Microecon Lecture Note for 23Jan.2013

8/12/2019 Microecon Lecture Note for 23Jan.2013

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ELASTICITYMicroeconomics


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ELASTICITY

is a measure of how much buyers and sellers

respond to changes in market conditions


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THE ELASTICITY OF DEMAND

Price elasticity of demandis a measure of how

much the quantity demanded of a good responds to

a change in the price of that good.

Price elasticity of demand is the percentage change

in quantity demanded given a percent change in the

price.


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DETERMINANTSOFPRICEELASTICITY

OFDEMAND

Availability of Close Substitutes:

More close substitutes=More elastic

Example: Butter vs Egg

Necessities versus Luxuries:

inelastic versus elastic

Example: visit a doctor vs sailboat


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OFDEMAND

Definition of the Market:

Narrowly defined marketmore elastic

Broadly defined market less elastic

Example: Food vs Ice Cream

Time Horizon

Longer time horizonmore elastic

Shorter time horizonless elastic


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SUMMARY

Demand tends to be more elastic :

the larger the number of close substitutes.

if the good is a luxury.

the more narrowly defined the market.

the longer the time period.


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The (own) price elasticity of demand is computed

as the percentage change in the quantity

demanded divided by the percentage change in

price.

Price elasticity of demand =Percentage change in quantity demanded

Percentage change in price


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CALCULATINGELASTICITY

1.1

1.0

1.44 1.5


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CALCULATING ELASTICITY: POINT

ELASTICITY

Point Elasticity={[Q2-Q1]/Q1}/{[P2-P1]/P1}

Case 1: Price rises from 1 to 1.1

% change in qty = (1.44-1.5)/1.5= -4%

% change in price = (1.10-1)/1= 10%

Elasticity=-4%/10%=-0.4


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CALCULATINGELASTICITY: POINT

APPROACH

Case 2: Price falls from 1.1 to 1.

% change in qty = (1.5-1.44)/1.44= 4.16%% change in price = (1-1.10)/1.10= -9.09%

Elasticity=4.16%/-9.09%=-0.457


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POTENTIALPROBLEMOFPOINT

ELASTICITY

(Point) Elasticity level in case 1 is different from

(point) elasticity level in case 2


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MIDPOINT METHOD (ARC ELASTICITY

The midpoint formula is preferable when calculating

the price elasticity of demand because it gives the

same answer regardless of the direction of the

change.


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MIDPOINTMETHODFORMULA

Price elasticity of demand =( ) / [( ) / ]

( ) / [( ) / ]

Q Q Q Q

P P P P

2 1 2 1

2 1 2 1

2

2


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ARCELASTICITY

(MIDPOINTMETHOD)

Case 1: Price rises from 1 to 1.1.

% change in qty = (1.44-1.5)/1.47 = -4.1%

% change in price = (1.10-1)/1.05 = 9.5%

Elasticity=-4.1%/9.5%

=-0.432

Case 2: Price falls from 1.1 to 1.

% change in qty = (1.5-1.44)/1.47 = 4.1%

% change in price = (1-1.10)/1.05 = -9.5%

Elasticity=4.1%/-9.5%

=-0.432


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ELASTIC OR INELASTIC?

Inelastic Demand

Quantity demanded does not respond strongly to pricechanges.

Price elasticity of demand is less than one.

Elastic Demand Quantity demanded responds strongly to changes in

price.

Price elasticity of demand is greater than one.


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OTHERTYPES

Perfectly Inelastic

Quantity demanded does not respond to pricechanges.

Perfectly Elastic

Quantity demanded changes infinitely with anychange in price.

Unit Elastic

Quantity demanded changes by the samepercentage as the price.


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SUMMARY

|E|=0, perfectly inelastic

0


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Product Market ElasticityAutomobiles

Chevette U.S. -3.2

Civic U.S. -4

Consumer products

music CDs Aus -1.83cigarettes U.S. -0.3

liquor U.S. -0.2

football games U.S. -0.275

Utilities

electricity (residential) Quebec -0.7telephone service Spain -0.1

water (residential) U.S. -0.25

water (industrial) U.S. -0.85

OWN-PRICEELASTICITIES


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SLOPEANDELASTICITY

Because the price elasticity of demand measures

how much quantity demanded responds to the price,

it is closely related to the slope of the demand

curve.

Higher slope, lower elasticity


20/49Copyright2003 Southwestern/Thomson Learning

(a) Perfectly Inelastic Demand: Elasticity Equals 0

5

4

Quantity

Demand

1000

1. Anincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price


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(b) Inelastic Demand: Elasticity Is Less Than 1

Quantity0

5

90

Demand1. A 22%increasein price . . .

Price

2. . . . leads to an 11% decrease in quantity demanded.

4

100



2. . . . leads to a 22% decrease in quantity demanded.

