ecn 2 q
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1PElasticity.pptxSection 2 topics
Elasticity
Costs of production
Pure Competition
Pure Monopoly
Oligopoly
Monopolistic Competition
Creative Commons Attribution 4.0 License, Charles Hackner Houston Community College unless otherwise noted CC BY NC
Elasticity
Please listen to the audio as you work through the slides.
Microeconomics
Looking at the behavior of:
Consumers,
Businesses, and
Resource suppliers
In various market structures
Elasticity
Learning objectives
Students should be able to thoroughly and completely explain:
What Elasticity measures, who cares, and why.
All the measures of elasticity that we covered in class:
Elasticity of Demand,
Supply,
Income, and
Cross Elasticity of Demand
The determinants of Price Elasticity of Demand.
Extend the discussion of demand and supply to look at the concept of Responsiveness.
The buying and selling responses of consumers and producers to price changes.
The responses of producers of one product when the price of another product changes.
The buying responses of consumers when their incomes change.
Elasticity
Elasticity of:
Demand
Supply
Cross Elasticity
Income Elasticity
Types of Elasticity (responsiveness)
How much more or less?
Does it matter?
To whom?
THE LAW OF DEMAND SAYS...
Price Elasticity of Demand
Consumers will buy more when prices go down and less when prices go up
Price Elasticity Provides an Answer
The Price-Elasticity Coefficient and Formula
Price Elasticity of Demand
Ed =
Percentage change in quantity
demanded of product X
Percentage change in price
of product X
Or equivalently…
Ed =
Percentage change in quantity demanded of X
Original quantity demanded of X
Change in price of X
Original price of X
Where will you get this piece of data?
Interpretations of Ed
Price Elasticity of Demand
Demand is Elastic if a specific percentage change in price results in a larger percentage change in quantity demanded.
Then Ed will be > 1
What is an example of a product with elastic demand?
Vacations, restaurants, movies, concerts, books, etc. If the price rises, you can easily give it up either because they are not necessary or they have substitutes
Interpretations of Ed
Price Elasticity of Demand
Demand is Inelastic if a specific percentage change in price results in a smaller percentage change in quantity demanded. Not very responsive.
Then Ed will be < 1
What would be an example of a product with inelastic demand?
Gasoline, staple foods, basic clothing, phone, internet or cable service is often seen as a necessity and will not get cut based on a price increase.
Interpretations of Ed
Price Elasticity of Demand
Demand is of Unit Elasticity if a specific percentage change in price results in an equal percentage change in quantity demanded.
Then Ed will be = 1
What would be an example of a product with unit elasticity?
Interpretations of Ed
Price Elasticity of Demand
Demand is Perfectly Inelastic if a price change results in no change in quantity demanded.
Then Ed will be = 0
Example - A diabetic’s demand for insulin.
Other examples?
Interpretations of Ed
Price Elasticity of Demand
Demand is Perfectly Elastic if a small price reduction causes buyers to increase their purchases from 0 to all they can obtain.
Then Ed will be =
Example - A firm selling it’s product in a purely competitive market.
Elastic Demand - Ed will be > 1
Inelastic Demand - Ed will be < 1
Unit Elastic Demand - Ed will be = 1
Perfectly Inelastic Demand - Ed will be = 0
Perfectly Elastic Demand - Ed will be =
Summary of Price Elasticity of Demand
5 interpretations
The percentage change in price
The percentage change in quantity
.01
.02
Elasticity is .5
Q
P
P1
P2
Q1
Q2
D
Measures Responsiveness to Price Changes
Price Elasticity of Demand
The percentage change in price
The percentage change in quantity
Q
P
P1
P2
Q1
Q2
D
Commonly Expressed as…
Price Elasticity of Demand
%
P
%
Q
d
Elasticity is .5
Extreme Cases
Price Elasticity of Demand
Perfectly Inelastic Demand
Perfectly Elastic Demand
P
0
P
0
D1
Ed = 0
D2
Ed =
Q
Q
So, who cares about elasticity?
Firms do!
Why?
Impact on Revenue!
Total Revenue Test
Demand for a product is elastic if a price change causes total revenue to change in the opposite direction.
