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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