Elasticity - “Responsiveness to change”
- How economists measure the sensitivity of one variable to changes in another variable
- Applications:
- Price Elasticity of Demand
- Income Elasticity of Demand
- Price Elasticity of Supply
- Cross-Price Elasticity of Demand of two goods
Price Elasticity of Demand- % change in Qty demanded divided by % change in P
- “Price Sensitivity” of Buyers
- More meaningful/useful than ‘slope’
- Determined by:
- Availability / quality of substitutes
- % of consumer’s budget
- Time for Reacting
Price Elasticity of Demand- price elasticity of demand measures:
% change in quantity demanded
divided by
the % change in price
- Categories
- Perfectly Inelastic e= 0
- Inelastic e<1.0
- Unit-elastic e= 1.0
- Elastic e>1.0
- Perfectly Elastic e= 0
Price Elasticity of Demand:
What do you think?- Product Short-run Long-run
- Cigarettes
- Electricity (residential)
- Air Travel
- Medical Care/Hospitalization
- Gasoline
- Milk
- Fish (cod)
- Wine
- Movies
- Natural Gas (residential)
- Automobiles
- Chevrolets
Price Elasticity of Demand:
Survey Sez….- Product Short-run Long-run
- Cigarettes - 0.4
- Electricity (residential) 0.1 1.9
- Air Travel 0.1 1.9
- Medical Care/Hospitalization 0.3 0.9
- Gasoline 0.4 1.5
- Milk 0.4 1.5
- Fish (cod) 0.5
- Wine 0.7 1.2
- Movies 0.9 3.7
- Natural Gas (residential) 1.4 2.1
- Automobiles 1.9 2.2
- Chevrolets 4.0
Elasticity and Total Revenue - A price effect: After a price increase, each unit sold sells at a higher price, which tends to raise revenue.
- A sales effect: After a price increase, fewer units are sold, which tends to lower revenue.
Elasticity and Total Revenue- If demand for a good is elastic, an increase in price reduces total revenue. (Sales effect > Price effect).
- If demand for a good is inelastic, a higher price increases total revenue. (Price effect > Sales effect).
- If demand for a good is unit-elastic, an increase in price does not change total revenue. (Sales effect = Price effect).
Price Elasticity of Supply- Measures:
% change in quantity supplied
divided by
% change in price
- Categories:
- Perfectly inelastic
- Inelastic
- Unit Elastic
- Elastic
- Perfectly Elastic
Income Elasticity of Demand- Measures:
% change in demand
divided by
% change in income
- Categories
- If income elasticity < 0 --> “inferior good”
- If income elasticity > 1.0 --> “income elastic”