Chapter 4: Elasticity

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Chapter 4 Elasticity

• Its like a BALLOON!!!

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OVERVIEW

• ONE OF MY FAVORITE CHAPTERS
• We know supply and demand, but that doesnt
  really focus on changes in prices
• Simple chapter (one concept), but also our most
  difficult calculation

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We know we buy cheap stuff

• First thing--elasticity is NOT the same as the
  law of demand
• We do but more at lower prices but that is NOT
  what elasticity measures

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Consider the Following

• If I was selling cookies for .25, how many would
  you buy?
• If I was selling newspapers for .50, how many
  would you buy?
• Now what if cookies were increased to .50? What
  if papers were decreased to .25?

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Did we just violate the law of demand?

• Why would we still buy a lot of cookies? Why
  wouldnt we buy more newspapers?
• The law of demand tells us we will buy more at a
  low price, but ELASTICITY OF DEMAND tells us HOW
  MUCH MORE WE BUY

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ELASTICITY CALCULATED

• Measured as the change in quantity / change
  in price
• Break it down
• Hammer time

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Only one thing here really matters

• The biggest reason for doing this calculation is
  to determine whether the number is above or below
  1
• If above 1, it means that the good is ELASTIC
• If below 1, it means that the good is INELASTIC

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Things vary in importance

• Like it or not some things we have to buy
• When these things exist, like gasoline, they are
  considered inelastic goods
• Essentially that means that the change in price
  will not offset the change in quantity
• WE ALWAYS BUY THEM

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Flip side

• The opposite occurs with things that we can
  decide not to buy, for example if there are a lot
  of substitutes
• Which do you prefer, Pepsi or Coke?
• I buy the one thats cheaper
• In this case a small change in price can result
  in a large change in quantity

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Why does it matter?

• As long as I can buy what I want, I really dont
  care about much elseso why worry about
  elasticity?
• Its not for our benefit but for that of the
  producers
• How would you respond if you knew someone was
  always going to buy something (inelastic)?

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Their goal is to make money

• Think about the things we pay the highest price
  formedicine, gas, medical carewe dont have a
  choice
• If a good is inelastic, producers can make more
  money by raising the price
• Think about the oppositethey make more by
  lowering the price

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Graph it
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They want to charge more

• We already talked about MARKET POWER and how if
  you can charge more you do
• From the graph on the previous slide, you NEVER
  WANT TO SELL IN THE INELASTIC PORTION OF YOUR
  DEMAND CURVE
• You make more money by raising the pricedoes
  that mean you raise it as much as you can?

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Their side

• While we have elasticity of demand, we also have
  an elasticity of supply
• Their responsiveness to a change in price
• Except for them its not as easy

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Time is the variable

• For a producer, the time you have to react will
  most determine your ability to
• Goods with an INELASTIC SUPPLY, like oranges and
  diamonds and fish, take a long time to grow/find
• Goods with an ELASTIC supply, like a certain
  brand of clothing, can be produced quite quickly

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Calculated the same way

• Both elasticities are calculated the same, but we
  rarely use supply
• Sometimes goods have a perfectly fixed supply or
  demand which brings the govt into the picture

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We know value, but so do they

• As consumers we dont really use itproducers do
  a lot
• The govt can also use it so that they know who
  and what they can tax the most effectively
• The key is INELASTICthe side that doesnt change

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Who should pay?

• The term INCIDENT is used to describe the
  ultimate economic impact or burden of a tax
• In other words who is going to pay it, the
  producer or the consumer?
• Lets start at the extremes

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Perfectly

• If you ever have a perfectly inelastic supply or
  demand curve it means the same thinga vertical
  line
• Perfectly elastic means the oppositea horizontal
  line

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Think about Land

• Land has a fixed quantity (perfectly inelastic
  supply)
• That means someone is always going to own every
  piece of land
• When it is taxed then, the producer (landowner)
  automatically bears the full brunt of the tax

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Consider Medicine

• I doubt they do, but imagine if the govt taxed
  serious medical treatment
• With a perfectly inelastic demand curve we dont
  have a choice but to buy itwe pay the full brunt
  of the tax

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Incident measures who pays

• Most of the time though the curves are both
  sloped
• If you have a tax, and the curves are sloped,
  then the two share
• But you can also tell how much each bears

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Memorize Me
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Overview

• ELASTICITY
• Calculations at the start of class for the next
  week
• Quiz consisting exclusively on calculating
  elasticity and making assumptions/adjustments
  with results
• Implications will come later, but know that the
  producers use it for their benefit, the govt
  uses it to know who they can tax