CHAPTER 5 Elasticity

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What you will learn in this chapter:
What is the definition of elasticity? What is the meaning and importance of price elasticity of demand? income elasticity of demand and? price elasticity of supply? What factors influence the size of these various elasticities? How elasticity affects the incidence of a tax, the measure of who bears its burden?
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Defining and Measuring Elasticity
The price elasticity of demand is the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve.

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The Price Elasticity of Demand 4 .

At a price of $20 per barrel.The World Demand for Oil When price rises to $21 per barrel. 5 .9 million barrels per day (point B). world demand falls to 9. the world quantity of oil demanded is 10 million barrels per day (point A).

Calculating the price elasticity of demand for oil 6 .

we calculate changes in a variable compared with the average. of the starting and final values. In this approach. or midpoint.Using the Midpoint Method to Calculate Elasticities The midpoint method is a technique for calculating the percent change. 7 .

Using the Midpoint Method to Calculate Elasticities 8 .

Using the Midpoint Method to Calculate Elasticities – numerical example = %20 = %20 =1 9 .

Some Estimated Price Elasticities of Demand Good Inelastic demand Eggs Beef Stationery Gasoline Elastic demand Housing Restaurant meals Airline travel Foreign travel 1.2 2.3 2.5 0.4 4.4 0.5 Price elasticity Price elasticity of demand < 1 Price elasticity of demand > 1 10 .1 0.1 0.

Interpreting the Price Elasticity of Demand: How Elastic Is Elastic? Two Extreme Cases of Price Elasticity of Demand Demand is perfectly inelastic when the quantity demanded does not respond at all to the price. the demand curve is a vertical line. When demand is perfectly elastic. When demand is perfectly inelastic. Demand is perfectly elastic when any price increase will cause the quantity demanded to drop to zero. 11 . the demand curve is a horizontal line.

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and unit-elastic if the price elasticity of demand is exactly 1.Interpreting the Price Elasticity of Demand: How Elastic Is Elastic? Unit-Elastic Demand. inelastic if the price elasticity of demand is less than 1. Inelastic Demand. and Elastic Demand Demand is elastic if the price elasticity of demand is greater than 1. 14 .

Highway department charges for crossing a bridge 15 .

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e. inelastic. i. or elastic? Because this classification predicts how changes in the price of a good will affect the total revenue earned by producers from the sale of that good. The total revenue is defined as the total value of sales of a good.Why does it matter whether demand is unit-elastic. Total revenue = Price × quantity sold 18 .

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■ A sales effect: After a price increase. which tends to lower revenue. there are two countervailing effects in action (except in the rare case of a good with perfectly elastic or perfectly inelastic demand): ■ A price effect: After a price increase. 20 . which tends to raise revenue. fewer units are sold. each unit sold sells at a higher price.Elasticity and Total Revenue When a seller raises the price of a good.

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the price effect is stronger than the sales effect. 22 . the sales effect is stronger than the price effect. If demand for a good is inelastic (the price elasticity of demand is less than 1). an increase in price does not change total revenue. If demand for a good is unit-elastic (the price elasticity of demand is 1). In this case. the sales effect and the price effect exactly offset each other. a higher price increases total revenue.Elasticity and Total Revenue If demand for a good is elastic (the price elasticity of demand is greater than 1). In this case. In this case. an increase in price reduces total revenue.

The Price Elasticity of Demand Changes Along the Demand Curve 23 .

What Factors Determine the Price Elasticity of Demand? Whether Close Substitutes Are Available Whether the Good Is a Necessity or a Luxury Time 24 .

Other Demand Elasticities: Cross-Price Elasticity The cross-price elasticity of demand between two goods measures the effect of the change in one good’s price on the quantity demanded of the other good. It is equal to the percent change in the quantity demanded of one good divided by the percent change in the other good’s price. The Cross-Price Elasticity of Demand Between Goods A and B: 25 .

Cross-Price Elasticity Goods are substitutes when the cross-price elasticity of demand is positive. 26 . Goods are complements when the cross-price elasticity of demand is negative.

The Income Elasticity of Demand The income elasticity of demand is the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in the consumer’s income. 27 .

28 . the quantity demanded at any given price increases as income increases. the good is a normal good — that is. the quantity demanded at any given price decreases as income increases. the good is an inferior good — that is.Normal goods and inferior goods When the income elasticity of demand is positive. When the income elasticity of demand is negative.

It is the ratio of the percent change in the quantity supplied to the percent change in the price as we move along the supply curve.Measuring the Price Elasticity of Supply The price elasticity of supply is a measure of the responsiveness of the quantity of a good supplied to the price of that good. Next two slides: Two Extreme Cases of Price Elasticity of Supply… 29 .

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It tends to be small when inputs are difficult to obtain. 32 . This means that the long-run price elasticity of supply is often higher than the short-run elasticity.What Factors Determine the Price Elasticity of Supply? The Availability of Inputs: The price elasticity of supply tends to be large when inputs are easily available. Time: The price elasticity of supply tends to become larger as producers have more time to respond to a price change.

They thought big increases in production were unlikely since there was little new land available in Europe for cultivation. So although farm acreage didn’t increase much. However. but underestimated the price elasticity of agricultural supply due to availability of inputs.Economics in Action: “European Farm Surpluses” Imposition of a price floors to support the incomes of farmers has created “butter mountains” and “wine lakes” in Europe. Were European politicians unaware that their price floors would create huge surpluses? They probably knew that surpluses would arise. farm production did! 33 . farm production could expand by adding other resources. especially fertilizer and pesticides.

34 . an excise tax falls mainly on the producers. When the price elasticity of supply is higher than the price elasticity of demand. an excise tax falls mainly on consumers. So elasticity—not who literally pays the tax—determines the incidence of an excise tax.Elasticity and the Incidence of Excise Tax When the price elasticity of demand is higher than the price elasticity of supply.

An Excise Tax Paid Mainly by Consumers 35 .

An Excise Tax Paid Mainly by Producers 36 .

The End of Chapter 5 coming attraction: Chapter 6: Consumer and Producer Surplus 37 .

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