Price falls and Total Revenue rises
Price rises and Total Revenue falls
Demand for a product is Inelastic if a price change causes total revenue to change in the same direction.
Price falls and Total Revenue falls
Price rises and Total Revenue rises
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Elasticity on a Linear Demand Curve It has 3 phases
1
2
3
4
5
6
7
8
$8
7
6
5
4
3
2
1
5.00
2.60
1.57
1.00
0.64
0.38
0.20
$8,000
14,000
18,000
20,000
20,000
18,000
14,000
8,000
Elastic
Elastic
Elastic
Unit Elastic
Inelastic
Inelastic
Inelastic
(1)
Total Quantity of
Tickets Demanded
Per Week, Thousands
(2)
Price Per Ticket
(3)
Elasticity
Coefficient (Ed)
(4)
Total Revenue
(1) X (2)
(5)
Total-Revenue
Test
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Elasticity and the TR Curve
0
1
2
3
4
5
6
7
8
0
1
2
3
4
5
6
7
8
Quantity Demanded
Quantity Demanded
Price
Total Revenue
(Thousands of Dollars)
$20
18
16
14
12
10
8
6
4
2
$8
7
6
5
4
3
2
1
a
b
c
d
e
f
g
h
Elastic
Ed > 1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
D
TR
Price Elasticity and Total Revenue
Price elasticity is..
Inelastic from 0 to 1
Typical of necessities one must have.
Elastic from 1 to infinity
Typical of luxuries one wants.
Unit elastic when exactly = 1
Price change does not reduce total revenue.
Determinants of Price Elasticity of Demand
(Generalizations)
Substitutability
Proportion of Income
Luxuries versus necessities
Time
Determinants of Price Elasticity of Demand
Substitutability
The larger the number of substitute goods that are available, the greater the Price Elasticity of Demand.
In the purely competitive market, the single seller faces a perfectly elastic demand curve. Why?
Lowering world trade barriers increases elasticity of demand for most products. Why?
Determinants of Price Elasticity of Demand
Substitutability
The elasticity of demand for a product depends on how narrowly the product is defined.
Reeboks – lots of substitutes
Shoes – few substitutes for shoes
Determinants of Price Elasticity of Demand
Proportion of Income
Other things equal, the higher the price of a good relative to consumers’ incomes, the greater the Price Elasticity of Demand.
A 10% increase in price of cheap pencils yields a small decline in quantity demanded. Small proportion of income.
A 10% increase in price of cars or housing yields a large decline in quantity demanded. Large proportion of income.
Determinants of Price Elasticity of Demand
Luxuries versus Necessities
In general, the more that a good is considered a “luxury” rather than a “necessity”, the greater is the Price Elasticity of Demand.
Food and water - necessities (inelastic)
Travel vacations and jewelry – luxuries (elastic)
Determinants of Price Elasticity of Demand
Time
Generally, product demand is more elastic the longer the time period under consideration.
Consumers often need time to adjust to price changes.
Elasticity of demand for gasoline in the “short run”
Ed = .2 more inelastic than…
Elasticity of demand for gasoline in the “long run”
Ed = .7
Determinants of Price Elasticity of Demand
Some Applications
Excise Taxes
When selecting which goods and services on which to levy excise taxes, the Government needs to pay attention to elasticity of demand.
Higher taxes on products with elastic demand will bring in less tax revenue.
Why tax the following?
Liquor,
Gasoline,
Cigarettes
State the law of supply
Price Elasticity of Supply a measure used in economics to show the responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its price or cost. 5 interpretations
If producers are relatively responsive to price or cost changes, supply is elastic
If producers are relatively insensitive to price or cost changes, supply is inelastic.
The degree of Price Elasticity of Supply depends on how easily – and therefore how quickly – producers can shift resources between alternate uses.
*Now, compare the immediate market period, the short-run, and long run impact on elasticity of supply.
Supply curve becomes more elastic with time.
Price Elasticity of Supply
Coefficient of Price Elasticity of Supply
Es=
Percentage change in quantity
supplied of good X
Percentage change in
the price of good X
How does Time impact the Price Elasticity of Supply?
