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Elasticity and its Application (By Kristin and Sophia)
- 1. Ch. 5 Elasticity and Its ApplicationBy Sophia TC and Kristin Soreide
- 2. ElasticityElasticity measures how buyers and sellers respond to changes in market conditionsIf a good is inelastic, the quantity demanded responds only slightly to a change in priceIf a good is elastic, the quantity demanded responds substantially to a change in price
- 3. Perfectly inelastic demand-Quantity demanded is the same regardless of pricePerfectly inelastic supply- Quantity supplied is the same regardless of pricePerfectly elastic demand- Very small changes in price lead to very large changes in quantity demandedPerfectly elastic supply- Very small changes in price lead to very large changes in quantity supplied
- 4. Price Elasticity of DemandMeasures how much the quantity demanded of a good responds to a change in the price of that good%change in QD/ % change in PShows how willing consumers are to move away from a good as its price rises
- 5. What determines PEOD?Availability of close substitutesNecessities vs. Luxuries Definition of the MarketTime HorizonMore substitutes have higher elasticity of its demandNarrow vs. Broad marketsLong vs. Short period of time
- 6. Continue of PEOD…EX. Eggs have no close substitute where as butter has many substitutes(margarine..etc); therefore the demand for eggs is less elastic than demand for butterNecessities are more inelastic than luxuries which are more elastic because people can go without having luxuries for a certain period of time, but it is hard to go by without necessitiesNarrowly defined markets(bean burritos) have more elastic demand than broadly defined markets(food)Goods have more elastic demand over longer time horizonsEX. When price of gas rises, the QD falls only slightly in the first few months but over time people find different ways of transportation and QD falls substantially
- 7. Mid Point MethodThe Mid Point method is used to calculate the price elasticity of demand and prevents from making small mistakes between two pointsGives the same answer regardless of the direction change Elasticity >1- elasticElasticity<1- inelasticElasticity=1- unit elasticityEx.(Q2-Q1)/[(Q2+Q1)/2](P2-P1)/[(P2+P1)/2]
- 8. Total RevenueInformationThe amount paid by buyers and received by sellersComputed as PRICE of the good x QUANTITY of the goodChanges in total revenue depend on elasticity of demandGRAPH
- 9. Income Elasticity Of DemandA measure of how much the quantity demanded of a good responds to a change in consumer income% change in quantity demanded% change in incomeNormal goods: positive elasticity Most goods (higher income raises quantity demanded)Inferior goods: negative elasticity Ex. Bus rides ( higher income lowers the quantity demanded)
- 10. Cross Price Elasticity of DemandA measure of how much the quantity demanded of one good responds to a change in the price of another good% change in quantity demanded (1st good)% change in price (2nd good)Substitutes and complements affect whether the cross price elasticity is a positive or negative numberSubstitutes= positive elasticityComplements= negative elasticity
- 11. Price Elasticity of SupplyA measure of how much the quantity supplied of a good responds to a change in the price of that good % Change quantity supplied % Change in price
- 12. For example…An increase in the price of milk from $2.85 to $3.15 a gallon raises the amount that dairy farmers produce 9,000 to 11,000 gallons(3.15-2.85)/3.00x100 = 10 percent(11,000-9,000)/10,000x100= 20 percentPrice elasticity of supply= 20 percent/ 10 percent =2.0
- 13. Determinants of PEOSFlexibility of sellersGoods that are somewhat fixed in supplyTime HorizonsBeach fronts (inelastic) vs. Manufactured goods (elastic) – harder to supply more beach landSupply is usually more inelastic in the short run than in the long run