Documents
Resources
Learning Center
Upload
Plans & pricing Sign in
Sign Out
Your Federal Quarterly Tax Payments are due April 15th Get Help Now >>

elasticity

VIEWS: 15 PAGES: 9

									THE ELASTICITY OF DEMAND (AND
JUST ABOUT ANYTHING)
THE CONCEPT: THE ELASTICITY OF STEEL VS.
   RUBBER

     HOW MUCH DOES ONE THING CHANGE IN
     RESPONSE TO A CHANGE IN SOMETHING
     ELSE?

THE CONCEPT OF ELASTICITY IS USED IN
   ENGINEERING & MANY BUSINESS FIELDS &
   ECONOMISTS USE SEVERAL DIFFERENT
   TYPES OF ELASTICITY MEASURES

1.   (OWN) PRICE ELASTICITY OF DEMAND


     Ed = ELASTICITY COEFFICIENT

        % CHANGE IN QUANTITY DEMANDED
       = ---------------------------------------------------------
                   % CHANGE IN PRICE


A NOTE ABOUT THE SIGN (NEGATIVE VS.
   POSITIVE): FOR OWN PRICE ELASTICITY, THE
   SIGN IS ALWAYS NEGATIVE, SO WE IGNORE
   IT. (CAN’T DO THAT WITH OTHER KINDS OF
   ELASTICITY)
TERMINOLOGY

INELASTIC         Ed < 1

   THIS MEANS QUANTITY DOES NOT CHANGE
   MUCH RELATIVE TO PRICE

UNIT ELASTIC       Ed = 1

   THIS MEANS QUANTITY DEMANDED
   CHANGES PROPORTIONALLY TO PRICE

ELASTIC            Ed > 1

   THIS MEANS QUANTITY DEMANDED
   CHANGES MORE THAN PRICE

A CAUTION ABOUT SAYING DEMAND IS
   “ELASTIC” OR “INELASTIC” (ELASTICITY IS
   NOT THE SAME AS SLOPE)

   ELASTICITY IS ALWAYS RELATIVE TO
   WHERE YOU ARE ON A DEMAND CURVE OR
   BETWEEN TWO OR MORE DEMAND CURVES.
                 %Δ Q       3–4        - 1/3     - 0.33
 P
           Ed = ------ = ---------- = ----- = ------ =- - 1.65
                 %Δ P      10 – 8        2/10      0.20



     $10


$8
                                                      %Δ Q       9 – 10         - 1/9   - 0.11
                                                Ed = ------ = ---------- = ----- = ------ =- - 0.22
                                                      %Δ P        2-1            1/2         0.50




$2

$1                                                                                                  D



                 3           4                                              9           10              Q
WHY DO WE CARE?

KNOWING PRICE ELASTICITY ALLOWS US TO BE
   ABLE TO PREDICT

   CHANGES IN THE QUANTITY DEMANDED IN
    RESPONSE TO PRICE CHANGES

   CHANGES IN REVENUES

ELASTICITY: SOME ADDITIONAL
  COMMENTS
AVAILABILITY OF SUBSTITUTES (MORE
   CONSUMER CHOICE) INCREASES
   ELASTICITY

    DEFINING MARKETS AND PRODUCT LINES,
    E.G.,

THE DEMAND FOR PEPSI IS MUCH MORE ELASTIC
   THAN THE DEMAND FOR “COLA”

THE DEMAND FOR BUDWEISER IS MUCH MORE
   ELASTIC THAN THE DEMAND FOR “BEER”
ELASTICITY AND TIME: THE LONGER THE
   PERIOD THAT CONSUMERS HAVE TO
   ADJUST, THE MORE ELASTIC DEMAND.

   EXAMPLES: GASOLINE, ELECTRICITY

THE BIGGER THE PRICE INCREASE, THE MORE
   ELASTIC THE DEMAND.

   MOVING TO A MORE ELASTIC PART OF THE
   DEMAND CURVE

   MAKES CONSUMERS MORE WILLING TO
   BEAR SEARCH AND TRANSACTIONS COSTS
   TO FIND SUBSTITUTES, ETC.


