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ELASTICITY AND ITS APPLICATION, image, = image, image, image, image -…
ELASTICITY AND ITS
APPLICATION
The Elasticity of Demand
The Price Elasticity of Demand
How much the quantity demanded of a good
responds to a change in the price of that good
Price elasticity of demand is
Along a D curve, P and Q move in opposite directions, which would make price elasticity negative.
We will drop the minus sign and report all price elasticities as
positive numbers (absolute values).
The Variety of Demand Curves
Demand is perfectly inelastic:
– Price elasticity of demand = 0
Demand is inelastic:
– Price elasticity of demand < 1
Demand has unit elasticity:
– Price elasticity of demand = 1
Demand is elastic:
– Price elasticity of demand > 1
Demand is perfectly elastic:
– Price elasticity of demand = infinity
The greater the price elasticity of demand
– The flatter the demand curve
Calculating the Price Elasticity of Demand
Standard method of computing the percentage (%) change:
=
Midpoint method - The midpoint is the average of the start and end values
Elasticity along a linear demand curve
The slope of a linear demand curve is constant, but its elasticity is not.
Elasticity falls as you move downward and rightward along a linear demand curve.
Price Elasticity and Total Revenue
Total Revenue (TR) = P x Q
• A price increase has two effects on revenue:
– Higher revenue: because of the higher P
– Lower revenue: because of the lower Q
For a price increase, if demand is elastic
+E > 1: % change in Q > % change in P
+The fall in revenue from lower Q > the increase in revenue from higher P => TR decreases
For a price increase, if demand is inelastic
+E < 1: % change in Q < % change in P
+The fall in revenue from lower Q < the increase in
revenue from higher P TR increases
When D is unit-elastic, an increase in price leaves
revenue unchanged:
+the increase in revenue from higher P exactly
offsets the lost revenue due to lower Q.
Elasticity : Measure of the responsiveness of Qd or Qs to a change in one of its determinants
Income Elasticity of Demand
– How much the quantity demanded of a good
responds to a change in consumers’ income
– Percentage change in quantity demanded
divided by the percentage change in income
• Classification
– Normal goods: income elasticity > 0
– Inferior goods: income elasticity < 0
– Luxuries: income elasticity > 1
– Necessities: income elasticity positive but < 1
Cross-Price Elasticity of Demand
•Cross-price elasticity of demand
– How much the Qd of one good responds to a
change in the price of another good
• Classification
– Substitutes: cross-price elasticity > 0
– Complements: cross-price elasticity < 0
The Elasticity of Supply
Price elasticity of supply
– How much the quantity supplied of a good
responds to a change in the price of that good
– Loosely speaking, it measures sellers’
price-sensitivity
Price elasticity of supply
The Variety of Supply Curves
•Supply is perfectly inelastic
– Price elasticity of supply = 0
• Supply is inelastic
– Price elasticity of supply < 1
• Supply is unit elastic
– Price elasticity of supply = 1
• Supply is elastic
– Price elasticity of supply > 1
• Supply is perfectly elastic
– Price elasticity of supply = infinity
• The greater the price elasticity of supply
– The flatter the supply curve
The Determinants of Supply Elasticity
• The more easily sellers can change the
quantity they produce, the greater price
elasticity of supply
• Price elasticity of supply is greater in the
long run than in the short run
Some applications of elasticity
Can Good News for Farming Be Bad
News for Farmers?
– Applying new technological production of rice
20% increased production per hectare
– Notice: Demand is inelastic
Why Did OPEC Fail to Keep the Price of
Oil High?
• Decrease in oil supply => large increase in price
in short-run (1973-1974)
• Decrease in supply => small increase in price in
long-run (1971-1981)
In the short-run:
• Supply and demand are inelastic
=> S and D curves are very steep.
In the long run:
• Supply and demand are elastic
=>S and D curves are very flat
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