Principles of economics openstax chapter5

Elasticity: the responsiveness of quantity to a change in another variable i.e., price, income, price of other goods Price Elasticity of Demand: the responsiveness of quantity demanded

College Physics

Chapter # Chapter Title

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Principles of Economics

Chapter 5 Elasticity

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Elasticity: the responsiveness of quantity to a change in another

variable (i.e., price, income, price of other goods)

Price Elasticity of Demand: the responsiveness of quantity demanded

to a change in the price

Price Elasticity of Supply: the responsiveness of quantity supplied to a change in the price

Elasticity Formula

Elasticity =

%ΔQ

%ΔP

=

ΔQ

ΔP Q

P

Because the demand curve is downward sloping and the supply curve is upward sloping the elasticity of demand is negative and the elasticity of supply is positive Often these signs are ignored

Elasticity Formula

Elasticity =

%ΔQ

%ΔP

=

ΔQ

ΔP Q

P

(P2 – P1)/(P2 + P1)

Elasticity Formula

Q1 = 2,800, P1 = 70 and Q2 = 3,000, P2 = 60

%ΔQ = (3,000 – 2,800)/(3,000 + 2,800) = 200/5,800 = 1/29

%ΔP = (60 – 70)/(60 + 70) = -10/130 = -1/13

Elasticity coefficient = (1/29)/(-1/13) = -13/29 = -0.45

Elasticity Terminology

Elastic: %ΔQ > %ΔP, elasticity coefficient > 1 Consumers show a strong

reaction to a price change.

Inelastic: %ΔQ < %ΔP, elasticity coefficient < 1: Consumers show a weak

reaction to a price change.

Unitary Elastic: %ΔQ = %ΔP, elasticity coefficient = 1 Consumers reaction to a price change is neutral.

The Price Elasticity of Demand

Elasticity and the slope of the demand curve are not the same concepts, but they are related.

With a linear demand curve, the elasticity coefficient is greater at high prices; the upper segment of a linear demand is price elastic

With a linear demand curve, the elasticity coefficient is smaller at low prices; the lower segment of a linear demand is price inelastic

Price elasticity of demand

The mid-point of a linear demand is unitary elastic

The upper segment of a linear demand is elastic

The lower segment of a linear demand is inelastic

Determinants of Elasticity

Number of and Closeness of Substitutes:

The more alternatives you have, the less likely you are to pay high prices and the more likely you are to buy a substitute (e.g., candy bars).

Passage of Time:

The longer you take to come up with alternatives to paying high prices, the more like you choose those alternatives (e.g., gasoline).

Importance in Consumer Budget:

The greater the portion of the budget an item takes up, the greater is the

elasticity coefficient (e.g., housing vs salt).

Elasticity Examples

Inelastic Goods Price Elasticity of Demand

Unit Elastic Good (or close to it)

Elastic Goods

Price elasticity of supply

The price elasticity of supply is calculated as the percentage change in quantity divided by the percentage change in price

Perfectly elastic

If %ΔP = 0, elasticity coefficient = ∞

The demand/supply is perfectly elastic, a horizontal line at the given price,

Perfectly inelastic

If %ΔQ = 0, elasticity coefficient = 0

The demand/supply is perfectly inelastic, a vertical line at the given quantity

Unitary elastic demand

A demand curve with constant unitary elasticity will be a curved line Notice how price and quantity demanded change by an identical amount in each step down the demand curve

Unitary elastic supply

A constant unitary elasticity supply curve is a straight line reaching up from the origin Between each point, the percentage increase in quantity demanded is the same as the percentage increase in price

Demand Elasticity & price change

Cost-saving gains cause supply to shift out to the right from S0 to S1; that is, at any given price, firms will be willing to supply a greater quantity

Figure (a): The demand is inelastic, the result of this cost-saving technology is a substantially lower price

Figure (b): The demand is elastic, the result of this cost-saving technology is a

substantially larger quantity

Demand Elasticity & price change

Demand Elasticity & Sales Tax

An excise tax introduces a wedge between the price paid by consumers (Pc) and the price received by producers (Pp)

Figure (a): Demand is more elastic than supply, the burden of tax is on producer as Pe – Pp

> Pc – Pe

Figure (b): Demand is less elastic than supply, the burden of tax is on consumer as Pc – Pe

> Pe – Pp

Demand Elasticity & Sales Tax