Elasticity and its application (KINH tế VI mô SLIDE)

The Elasticity of Demand  The price elasticity of demand  The income elasticity of demand  The cross-price elasticity of demand 2.. The Elasticity• Elasticity – Measure of the respons

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Elasticity and Its

Application

3

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1. The Elasticity of Demand

 The price elasticity of demand

 The income elasticity of demand

 The cross-price elasticity of demand

2. The Elasticity of Supply

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The Elasticity

• Elasticity

– Measure of the responsiveness of quantity

demanded or quantity supplied to one of its determinants

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1.The Elasticity of Demand

1.1 Price elasticity of demand

demanded of a good responds to 1% change in the price of that good

EDp = % Q△Q D /% P△Q

– Measures how willing consumers are to buy less of the good as its price rises

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The Elasticity of Demand

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1.1.2 Determinants of price elasticity of demand

– Availability of close substitutes

– Necessities vs luxuries

– Definition of the market

– Time horizon

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1.1.3 Computing the price elasticity of demand

Use absolute value (drop the minus sign)

– Arc-elasticity of demand: Midpoint method

• Two points: (Q 1 , P 1 ) and (Q 2 , P 2 )

] )/

P )/[(P

P (P

] )/

Q )/[(Q

1 2

elasticity Price

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1.1.3 Computing the price elasticity of demand

Q Q

P dP

dQ P

dP

Q

dQ P

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1.1.4 Variety of demand curves

(a) Demand is perfectly inelastic

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• Variety of demand curves

(d) Demand is elastic

• Elasticity > 1

(e) Demand is perfectly elastic

• Elasticity = infinity

• Demand curve – horizontal

The flatter the demand curve, the greater the price elasticity of demand

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(e) Perfectly elastic demand:

Elasticity equals infinity

1 an

Price

Quantity 0

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1.1.5 Total revenue and price elasticity of

demand

• Total revenue - TR

– Amount paid by buyers

– Received by sellers of a good

– Computed as: price of the good times the

quantity sold

TR = P x Q

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Quantity 0

Demand Price

100

$4

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1.1.5 Total revenue and price elasticity of demand

• Elastic demand: E>1

P2

(b)

|E p D| >1

(a) (c)

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1.1.5 Total revenue and price elasticity of demand

(c)

(b)

(a)

Q1 Q2

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• When demand is inelastic

– Price and total revenue move in the same

direction

• When demand is elastic

– Price and total revenue move in opposite

directions

• If demand is unit elastic

– Total revenue remains constant when the

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• Elasticity and total revenue along a linear

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1.2 Income elasticity of demand EDI

– Measure of how much the quantity

demanded of a good responds to 1% change

in consumers’ income

E D I = % Q △Q D / % I △Q

– Normal goods: positive income elasticity

• Necessities: smaller income elasticities

• Luxuries: large income elasticities

– Inferior goods: negative income elasticities

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1.2 Income elasticity of demand: EDI

– Normal goods:

• Necessities:

• Luxuries:

– Inferior goods:

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1.3 Cross-price elasticity of demand

– Measure of how much the quantity

demanded of one good X responds to 1%

change in the price of another good Y

Exy = % Q △Q Dx / % Py △Q

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1.3 Cross-price elasticity of demand

• Substitutes:

• Complements:

• Independents:

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2.The Price elasticity of supply

2.1 Definition:

Measure of how much the quantity supplied

of a good responds to 1% change in the

price of that good

ESp = % Q△Q S /% P△Q

– Depends on the flexibility of sellers to change the amount of the good they produce

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The Elasticity of Supply

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2.2 Determinant of price elasticity of supply

– Time period

– Substitutions of inputs:

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2.3 Computing price elasticity of supply

Arc elasticity

(P1, Q1) (P2, Q2)

Point elasticity

A(P, Q)

) 2

2 1

(

2 1

) 2

0 1

(

0 1

P P

Q Q

P dP

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2.4 Variety of supply curves

– Supply is perfectly inelastic

• Elasticity =0

• Supply curve – vertical – Inelastic supply

• Elasticity < 1 – Unit elastic supply

• Elasticity =1 – Elastic supply

• Elasticity >1 – Supply is perfectly elastic

• Elasticity = infinity

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(e) Perfectly elastic supply:

Elasticity equals infinity

1 an

Price

Quantity 0

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Applications of Supply, Demand, & Elasticity

• Why did OPEC fail to keep the price of oil

high?

– 1970s: OPEC reduced supply of oil

• Increase in prices 1973-1974 and 1971-1981

• Short-run: supply is inelastic

– Decrease in supply: large increase in price

– 1982-1990 – price of oil decreased

• Long-run: supply is elastic

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When the supply of oil falls, the response depends on the time horizon In the short run,

(b) The Oil Market in the Long Run

S1

S2

P1

1 In the short run, when supply and

demand are inelastic, a shift in supply .

2 … leads to a

small increase

in price

Quantity

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