# Elasticity and its Application

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```					Elasticity and its Application
Concept of Elasticity

   Elasticity is used to describe the behavior of
buyers and sellers in the market
   Elasticity is a measure of the quantity
demanded or supplied to one of its
determinants
   Elasticity of demand measures how much
quantity demanded responds to change in one
of its determinants
   Price elasticity of demand is a measure of
how much the quantity demanded of a good
responds to a change in the price of that good
Concept of Elasticity

Price e of demand=
% change in quantity demanded/ % change in price
   Remember price elasticity of demand is
always negative
   Price e of demand determines whether the
demand curve is steep or flat
   Demand for a good is elastic if the quantity
demanded responds substantially to
changes in the price
   Demand for a good is inelastic if the
quantity demanded responds only slightly
to changes in the price
Determinants of Price Elasticity of
Demand

    Necessities (inelastic) versus luxuries
(elastic)
    Availability of close substitutes (highly
elastic)
    Definition of the market
    Time horizon
Computing Price Elasticity of Demand

   Using the midpoint method
   The midpoint method gives us the same
price elasticity of demand between two
points regardless of the direction of change
   The midpoint method computes a % change
by dividing the change by midpoint of the
initial and final levels
   Always use midpoint method to calculate
elasticity between two points
Variety of Demand Curves

   Perfectly inelastic demand (e=0)
   Inelastic demand (e<1)
   Unit elastic demand (e=1)
   Elastic demand (e>1)
   Perfectly elastic demand (e=infinity)
   The flatter the curve passing through a given
point, the greater the elasticity of demand
   The steeper the curve passing through a given
point, the smaller the elasticity of demand
Total revenue and the Price Elasticity
of Demand

   TR= PxQ
   TR changes as one moves along the demand
curve due to changing price elasticity of demand
   The slope of a linear demand curve is constant
but its elasticity is not
   The following general rules apply:
   When demand is inelastic, a price increase raises TR,
and a price decrease reduces TR
   When demand is elastic, a price increase reduces TR,
and a price decrease raises TR
   In case of unit elastic demand, a change in the price
does not affect TR
Other Demand Elasticities

   Income elasticity of demand =% change in
quantity demanded/ % change in income
   Normal goods (positive income elasticity)
   Inferior goods (negative income elasticity)
   Necessities (small income elasticity)
   Luxuries (high income elasticity)
   Cross price elasticity of demand= % change in
quantity demanded of good X/ % change in price
of good Y
   Substitutes (positive cross-price elasticity)
   Complements (negative cross-price elasticity)
Elasticity of Supply

 Price elasticity of supply is a measure of how
much the quantity supplied of a good responds to
a change in the price of that good
 Price elasticity of supply=

% change in quantity supplied/ % change in price
 Determinants of elasticity of supply:

 Flexibility of sellers to change their production
levels
 Time period (short versus long)
Elasticity of Supply

   Supply of a good is elastic if the quantity supplied
responds substantially to changes in price
   Supply of a good is inelastic if the quantity
supplied responds slightly to changes in price
   Computing price elasticity of supply using midpoint
method

   (Change in quantity/midpoint of initial and final quantity)
/ (change in price/midpoint of initial and final price)
Variety of Supply Curves

   Perfectly inelastic supply (e=0)
   Inelastic supply (e<1)
   Unit elastic supply (e=1)
   Elastic supply (e>1)
   Perfectly elastic supply (e=infinity)
   The flatter the curve passing through a given
point, the greater the elasticity of supply
   The steeper the curve passing through a given
point, the smaller the elasticity of supply
Variety of Supply Curves

   Price elasticity of supply varies over the
supply curve in some markets. Why?

e<1
Price

e>1

QS
Applications of supply, demand,
and elasticity

   Impact of change in technology on market
equilibrium
   Can good news for farming be bad news for farmers?
   Advanced technology results in a new market equilibrium
with lower prices and larger quantity sold in the market.
   Behavior of supply and demand in the SR and
LR
   Why did OPEC fail to keep the price of oil high?
   In the SR supply and demand are inelastic and in the LR
both of them are elastic
Applications of supply, demand,
and elasticity

   Impact of policy on market equilibrium
   Does drug interdiction policy increase or
decrease drug-related crime?
   Drug related crime increases in the SR and
decreases in the LR
   Drug education policy would reduce drug usage
and drug- related crime in the SR.

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 views: 4 posted: 8/9/2012 language: pages: 14