Elasticity and Its Applications

UNIT 5

Elasticity...
...is a measure of how much buyers and sellers respond to changes in market conditions... ...allows us to analyse supply and demand with greater precision.

Three Types of Elasticities 
 

Price elasticity of demand Income elasticity of demand Price elasticity of supply

Price Elasticity of Demand 

Price elasticity of demand is the percentage change in quantity demanded given a one percent change in the price.

Ranges of Elasticity 

Inelastic Demand
Quantity demanded does not respond strongly to price changes. 

Elastic Demand
Quantity demanded responds strongly to changes in price.

 Unit Elastic Quantity demanded changes by the same percentage as the price. .Ranges of Elasticity  Perfectly Inelastic Quantity demanded does not respond to price changes.  Perfectly Elastic Quantity demanded changes infinitely with any change in price.

... .The Price Elasticity of Demand: Perfectly Inelastic Price Demand $5 4 1. An increase in price..leaves the quantity demanded unchanged.. 0 100 Quantity 2.

quantity demanded is infinite. At any price above $4.The Price Elasticity of Demand: Perfectly Elastic Price 1. consumers will buy any quantity. At exactly $4. At a price below $4. 0 Quantity . Demand 3. $4 2. quantity demanded is zero.

. A 12.5% decrease in quantity demanded..The Price Elasticity of Demand: Unit Elastic Price $5 4 1. Demand 0 80 100 Quantity 2. .5% increase in price..leads to a 12. ..

.5% increase in price. Demand 0 50 100 Quantity 2. ....leads to a 50% decrease in quantity demanded.The Price Elasticity of Demand: Elastic Demand Price $5 4 1. . A 12.

..The Price Elasticity of Demand: Inelastic Demand Price $6 4 1..leads to an 11% decrease in quantity demanded. .. Demand 0 90 100 Quantity 2. A 25% increase in price..

the more narrowly defined the market..if the good is a luxury... the larger the number of close substitutes... . the longer the time period... .Determinants of Price Elasticity of Demand  Demand tends to be more elastic.. .. .. .

.. ...the shorter the time period.. the more broadly defined the market.. .the fewer the number of close substitutes.. . ...if the good is a necessity.Determinants of Price Elasticity of Demand  Demand tends to be more inelastic.. .

Computing the Price Elasticity of Demand  The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. .

Computing the Price Elasticity of Demand  The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. Percentage Change in Quantity Demanded Price Elasticity of Demand = Percentage Change in Price .

Computing the Price Elasticity of Demand Price 110 90 Demand 0 160 240 Quantity .

Computing the Price Elasticity of Demand Price A= P1 ± 90 Q1 ± 240 B= P1 ± 110 Q2 ± 160 110 90 Demand 0 160 240 Quantity .

TR = P X Q . Computed as the price of the good times the quantity sold.Elasticity and Total Revenue   Total revenue is the amount paid by buyers and received by sellers of a good.

Elasticity and Total Revenue Price $4 P P X Q = $400 (total revenue) Demand 0 Q 100 Quantity .

Elasticity and Total Revenue  With an elastic demand curve. . an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus. total revenue decreases.

Elasticity and Total Revenue: Elastic Demand Price Price $5 $4 Demand Revenue = $200 Demand Revenue = $100 0 50 Quantity 0 20 Quantity .

.Elasticity and Total Revenue  With an inelastic demand curve. an increase in price leads to a decrease in quantity that is proportionately smaller. Thus. total revenue increases.

Elasticity and Total Revenue: Inelastic Demand Price Price $3 Revenue = $240 $1 0 Revenue = $100 Demand 100 Quantity 0 80 Demand Quantity .

Income Elasticity of Demand   Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers¶ income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income. .

Computing Income Elasticity Income Elasticity of Demand= Percentage Change in Quantity Demanded Percentage Change in Income .

.Income Elasticity. Types  Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. ..

. and medical services. utilities.Income Elasticity. Examples include food... fuel. clothing. Types  Goods consumers regard as necessities tend to be income inelastic.

. furs.Income Elasticity. Types  Goods consumers regard as luxuries tend to be income elastic.. Examples include sports cars. and expensive foods..

Explain the relationship between total revenue and elasticity of demand.Recap! Define the price elasticity of demand.   .

Price Elasticity of Supply  Price elasticity of supply is the percentage change in quantity supplied resulting from a one percent change in price. .

Ranges of Elasticity  Perfectly Elastic ES = g  Relatively Elastic ES > 1  Unit Elastic ES = 1 .

Ranges of Elasticity  Relatively Inelastic ES < 1  Perfectly Inelastic ES = 0 .

. 0 100 Quantity 2.Price Elasticity of Supply: Perfectly Inelastic Supply Price Supply $5 4 1. .leaves the quantity supplied unchanged.. An increase in price.. ..

A larger% increase in price. 100 110 Quantity 2.. . .Price Elasticity of Supply: Inelastic Supply Price $6 4 1.leads to a 10% increase in quantity supplied....

Price Elasticity of Supply: Elastic Supply Price $5 4 1. 100 200 Quantity 2. . A 12.5% increase in price. ....leads to a 50% increase in quantity supplied..

5% increase in price. At exactly $4. At a price below $4. $5 4 1. 100 3. At any price above $4.. A 12. quantity supplied is infinite..Price Elasticity of Supply: Perfectly Elastic Supply Price 1. 2. producers will supply any quantity. quantity supplied is zero. Quantity .

Beach-front land is inelastic. Supply is more elastic in the long run.Determinants of Elasticity of Supply  Ability of sellers to change the amount of the good they produce. Books. . or manufactured goods are elastic. cars.  Time period.

Computing the Price Elasticity of Supply  The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. .

r El ti it f S ppl r t tit S ppli t ri i i .Computing the Price Elasticity of Supply  The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

Recap! Define the elasticity of supply. Explain why the price elasticity of supply might be different in the long run than the short run.   .

Application of Elasticity  Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties? .

Use the supply-and-demand diagram to see how the market equilibrium changes.Application of Elasticity    Examine whether the supply or demand curve shifts. Determine the direction of the shift of the curve. .

An Increase in Supply in the Market for Wheat Price of Wheat S1 $3 Demand 0 100 Quantity of Wheat .

S1 $3 S2 Demand 0 100 Quantity of Wheat .. an increase in supply..An Increase in Supply in the Market for Wheat Price of Wheat 1. When demand is inelastic.

an increase in supply.An Increase in Supply in the Market for Wheat Price of Wheat 1. When demand is inelastic... S1 $3 2 S2 Demand 0 100 110 Quantity of Wheat .

... S2 Demand 0 100 110 Quantity of Wheat . When demand is inelastic.. S1 2.leads $3 to a large fall in 2 price.. an increase in supply.An Increase in Supply in the Market for Wheat Price of Wheat 1. ..

S1 2.. revenue falls from $300 to $220. When demand is inelastic.. ..and a proportionately smaller increase in quantity sold... an increase in supply..An Increase in Supply in the Market for Wheat Price of Wheat 1. . S2 Demand 0 100 110 Quantity of Wheat 3..leads $3 to a large fall in 2 price. .. As a result.

Compute Elasticity 100 -110 100 ED = 3.00 .33 .00 -0.2.30 0.00 3.10 ! } -0.

2.00 .30 0.00 -0.33 Demand is inelastic .10 ! } -0.00 3.Compute Elasticity 100 -110 100 ED = 3.

   . If it is inelastic. total revenue falls when the price rises. If a demand curve is elastic. total revenue rises as the price rises.Conclusion Price elasticity of demand measures how much the quantity demanded responds to changes in the price.

supply is more elastic in the long run than in the short run. In most markets.Conclusion The price elasticity of supply measures how much the quantity supplied responds to changes in the price.   .

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