ELASTICITY (PART 2)
PRICE ELASTICITY OF DEMAND ALONG
A STRAIGHT-LINE DEMAND CURVE
The price elasticity of demand for a straight-line
downward-sloping demand curve varies from highly
elastic to highly inelastic.
As we move towards the right (price falling and Qd
rising), elasticity of the demand curve reduces.
As elasticity is reducing from left to right, total revenue
will also change.
PRICE ELASTICITY OF DEMAND ALONG
A STRAIGHT-LINE DEMAND CURVE
(CONT)
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
Four Factors determine Price Elasticity of Demand:
1. Number of substitutes
2. Necessities versus luxuries
3. Percentage of one’s budget spent on the good
4. Time
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND (CONT)
Number of Substitutes:
The more substitutes there are for a good, the higher the
price elasticity of demand will be; the fewer substitutes there
are for a good, the lower the price elasticity of demand will
be.
The more broadly defined the goods is, the fewer the
substitutes it will have; the more narrowly defined the goods
is, the more the substitutes it will have
Necessities versus Luxuries: The more a good is considered
luxury (a good we can go without) rather than a necessity (a
good we can’t do without), the higher the price elasticity of
demand will be.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND (CONT)
Percentage of One’s Budget Spent on the Good:
The greater the percentage of one’s budget that goes to
purchase a good, the higher the price elasticity of
demand will be; the smaller the percentage of one’s
budget that goes to purchase a good, the lowerer the
price elasticity of demand will be
Time:
The more time that passes (since the price change), the
higher the price elasticity of demand for the good will
be; the less time that passes, the lower the price elasticity
of demand for the good.
CROSS ELASTICITY OF DEMAND
Measures the responsiveness in the quantity demanded
of one good to changes in the price of another good.
Defined as the percentage change in the quantity
demanded of one good divided by the percentage
change in the price of another good.
CROSS ELASTICITY OF DEMAND
This
concept is often used to determine whether two goods
are substitutes or complements and the degree to which
one good is a complement to or substitute for another.
Substitutes: Price increases in one leads to a rise in
Quantity demanded of the other good. So if
Complements: Price increases in one leads to a fall in
Quantity demanded of the other good. So if
The higher (bigger positive number) the cross elasticity of
demand is greater degree of substitution
INCOME ELASTICITY OF DEMAND
Measures the responsiveness of quantity demanded to
changes in income.
Define as the percentage change in quantity demanded of a
good divided by the percentage change in income.
Since using percentage changes can at times lead to
conflicting results, the following is also used:
INCOME ELASTICITY OF DEMAND
(CONT)
If Income elasticity of demand is positive (Ey > 0) normal
good.
The demand for an inferior good decreases as income
increases. So if Income elasticity of demand is negative (Ey <
0) inferior good
Comparing %∆Qd to %∆P
If %∆Qd > %∆P Ey >1, demand is considered to be
income elastic
If %∆Qd < %∆P Ey <1, demand is considered to be
income inelastic.
If %∆Qd = %∆P Ey =1, demand is considered to be unit
elastic
PRICE ELASTICITY OF SUPPLY
Measures
the responsiveness of quantity supplied to
changes in price.
Defined as the percentage change in quantity supplied of
a good divided by the percentage change in the price of
the good.
Supply can be classified as elastic, inelastic, unit elastic,
perfectly elastic, or perfectly inelastic.
PRICE ELASTICITY OF SUPPLY
PRICE ELASTICITY OF SUPPLY AND
TIME
The longer the period of adjustment to a change in price,
the higher the price elasticity of supply.
Additional production takes time.
Reducing production takes time.
Example: Housing market.
If price increases of houses, will we be able to increase
houses in short run? No.
In long run? Yes Dedicate more resources from
production of other things to produce houses, hence
increasing supply. Price Elasticity of Supply Increases
SUMMARY OF THE FOUR ELASTICITY
CONCEPTS
