Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Elasticity . . .

… is a measure of how much buyers

and sellers respond to changes in

market conditions. . .

… allows us to analyze supply and

demand with greater precision.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Elasticity: A General Definition:

The percentage (%) change in

something . . .

. . . given a one percent (1%) change

in something else.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Price Elasticity of Demand

The percentage change in the quantity

demanded given. . .

. . . a one percent change in the price.

A

B

DemandP

Q

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Ranges of Elasticity . . .

Perfectly Inelastic Consumers are

“completely unresponsive” to price changes.

Perfectly Elastic Consumers are “extremely

responsive” to price changes.

Unit Elastic Response is “equal to” change in

price.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Elasticity of Demand Illustrated

Perfectly Inelastic

P2

P1

Even if priceincreases a lot quantity demanded stays the same.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Elasticity of Demand Illustrated

Perfectly Elastic

P1

A small increasein price will causedemand to drop offcompletely.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Computing Elasticity Coefficient

Computed as the percentage change in the quantity demanded divided by the percentage change in price.

Price Elasticityof Demand

=

Percentage Change in Quantity Demanded

Percentage Change in Price

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Computing Elasticity Coefficient

Demand forIce Cream

2.20

2.00

108

ED

($2.20 - $2.00) / $2.00

(8 - 10) / 10

=

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Elasticity and Total Revenue

ED > 1 then

P Q TRand

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Elasticity and Total Revenue

ED < 1 then

P Q TRand

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Income Elasticity of Demand

The percentage change in the quantity demanded

given a one percent change in income.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Computing Income Elasticity

Computed as the percentage change in demand divided by the percentage change in Income.

Income Elasticityof Demand

=

Percentage Change in Demand

Percentage Change in Income

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Income Elasticity... Types

YD > 0 Normal Goods

YD < 0 Inferior Goods

YD = 0 Income-neutral Goods

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Price Elasticity of Supply

The percentage change in

quantity supplied

resulting from a one (1) percent change in price.

Price

Quantity

A

B

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Determinants of Elasticity of Supply

Flexibility or ability of sellers to change the amount of the good they produce.– Beachfront land vs. books, cars,

manufactured goods, etc.

– More elastic in the long run.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Computing Elasticity Coefficient

Computed as the percentage change in the quantity supplied divided by the percentage change in price.

Elasticityof Supply

=

Percentage Change in Quantity Supplied

Percentage Change in Price

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Applications of Elasticity

“Can Good News for Farming Be Bad News For Farmers?”

What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Apply Comparative Statics

Examine whether the supply or demand curve shifts.

Consider the direction the curve shifts.Use supply-and-demand diagrams to

see how the market equilibrium changes. Consider the state of elasticity.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Consider which direction the curve shifts.

SA

DA

Price

Quantity

$4.00

2000

SB

Technologycauses an increasein supply.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Compute Elasticity

ED =(2400 - 2000) / (2000)

($2.60 - $4.00) / ($4.00)

ED = 0.57 (Inelastic)

Principles of Microeconomics & Principles of Macroeconomics: Ch. 5 First Canadian Edition

Observe the Change in Total Revenue

SA

DA

Price

Quantity

$4.00

2000

SB

2400

$2.60

TRSA = $8,000

TRSB = $5,760!