CALCULATING ELASTICITY

MEASURING ELASTICITY IS SENSITIVE TO HOW
   YOU DO IT & INFORMATION AVAILABLE

IF ALL YOU KNOW IS THAT Q CHANGED X% & P
    CHANGED Y%, THEN ALL YOU CAN DO IS:

       Ed = (X%)/(Y%)

FOR EXAMPLE, IF THE PRICE OF GASOLINE RISES
   10% AND QUANTITY DEMANDED FALLS 1%:
        Ed = (1%)/(10%) = 0.1, I.E., INELASTIC


IF WE KNOW PRICES AND QUANTITIES THEN WE
    CAN BE MORE PRECISE:
         Q2-Q1          P1
   Ed = --------- X ----------
            Q1        P2-P1


ARC ELASTICITY

THE PROBLEM OF MEASURING ELASTICITY IS
   RESOLVED BY USING AN AVERAGING
   METHOD
           Q2 - Q1          P2 – P1
   Ed = -------------- ÷ --------------
        (Q1 + Q2)/2      (P2 + P1)/2

        Q2 - Q1     P2 + P1
   Ed = --------- x ----------
        Q1 + Q2     P2 – P1

AN EXAMPLE: SELLING 2X4s

@ 49¢ ea. WE SOLD 12,000 PER WEEK

WE DROPPED THE PRICE TO 39¢, SALES
   INCREASED TO 14,000
WHAT IS THE PRICE ELASTICITY OF DEMAND
  AND WHAT DOES IT IMPLY FOR PRICING
  POLICY?
     14,000 - 12,000        .39 + .49
Ed = -------------------- x -------------
     12,000 + 14,000 .39 - .49
      2,000      .88
Ed = --------- x ------- = (.0769) X (-8.8) = - 0.69
     26,000      -.10

IN OTHER WORDS, DEMAND WAS INELASTIC, AND
    YOU SHOULD RAISE PRICES TO INCREASE
    REVENUES.

PROBLEM: THE MARK-UP ON MOST LUMBER WAS
   10 - 20%. THE MARK-UP ON HARDWARE,
   PAINTS, ETC. THAT WE ALSO SOLD RANGED
   FROM 50 - 250%.

WE DON’T CARE IF WE LOSE MONEY ON 2X4s WE
   WANT TO GET THEM IN THE STORE AND SELL
   THEM OTHER STUFF (LOSS LEADER)

CROSS-PRICE ELASTICITY
HOW DOES THE CHANGE IN THE PRICE OF ONE
   GOOD, LIKE 2X4s, CHANGE THE QUANTITY
   DEMANDED (SHIFT THE DEMAND CURVE)
   FOR OTHER GOODS, LIKE HARDWARE?
            % CHANGE IN THE QUANTITY
         DEMANDED OF GOOD “A”
EC = --------------------------------------------------------
  % CHANGE IN THE PRICE OF GOOD “B”

NOW, THE SIGN OF THE COEFFICIENT IS
   IMPORTANT

IF EC > 0 ---> SUBSTITUTE GOODS

IF EC < 0 ---> COMPLEMENTARY GOODS

IF EC = 0 ---> UNRELATED GOODS

MONOPOLY? THE ALCOA CASE
INCOME ELASTICITY
MEASURES THE CHANGE IN QUANTITY
   DEMANDED (SHIFT IN THE DEMAND CURVE)
   RESULTING FROM A CHANGE IN
   CONSUMERS’ INCOMES

  % CHANGE IN THE QUANTITY DEMANDED
EY = --------------------------------------------------------------
    % CHANGE IN CONSUMERS’ INCOMES

AGAIN, THE SIGN MATTERS, IT TELLS WHETHER
   THE DEMAND CURVE IS SHIFTING OUT (+) OR
   IN (-)
IF EY > 0 ---> “NORMAL GOOD”

EXAMPLES: CLOTHING, CD’s, GASOLINE

IF EY > 0 AND LARGE ---> “LUXURY GOOD”

EXAMPLES: VARIETAL WINES (IN U.S.), FILET
   MIGNON, CHICKEN (IN THE 1930’s)

IF EY < 0 ---> “INFERIOR GOOD”

EXAMPLES: ROOT VEGATABLES, GRITS

WHAT IS A NORMAL GOOD IN ONE PLACE AND
  TIME MAY NOT BE IN ANOTHER


THE ELASTICITY OF JUST ABOUT
  ANYTHING
ADVERTISING

ORE BODIES

								
To top