Immediate Market period
All resources are fixed
Perfectly inelastic supply
Short run
Fixed plant size
Inelastic supply
Long run
Adjustable plant size
Supply more elastic
6-33
Time periods
The immediate market period
The period that occurs when the time immediately after a change in market prices is too short for producers to respond with a change in quantity supplied.
The tomato farmer case
Supply is perfectly inelastic. Vertical supply curve.
Time periods
The short run
A period of time too short to change plant capacity but long enough to use fixed plant more or less intensively.
What could the tomato farmer do?
We expect a somewhat greater output in response to a presumed increase in demand. This greater output is reflected in a more elastic supply curve.
Time periods
The long run
A period of time long enough for firms to adjust their plant sizes, adjust other inputs, and for new firms to enter (or existing firms to leave) the industry.
We expect the Price Elasticity of Supply to be even more elastic.
Po
P
Q
D1
Qo
An increase in
demand without
enough time to
change supply
causes…
Sm
Immediate Market period
Price Elasticity of Supply
Po
Pm
P
Q
D1
Qo
D2
An increase in
demand without
enough time to
change supply
causes… an
increase in price with
no qty. supply
increase.
Sm
Immediate Market period
Price Elasticity of Supply
Po
P
Q
D1
Qo
Short Run
Price Elasticity of Supply
An increase in
demand with
more intense
Use of fixed plant
causes...
Ss
Po
P
Q
D1
Qo
D2
Short Run
Price Elasticity of Supply
Ps
An increase in
demand with
more intense
Use of fixed plant
causes...a smaller
increase in price, and a small increase in
output
Ss
Qs
Po
P
Q
D1
Qo
Long Run
Price Elasticity of Supply
An increase in
demand in the
long run allows
greater change
causing...
SL
Po
P
Q
D1
Qo
D2
Long Run
Price Elasticity of Supply
PL
An increase in demand in the long run allows greater change causing... Supply to become even more elastic
smaller price increase
-larger Change in output
SL
QL
Applications of Price Elasticity of Supply
Antiques - Limited, Inelastic supply, high prices
Reproductions – Unlimited, Elastic supply, lower prices
Gold – highly inelastic supply, shifting demand
Price Elasticity of Supply
Cross Elasticity of Demand
Producers care about this
3 interpretations
Consumption of a good also is affected by a change in the price of a related good.
EXY measures how sensitive consumer purchases of one product (X) are to a change in the price of some other Product (Y).
Helps quantify and better understand substitute and complementary goods.
Cross Elasticity of Demand
Exy =
Percentage change in quantity
demanded of good X
Percentage change in
the price of good y
Cross Elasticity of Demand
EXY > 0, sales of good X move in the same direction as a change in price of good Y means the X and Y are substitutes.
The larger is EXY, the greater is the substitutability of X and Y.
EXY < 0, An increase in the price of one good decreases the demand for the other good. X and Y are complements.
The larger is the negative EXY, the greater are X and Y as complements.
EXY = 0, the two products are unrelated or independent
Cross Elasticity of Demand - Applications
Business application:
Coca-Cola considering raising the price of Sprite: check out the Coca-Cola product list with Google and note the number of products.
What is the Ed of Sprite and what is the EXY of Coke and Sprite?
A low EXY between Coke and Sprite means they are weak substitutes.
Cross Elasticity of Demand - Applications
Government application:
Merger analysis by the Justice Dept.
Should Coca-Cola and Pepsi be allowed to merge?
The EXY between Coca-Cola and Pepsi is high which means?
They are strong substitutes!
What should the Justice Dept. do?
Block the merger because competition will be hurt.
Income Elasticity of Demand
2 interpretations
Measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good.
We can now take a closer look at Normal goods and Inferior goods.
% change in quantity demand
Ei = _______________________
% change in income
Normal Goods
Ei > 0, demand increases as income increases
Inferior Goods
Ei < 0, demand decreases as income increases
Income Elasticity of Demand - Insights
Helps explain expansion and contraction of industries in the U.S.
As income in the USA increases, industries producing products for which demand is quite income-elastic have expanded their level of output.
Automobiles: Ei = +3
Housing: Ei = +1.5
During recessions incomes fall.
HEB typically does better than Best Buy. Why?
