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CHAPTER 20
ELASTICITY of DEMAND &
SUPPLYBy: Amanda Reina
&
Sandra Avila
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Three types of Elasticity Price Elasticity Cross Elasticity Income Elasticity
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Price Elasticity Response of consumers and producers to
price change Price Elasticity of Demand Price Elasticity of Supply
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Price Elasticity of Demand (Formulas)
Ed=
% change in quantity demanded
of product X
____________________________
% change in price of product X
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Price Elasticity of Demand (Formulas)
Ed=
[change in quantity demanded of X /
original quantity demanded of X]
__________________________________
[change in price of X / original price of X]
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Price Elasticity of DemandElimination of Minus Sign
Price and Quantity demanded are inversely related because of the down-sloping of the demand curve. Coefficient (first number) of demand Ed will
ALWAYS be negative (-). Take the absolute value. P
0 Q
Down-Sloping
D1
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Price Elasticity of DemandExample
Ed= % change in quantity demanded of product X __________________________ % change in price of product
P↓ Qd ↑
This means that the numerator in the
formula will be positive and the denominator negative.
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Price Elasticity of Demand Interpretations of Ed
Elastic Demand: Ed > 1 Inelastic Demand: Ed < 1 Unit Elasticity: Ed = 1 Perfectly Inelastic: Ed = 0
Consumers have NO response to price change (Vertical Line)
Perfectly Elastic: Ed =∞ A slight price fall causes consumers to increase their
purchases from 0 to all they can get (Horizontal Line)
Ed= % change in quantity demanded of product X __________________________ % change in price of product
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Mid-Point Formula
Ed = [Change in quantity /(sum of quantities/2)]
[Change in price /(sum of prices/2)]
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Graphical Analysis Demand is :
Elastic with high prices (lower quantity) Inelastic with low prices (higher quantity)
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Total Revenue Test
TR = P X QP= PriceQ= Quantity
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Total Revenue Test Elastic
↓P = TR↑
Inelastic ↓P = TR ↓
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Example
5
4
4 5 Quantity Demanded
Price ($)
Unit Elastic
Ed = 1
Elastic
Ed > 1
Inelastic
Ed < 1
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Determinants of Price Elasticity of Demand Substitutability:
Higher # of Substitute goods = greater Ed
Proportion of Income: Higher price of good relative to consumer’s income =
greater Ed
Luxuries v. Necessities: The more the good is luxury = the greater Ed is
Time: Longer time period = greater Ed
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Price Elasticity of Supply Response of consumers and producers to
price change
Es = % change in quantity supplied
of product X
____________________________
% change in price of product X
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Degree of Price Elasticity of Supply
How quickly and easily producers can shift resources b/w alternative uses “The longer the time, the greater the resource
“shiftability.”
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Impact of time on Elasticity of Supply
Immediate market period Period that occurs immediately after a change in
market price, where it is too soon for producers to respond with a change in quantity supplied
Perfectly inelastic supply
0D1
D2
Sm
P0
Pm
Q
P
Qo
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Impact of time on Elasticity of Supply Short run
Period too short to change plant capacity but long enough to use a fixed plant more or less intensively
P
Q 0D1
D2
Ss
P0
Ps
Qo Qs
**Supply more elastic than market period
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Impact of time on Elasticity of Supply
Long run Period long enough for all desired adjustments to
be made
P
Q
SL
D2
D1
P0
Pl
Qo Ql
**Supply is even more elastic
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Cross Elasticity of Demand Measures how sensitive consumer
purchases of product X are to a change in the price of product Y. Related products Change in income
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Cross Elasticity of DemandFormula
Exy =
% change in quantity demanded
of product X
__________________________
% change in price of product Y
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Cross Elasticity of Demand Substitute goods have a positive Exy
Sales of X is related to price changes of Y Beef and Chicken
Complementary goods have a negative Exy
Increase in price X = Decrease demand in Y Milk and Chocolate powder
Independent goods have zero Exy
X and Y are unrelated Candy and Books
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Income Elasticity of Demand Measurement of the consumers’ response
to a change in their incomes by buying more/less goods
Ei = % change in quantity demanded
% change in income
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Income Elasticity of Demand Positive Ei = Normal/ Superior Goods
Qd & I move in the same direction
Negative Ei = Inferior Goods Qd & I move in opposite direction