ELASTICITY

1
ELASTICITY

• Elasticity is the concept economists use to
  describe the steepness or flatness of curves or
  functions.
• In general, elasticity measures the
  responsiveness of one variable to changes in
  another variable.

2
PRICE ELASTICITY OF DEMAND

• Measures the responsiveness of quantity demanded
  to changes in a goods own price.
• The price elasticity of demand is the percent
  change in quantity demanded divided by the
  percent change in price that caused the change in
  quantity demanded.

3
FACTS ABOUT ELASTICITY

• Its always a ratio of percentage changes.
• That means it is a pure number -- there are no
  units of measurement on elasticity.
• Price elasticity of demand is computed along a
  demand curve.

Elasticity is not the same as slope.
4
LOTS OF ELASTICITIES!

• THERE ARE LOTS OF WAYS TO COMPUTE ELASTICITIES.
  SO BEWARE! THE DEVIL IS IN THE DETAILS.
• MOST OF THE AMBIGUITY IS DUE TO THE MANY WAYS YOU
  CAN COMPUTE A PERCENTAGE CHANGE. BE ALERT HERE.
  ITS NOT DIFFICULT, BUT CARE IS NEEDED.

5
Whats the percent increase in price here because
of the shift in supply?
S'
S
price
pE 2
D
Q
QE
CIGARETTE MARKET
6

• IS IT
• A) .5/2.00 times 100?
• B) .5/2.50 times 100?
• C) .5/2.25 times 100?
• D) Something else?

7

• From time to time economists have used ALL of
  these measures of percentage change --
• including the Something else!
• Notice that the numerical values of the
  percentage change in price is different for each
  case

Go to hidden slide
8

• A) .5/2.00 times 100 25 percent
• B) .5/2.50 times 100 20 percent
• C) .5/2.25 times 100 22.22 percent
• D) Something else stay tuned

9
Economists usually use the midpoint formula
(option C), above) to compute elasticity in cases
like this in order to eliminate the ambiguity
that arises if we dont know whether price
increased or decreased.
10
Using the Midpoint Formula
Elasticity change in p
times 100. change in p For
the prices 2 and 2.50, the change in p is
approx. 22.22 percent.
11
Whats the percent change in Q due to the shift
in supply?
S'
S
price
pE 2.50
pE 2
D
Q (millions)
QE 10
QE 7
CIGARETTE MARKET
12
Use the midpoint formula again.

• Elasticity
• change in Q
• change in Q
• For the quantities of 10 and 7, the change in Q
  is approx. -35.3 percent. (3/8.5 times 100)

13
NOW COMPUTE ELASTICITY

• change in p 22.22 percent
• change in Q -35.3 percent

E -35.3 / 22.22 -1.6 (approx.)
14

• But you can do the other options as well
• A) If you use the low price, and its
  corresponding quantity, as the base values, then
  elasticity 1.2
• B) If you use the high price, and its
  corresponding quantity, as the base values, then
  elasticity 2.1 (approx.)
• C) And the midpoint formula gave 1.6 (approx.)
• SAME PROBLEM...DIFFERENT ANSWERS!!!

15
MORE ELASTICITY COMPUTATIONS
QUANTITY
PRICE
P
0
10
14
1
9
12
2
8
10
3
7
8
4
6
6
5
5
4
6
4
2
7
3
Q
0
8
2
0
2
4
6
8
10
12
14
9
1
10
0
16
USE THE MIDPOINT FORMULA.
The change in Q The change in P
Therefore elasticity
Go to hidden slide
17
The change in Q 66.67 1 / 1.5 times
100 The change in P 11.76 1 / 8.5 times
100
Therefore elasticity -66.67 / 11.76 -5.67
(approx.)
18
P
QUANTITY
PRICE
14
0
10
12
1
9
10
2
8
3
7
8
4
6
6
5
5
4
6
4
2
7
3
0
Q
8
2
0
2
4
6
8
10
12
14
9
1
10
0
19
Now we try different prices
QUANTITY
PRICE
0
10
P
1
9
14
2
8
12
3
7
10
4
6
8
6
5
5
4
6
4
2
7
3
Q
0
8
2
0
2
4
6
8
10
12
14
9
1
10
0
20
The change in Q The change in P
Therefore elasticity
Go to hidden slide
21
The change in Q 13.33 1 / 7.5 times 100 The
change in P 40 1 / 2.5 times 100
Therefore elasticity -13.33 / 40 -.33
(approx.)
22
P
QUANTITY
PRICE
14
0
10
12
1
9
10
2
8
8
3
7
6
4
6
4
5
5
2
6
4
0
Q
7
3
0
2
4
6
8
10
12
14
8
2
9
1
10
0
23
ELASTICITY IS NOT SLOPE!
QUANTITY
PRICE
P
Note that elasticity is different at the two
points even though the slope is the same. (Slope
-1)
0
10
14
1
9
12
2
8
10
3
7
8
4
6
6
5
5
4
6
4
2
7
3
Q
0
8
2
0
2
4
6
8
10
12
14
9
1
10
0
24
TERMS TO LEARN

• Demand is ELASTIC when the numerical value of
  elasticity is greater than 1.
• Demand is INELASTIC when the numerical value of
  elasticity is less than 1.
• Demand is UNIT ELASTIC when the numerical value
  of elasticity equals 1.
• NOTE Numerical value here means absolute
  value.