(c) Unit Elastic Demand: Elasticity Equals 1

Quantity

4

1000

Price

5

80

1. A 22%increasein price . . .

Demand


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(d) Elastic Demand: Elasticity Is Greater Than 1

Demand

Quantity

4

1000

Price

5

50


2. . . . leads to a 67% decrease in quantity demanded.


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(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

4 Demand2. At exactly P4,consumers willbuy any quantity.

1. At any priceabove P4, quantitydemanded is zero.

3. At a price below P4,quantity demanded is infinite.


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LINEARDEMANDCURVE

Vertical intercept: perfectly elastic

Upper segment: elastic

Middle: Unit elastic

Lower segment: inelastic Horizontal intercept: perfectly inelastic


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TOTALREVENUEANDELASTICITY

Total revenueis the amount paid by buyers and

received by sellers of a good.

Computed as the price of the good times the

quantity sold.

TR = P x Q



Demand

QuantityQ

P

0

Price

PQ= P400(revenue)

4

100


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TOTALREVENUEANDELASTICITY

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.

With an inelastic demand curve, an increase in the

price leads to a decrease in quantity demanded that

is proportionately smaller. Thus, total revenue

increases.


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INCOMEELASTICITYOFDEMAND

Income elasticity of demandmeasures how much

the quantity demanded of a good responds to a

change in consumersincome.

It is computed as the percentage change in the

quantity demanded divided by the percentage

change in income.


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NORMALORINFERIOR?

Types of Goods

Normal Goods

Inferior Goods

Higher income raises the quantity demanded for

normal goods but lowers the quantity demanded for

inferior goods.

Normal goods: Positive income elasticity

Inferior goods: Negative income elasticity


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NECESSITYORLUXURY?

Goods consumers regard as necessities tend to beincome inelastic

Examples include food, fuel, clothing, utilities, andmedical services.

Goods consumers regard as luxuries tend to beincome elastic.

Examples include sports cars, furs, and expensivefoods.


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INCOMEELASTICITY

I >0, Normal good

I


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Item Market ElasticityConsumer products

cigarettes U.S. 0.1

liquor U.S. 0.2

food U.S. 0.8

clothing U.S. 1

newspapers U.S. 0.9

Utilitieselectricity (residential) Quebec 0.1

telephone service Spain 0.5

INCOMEELASTICITY


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PRICEELASTICITYOFSUPPLY

Price elasticity of supplyis a measure of how much

the quantity supplied of a good responds to a

change in the price of that good.

Price elasticity of supply is the percentage change

in quantity supplied resulting from a percent changein price.


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FORMULA

The price elasticity of supply is computed as the

percentage change in the quantity supplied divided

by the percentage change in price.

Price elasticity of supply =

Percentage changein quantity supplied

Percentage change in price


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SUMMARY

S=0, perfectly inelastic

0


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SLOPEANDELASTICITY

Because the price elasticity of supply measures

how much quantity supplied responds to the price,

it is closely related to the slope of the supply curve.

Higher slope, lower elasticity


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Copyright2003 Southwestern/Thomson Learning

(a) Perfectly Inelastic Supply: Elasticity Equals

0

54

Supply

Quantity1000

1. Anincreasein price . . .

2. . . . leaves the quantity supplied unchanged.

Price


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(b) Inelastic Supply: Elasticity Is Less Than 1

110

5

100

4

Quantity0


Price

2. . . . leads to a 10% increase in quantity supplied.

Supply


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(c) Unit Elastic Supply: Elasticity Equals

1

125

5

100

4

Quantity0

Price



Supply


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(d) Elastic Supply: Elasticity Is Greater Than 1

Quantity0

Price



4

100

5

200

Supply


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(e) Perfectly Elastic Supply: Elasticity Equals Infinity

Quantity0

Price

4 Supply

3. At a price below P4,quantity supplied is zero.

2. At exactly P4,producers willsupply any quantity.

1. At any priceabove P4, quantitysupplied is infinite.


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OFSUPPLY

Ability of sellers to change the amount of the good

they produce.

Beach-front land is inelastic.

Books, cars, or manufactured goods are elastic.

Time period.

Supply is more elastic in the long run.


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Item Horizon Price Elasticity

distillate short run 1.57

gasoline short run 1.61

pork long run 0.23

tobacco long run 7

housing long run 1.6 - 3.7

PRICEELASTICITIESOFSUPPLY


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APPLICATIONOFELASTICITY

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 existingvarieties?


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OTHERAPPLICATIONS

A reduction in supply in the world market for oil: the

response depends on the time horizon.

Policies to Reduce the Use of Illegal Drugs:

Drug interdiction

Drug education


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QUIZ1

Beachfront resorts: inelastic supply

Automobile: elastic supply

Suppose a rise in population doubles the demand

for both products.

Price? Quantity? Consumer spending?


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QUIZ2

Why? Why?

A drought around the world:

Total revenue that farmers received from sale of

grain rises. However, a drought in Kansas reduces

total revenue that Kansas farmers receive.

Documents

Microecon Lecture Note for 23Jan.2013