Lecture Economics - Chapter 4: Elasticity

Chapter 4 - Elasticity, in this chapter you will learn: Concept of elasticity; calculate price elasticity of demand and supply using the mid‐point method; explain how the determinants of price elasticity of demand and supply affect the degree of elasticity; calculate cross‐price and income elasticities of demand, and interpret the sign of the elasticities.

Chapter4 Elasticity â2014byMcGrawHillEducation Whatwillyoulearninthischapter? ã Conceptofelasticity ã Calculatepriceelasticityofdemandandsupply usingthemidpointmethod • Explain how the determinants of price  elasticity of demand and supply affect the  degree of elasticity • Calculate cross‐price and income elasticities of  demand, and interpret the sign of the  elasticities © 2014 by McGraw‐Hill Education What is elasticity? • Elasticity is a measure of the responsiveness to  a change in a market condition • The concept applies to supply and demand • It measures the response to a change in: – the price of the good – the price of a related good – income © 2014 by McGraw‐Hill Education Price elasticity of demand • The price elasticity of demand measures the magnitude  of change in the quantity demanded from a change in  its price. In other words, it estimates price sensitivity Price ($) 3.00 2.50 A 2.00 When price Decreases by 25% B 1.50 D 1.00 …quantity demanded increases by 50% 0.50 10 15 20 Quantity of coffee (millions of cups) © 2014 by McGraw‐Hill Education Calculating price elasticity • The midpoint method calculates the elasticity at  the midpoint of any two points. The formula is: %∆ %∆ where point 1 is  , / / / / and point 2 is , • The midpoint elasticity is the difference of any  two numbers divided by their average © 2014 by McGraw‐Hill Education Active Learning: Calculating the price  elasticity of demand Find the price elasticity of demand using the  midpoint formula for the points along a demand  curve: ($10,350) and ($20, 150) © 2014 by McGraw‐Hill Education Determinants of price elasticity of demand • Consumers are more sensitive to price changes  for some goods and services than for others • Many factors determine consumers’  responsiveness to price changes – Availability of substitutes – Degree of necessity – Cost relative to income – Adjustment time – Scope of the market © 2014 by McGraw‐Hill Education Categorizing elasticities • All goods and services can be broadly  categorized based on elasticity • The main categories are: – Elastic: A change in price causes a relatively large percentage change in quantity demanded.  – Inelastic: A change in price causes a relatively small percentage change in quantity demanded © 2014 by McGraw‐Hill Education Categorizing elasticities At the extremes, demand can be either perfectly elastic or  perfectly inelastic Perfectly elastic (|εd| = ∞) Price ($) 10 Perfectly inelastic (|ε d | = 0) Price ($) 10 D At prices higher than $5, the quantity demanded is D At any price, the quantity demanded is the same Consumers will buy any quantity at a price of $5 © 2014 by McGraw‐Hill Education 10 Quantity 10 Quantity Categorizing elasticities Between these two extremes, the elasticities are divided into  three categories Elastic (|εd | >1) Unit‐elastic (|εd | = 1) Price ($) Price ($) 10 …quantity demanded increases by 60% D 10 Quantity 10 Inelastic (|εd | 1 ã UnitElastic:s =1 ã Inelastic:s 0:thetwogoodsaresubstitutes 0: the good is normal. If  >1, then it is a luxury