higher market prices give business firms an incentive to expand production and output. As time goes by, the ability of firms to expand productive capacity is greater, and supply becomes more elastic.
Predicting Price Changes Using Predicting Price Changes Using ElasticitiesElasticitiesPredicting Price Changes Using Predicting Price Changes Using ElasticitiesElasticities The price-change formula can be used to
predict the change in price resulting from a change in demand.
For changes in price resulting from a change in supply:
percentage change in price = percentage change in demand
E Es d
percentage change in price = percentage change in supply
Predicting Price Changes Using Predicting Price Changes Using Elasticities: an ExampleElasticities: an ExamplePredicting Price Changes Using Predicting Price Changes Using Elasticities: an ExampleElasticities: an Example
Assume that Ed=1.5 and Es=2.0, a rightward shift in demand by 35%, will increase price by the following percentage: