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Ch. 6 Notes

Elasticity measures how responsive economic variables are to changes in other variables. Price elasticity of demand measures how much quantity demanded responds to price changes. Demand can be elastic, inelastic, or unit-elastic depending on whether the percentage change in quantity demanded is greater than, less than, or equal to the percentage change in price. The elasticity of demand depends on factors like availability of substitutes, how the market is defined, and whether the good is a necessity or luxury. Supply elasticity also depends on factors like the ability of firms to change production quantities in response to price changes. Income elasticity measures responsiveness of quantity demanded to income changes and cross-price elasticity measures responsiveness to price changes of

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67 views6 pages

Ch. 6 Notes

Elasticity measures how responsive economic variables are to changes in other variables. Price elasticity of demand measures how much quantity demanded responds to price changes. Demand can be elastic, inelastic, or unit-elastic depending on whether the percentage change in quantity demanded is greater than, less than, or equal to the percentage change in price. The elasticity of demand depends on factors like availability of substitutes, how the market is defined, and whether the good is a necessity or luxury. Supply elasticity also depends on factors like the ability of firms to change production quantities in response to price changes. Income elasticity measures responsiveness of quantity demanded to income changes and cross-price elasticity measures responsiveness to price changes of

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Emily Lau
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Ch.

6- Elasticity: The Responsiveness of Demand and Supply

 Elasticity: measure of how much one economic variable responds to changes in another economic
variable; sensitivity of Demand/Supply to change

Price Elasticity of Demand: responsiveness in quantity demanded to a change in price

% change in Qd
Price Elasticity of Demand=
% change in P

Elastic/ Inelastic Demand


 Elastic demand: %age change in Qd > %age change in P;
 price elasticity is > 1 in absolute value

 Inelastic demand: %age change in Qd < %age change in P


 Price elasticity < 1 in absolute value

 Unit-elastic demand: %age change in Qd = %age change in P


 Price elasticity = 1 in absolute value

Mid-Point Formula : use formula to ensure we have only one value of price elasticity of demand
between same two points on D curve

Price elasticity of demand=


Variety of Demand Curve Elasticities
 Flatter curve -> bigger elasticity
 Steeper curve -> smaller “ “

Perfectly Inelastic Demand (Extreme Case) Inelastic Demand

D-curve: relatively steep


D-curve: vertical C.P.S.: relatively low
C.P.S: zero Elasticity < 1

Unit-elastic Demand Perfectly Elastic Demand (other extreme)

D-curve: intermediate slop D-curve: horizontal


CPS: relatively high CPS: extreme
Elasticity: 1 Elasticity: ∞
Determinants of Price Elasticity of Demand
 Availability of close substitutes
o Price elasticity is higher when close substitutes are available
 Breakfast cereal vs. Sunscreen
 Definition of the market
o Price elasticity is higher for narrowly defined goods than broadly defined goods
 Blue jeans vs. clothing
 Luxuries versus necessities
o Price elasticity is higher for luxuries than for necessities
 Insulin vs. Cruise
 Passage of Time
o Price elasticity is higher in long run than short run
 Gasoline In short run vs. long run
 Xx Share of good in consumer’s budget
o Price elasticity is higher in a larger share of the good in the average consumer’s budget

Determinants of Price Elasticity of Supply


 ability/willingness of firms to alter quantity they produce as price increases
o supply will be increasingly elastic in longer run
 products that require resources that are fixed in supply are exception
o e.g. French winery rely on specific type of grape; if all the land on which that grape can be grown
Is already planted in vineyards, supply of that wine will be inelastic even over a long period

Elastic Demand Inelastic Demand

Elasticity > 1 Elasticity > 1


Variety of Supply Curve Elasticities

Perfectly Inelastic Inelastic

Elasticity = 0 Elasticity <1

Unit-Elastic Perfectly Elastic

Elasticity = 1 Elasticity = ∞
Income Elasticity of Demand
 measures responsiveness of Qd to changes in income

% ∆ Qd
= Income elasticity of demand
% ∆ Income

Normal good Inferior good Income


>0 <0
Cross-Price Elasticity of Demand
 how quantity demanded of good 1 changes as price of good 2 changes
 percentage change in Qd of one good divided by the percentage change in the price of another
good

% ∆ Qd1
= Cross-price elasticity of demand
% ∆ P2

Cross-Price Elasticity of Demand is…


0 = not related
>0 = substitute good
<0 = complement good

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