CHAPTER 4: ELASTICITY

 Elasticity of demand
A measure of how sensitive QD is to the change in the price.

 PRICE ELASTICITIES OF DEMAND

PERFECTLY Smallest possible increase in price is

ELASTIC ∞ equal to in a decrease in QD

ELASTIC A percentage decrease in QD is more

(SENSITIVE) >1 than the percentage increase in price

UNIT A percentage decrease in QD is equal

ELASTIC 1 to a percentage increase in price

INELASTIC <1 AND A percentage decrease in QD is less

(INSENSITIVE) than the percentage increase in price
>0

PERFECTLY QD is the same at all prices

INELASTIC 0

 CALCULATION (STEPS):
1. Percentage change in Quantity:
CHANGE IN QUANTITY
AVERAGE X 100 = % CHANGE IN QUANTITY
2. Percentage change in Price:
CHANGE IN PRICE
AVERAGE X 100 = % CHANGE IN PRICE
3. Price of Elasticity:
% CHANGE IN QUANTITY
% CHANGE IN PRICE

 TOTAL REVENUE ELASTICITY:

TR TEST – A method of estimating the POED by observing the change in TR as a result of a change in
price.

INELASTIC ELASTIC

Price increases = Total Revenue Price increases = Total Revenue

increases decreases
Price decreases = Total Revenue Price decreases = Total Revenue
decreases increases
  FACTORS THAT INFLUENCE ELASTICITY OF DEMAND

PROPORTION OF INCOME
SPENT ON A GOOD:

Greater proportion-elastic,

And vice versa….

FACTORS THAT
INFLUENCE ELASTICITY
OF DEMAND CLOSENESS TO SUBSTITUTES:
TIME ELAPSED SINCE PRICE The closer to substitutes-
CHANGE: elastic,
The longer the time-elastic, And vice versa…
And vice versa...

 INCOME ELASTICITIES OF DEMAND:

Measure of how sensitive the demand is to a change in income.

INCOME Percentage increase in QD is greater Income

ELASTIC >1 than percentage increase in come spent (+)
(NORMAL Income (+)
GOOD)

INCOME <1 AND Percentage increase in QD is greater Income

INELASTIC than 0 BUT less than the percentage spent (-)
(NORMAL >0 increase income (savings) Income (+)
GOOD)

NEGATIVE Income increases and QD decreases Income

(INFERIOR <0 spent (-)
GOOD) Income (+)

 CALCULATION: (same as the 1st and 2nd steps in POED)

3. Income elasticity of demand:
% CHANGE IN QUANTITY
% CHANGE IN INCOME
  CROSS ELASTICITIES OF DEMAND:
Measure of how sensitive the demand is to the change of price of substitutes/complements.

CLOSE Large Small possible increase in one good is

SUBSTITUTES/ Value equal to large increase/decrease in ⅍
COMPLEMENTS of another good

SUBSTITUTES Positive Price of one good increase is equal to

Value QD of another good increase

UNRELATED Zero Price of one good increase is equal to

GOODS QD of another good remains the same

COMPLEMENTARY NEGATIVE Price of one good increase is equal to

VALUE QD of another good increase

 CALCULATION: (same as the 1st and 2nd steps in POED)

4. Cross elasticity:
% CHANGE IN QUANTITY
% CHANGE IN PRICE OF COMPLEMENTARY/SUBS.

 Elasticity of supply
A measure of how sensitive quantity supplied is to a change.

PERFECTLY Smallest possible increase in price is

ELASTIC ∞ equal to in a large increase in QS

ELASTIC A percentage increase in QS is more

(SENSITIVE) <∞ than the percentage increase in price
AND >1

UNIT A percentage increase in QS is equal to

ELASTIC 1 a percentage increase in price

INELASTIC >0 AND A percentage increase in QS is less than

(INSENSITIVE) the percentage increase in price
<1

PERFECTLY QS is the same at all prices

INELASTIC 0
  CALCULATION: (same as the 1st and 2nd steps in POED)
5. Income elasticity of supply:
% CHANGE IN QUANTITY
% CHANGE IN PRICE

 FACTORS THAT INFLUENCE ELASTICITY OF DEMAND

TIME FRAME FOR SUPPLY

DECISIONS:

Momentary supply –
(Immediate response after
the price changes) In
FACTORS THAT advance decisions-Inelastic
INFLUENCE ELASTICITY
OF SUPPLY Short-Run supply –
RESOURCE SUBSTITUTION (Response of QS to price
POSSIBILITIES: change only when some
Unique/rare goods – Low adjustments in production is
elasticity made) Inelastic.

And vice versa… Long-Run supply –

(Response of QS to price
change when all
technological ways of
adjusting supply is
exploited) Elastic.

NOTES:
ELASTIC – demand/supply responds to changes in price
INELASTIC – demand/supply remains the same
The steeper the slope, the less elastic