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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