25
LIKE THIS!
P
QUANTITY
PRICE
14
0
10
12
1
9
10
2
8
8
3
7
6
4
6
4
5
5
2
6
4
Q
0
7
3
0
2
4
6
8
10
12
14
8
2
9
1
10
0
26
A FINAL ELASTICITY MEASURE

• POINT ELASTICITY OF DEMAND
• If you know or can see the demand curve for a
  good (you dont know just two points), you can
  compute point elasticity of demand at a single
  point on the demand curve.
• Heres the idea

27

• The change in price can be written as
• ??P)/Pbase times 100
• The change in quantity can be written as
• ??Q)/Qbase times 100
• So elasticity is (??Q)/ (?P)) ( Pbase / Qbase)

28

• So elasticity is ??Q)/ (?P) multiplied by the
  ratio of base price to base quantity.
• Point elasticity uses this formula to compute the
  elasticity of demand AT A POINT on a demand
  curve.

29
EXAMPLE
P
Elasticity at a price of 3 is .90.
6
3
D
Q
10
18
30

• There is an important relationship between what
  happens to consumers spending on a good and
  elasticity when there is a change in price.
• Spending on a good P Q.
• Because demand curves are negatively sloped, a
  reduction in P causes Q to rise and the net
  effect on PQ is uncertain, and depends on the
  elasticity of demand.

31
At P 9, spending is 9 ( 1 times 9). At P
8, spending is 16 ( 2 times 8). When price
fell from 9 to 8, spending rose. Q must
have increased by a larger percent than P
decreased. So...
QUANTITY
PRICE
0
10
P
1
9
14
2
8
12
3
7
10
4
6
8
5
5
6
6
4
4
7
3
2
8
2
Q
0
9
1
0
2
4
6
8
10
12
14
10
0
32
At P 3, spending is 21 ( 7 times 3). At P
2, spending is 16 ( 8 times 2). When price
fell from 3 to 2, spending fell. Q must
have increased by a smaller percent than P
decreased. So...
QUANTITY
PRICE
P
0
10
14
1
9
12
2
8
10
3
7
8
4
6
6
5
5
4
6
4
2
7
3
0
8
2
Q
0
2
4
6
8
10
12
14
9
1
10
0
33

• There is an easy way to tell whether demand is
  elastic or inelastic between any two prices.
• If, when price falls, total spending increases,
  demand is elastic.
• If, when price falls, total spending decreases,
  demand is inelastic.

34
But total spending is easy to see using a demand
curve graph
P
QUANTITY
PRICE
14
0
10
12
1
9
The shaded area is P times Q or total spending
when P 9.
10
2
8
8
3
7
6
4
6
4
5
5
6
4
2
7
3
0
Q
0
2
4
6
8
10
12
14
8
2
9
1
10
0
35
P
14
PRICE
QUANTITY
12
The shaded area is P times Q or total spending
when P 8.
0
10
10
1
9
8
2
8
6
3
7
4
4
6
2
5
5
0
Q
6
4
0
2
4
6
8
10
12
14
7
3
8
2
9
1
10
0
36
loss in TR due to fall in P
gain in TR due to rise in Q
P
14
QUANTITY
PRICE
12
0
10
10
1
9
Total spending is higher at the price of 8 than
it was at the price of 9.
8
2
8
6
3
7
4
4
6
2
5
5
6
4
0
Q
0
2
4
6
8
10
12
14
7
3
8
2
9
1
10
0
37
P
14
QUANTITY
PRICE
12
0
10
The shaded area is total spending (total revenue
of sellers) when P 3.
1
9
10
2
8
8
3
7
6
4
6
4
5
5
2
6
4
7
3
0
Q
0
2
4
6
8
10
12
14
8
2
9
1
10
0
38
P
QUANTITY
PRICE
14
0
10
12
1
9
Total revenue of sellers (total spending by
buyers) falls when price falls from 3 to 2.
10
2
8
8
3
7
6
4
6
4
5
5
2
6
4
7
3
0
Q
0
2
4
6
8
10
12
14
8
2
9
1
10
0
39
Heres a convenient way to think of the relative
elasticity of demand curves.
p
p
Q
Q
40
Examples of elasticity

• Doctors through the AMA restrict the supply of
  physicians. How does this affect the incomes of
  doctors as a group?
• A labor union negotiates a higher wage. How does
  this affect the incomes of affected workers as a
  group?
• MSU decides to raise the price of football
  tickets. How is income from the sale of tickets
  affected?
• Airlines propose to raise fares by 10. Will the
  boost increase revenues?

41
MORE ...

• MSU is considering raising tuition by 7. Will
  the increase in tuition raise revenues of MSU?
• CATA recently raised bus fares in the Lansing
  area. Will this increase CATAs total receipts?

42

• The answers to all of these questions depend on
  the elasticity of demand for the good in
  question. Be sure you understand how and why!

43
DETERMINANTS OF DEMAND ELASTICITY

• The more substitutes there are available for a
  good, the more elastic the demand for it will
  tend to be. Related to the idea of necessities
  and luxuries. Necessities tend to have few
  substitutes.
• The longer the time period involved, the more
  elastic the demand will tend to be.
• The higher the fraction of income spent on the
  good, the more elastic the demand will tend to be.

44
OTHER ELASTICITY MEASURES

• In principle, you can compute the elasticity
  between any two variables.
• Income elasticity of demand
• Cross price elasticity of demand
• Elasticity of supply

45

• Each of these concepts has the expected
  definition. For example, income elasticity of
  demand is the percent change in quantity demand
  divided by a percent change income
• EINCOME
• Income elasticity of demand will be positive for
  normal goods, negative for inferior ones.