Elasticity
Or Price Sensitivity
Pages 13 and 14 in packet o’graphs
First a definition
•
•
•
•
•
•
•
•
The sensitivity to change in price
Elastic = sensitive to price changes
Inelastic = insensitive to price changes
Determined three ways: expressed as a
percentage change, total revenue test or four
factors if product stated
% ▲Q formula for price elasticity of demand
% ▲P
E > 1 = elastic demand
E < 1 = inelastic demand
E = 1 = unit elastic demand
Calculating price
elasticity coefficient
Elastic Demand
Perfectly Elastic
Demand
Inelastic Demand
Perfectly Inelastic
Demand
The internet replies…
Unit Elastic Demand
Coefficient E = 1
Unit elastic demand means
that any change in price is
matched by an equal relative
change in quantity
Total Revenue Test:
Total revenue = price x
quantity
If price and total revenue
move in opposite
directions then demand is
elastic
If price and total revenue
move in the same
direction, then demand is
inelastic
Factors in Price
Elasticity of Demand
•
•
•
•
•
•
Available substitutes
Percentage of income
Necessity vs. luxury
Time
NAP-Time!
Necessity vs. luxury, available
substitutes, percentage income +
time
Taxes and Elasticity
Supply Elasticity
• Elasticity of supply is based on
amount of time producer has to
respond to changes in product
price.
• Elastic supply – producer has
more time to respond
• Inelastic supply – producer has
less time to respond
Divide Supply Elasticity
into 3 Time Periods
• Market period: inelastic, product already in
the stores, no time to adjust. Example –
holiday shopping season.
• Short run: more elastic, producer has more
time to respond to price changes. Example
– producer has time to hire more workers.
• Long run: most elastic, producer has
maximum flexibility, time to add to the
production process. Example – buying new
equipment, training new workers
• Coefficient of supply elasticity formula
% ▲Q Supply
% ▲P
Income Elasticity of
Demand
• The percentage change in quantity
demanded resulting from some
percentage change in consumer
income.
• Ei = % change in quantity demanded
% change in income
• Positive income elasticity = normal
good
• Negative income elasticity = inferior
good
Cross Elasticity of
Demand
• The effect of a change in a product’s price
on the quantity demanded for another
product.
• Ely = % change Q of X
% change P of Y
• If cross elasticity is positive, then X and Y
are substitutes.
• If cross elasticity is negative, then X and Y
are complements.
• If cross elasticity is zero, then X and Y are
unrelated products.
Problems
#1: If cross elasticity coefficient of
products A and B is 3.6, what is their
relationship? If cross elasticity coefficient
of products C and D is – 5.4, what is their
relationship?
#2: Determine if normal or inferior goods
Income elasticity for movies = 3.4
Income elasticity for dental work = 1
Income elasticity for clothing = .5
What does it mean if income elasticity is
negative?
Answers
#1 – A and B are substitutes
(positive #). C and D are
complements (negative #).
#2 – All are normal goods.
Negative income elasticity means
good is inferior.