Elasticity and its Application

1
Elasticity and its Application

• How much do buyers and sellers respond to a
  change in price

2
Elasticity measures the change in quantity
against another variable

• .
• On the demand side
• 1.Price elasticity of demand
• ? quantity vs. ? price
• 2. Income elasticity of demand
• ?quantity vs. ? income
• 3. Cross price elasticity of demand
• ? quantity vs. ? price of another product

3
Price elasticity of demand

• Three ways to measure price elasticity of demand
• Determinants
• Total revenue test
• Midpoint formula

4
Determinants of price elasticity of demand

• Availability of close substitutes
• Necessity or luxury
• Definition of market
• Time horizon

5
Please Note

• Elasticity is actually measured between prices
• Elasticity is the change in quantity measured
  against the change in the other variable
• No linear demand curve is either elastic or
  inelastic
• Higher prices tend to be more elastic than lower
  prices

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Total Revenue Test

• Total Revenue Price x Quantity or
• TR P x Q
• If price and total revenue change in the same
  direction demand is inelastic
• If price and total revenue change in opposite
  directions demand is elastic
• If a change in price causes no change in total
  revenue demand is unit elastic

7
Midpoint Formula

• The midpoint formula eliminates the problem
• of end points and start points
• Midpoint formula
• ?Q ?P
• Sum of Qs/2 Sum of
  Ps/2
• If coefficient gt 1 Elastic
• If coefficient lt 1 Inelastic
• If coefficient 1 unit elastic

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Income Elasticity of Demand

• Formula
• ? in quantity
• ? in income
• Positive coefficient Normal Good
• Negative coefficient Inferior Good

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Cross-Price Elasticity of Demand

• Formula
• ? in quantity of good 1
• ? in the price of good 2
• Positive coefficient Substitute
• Negative coefficient Complement

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Determinants of price elasticity of Supply

• A) Depends on the flexibility of sellers to
  change the amount of good they produce
• 1)Textbooks highly elastic
• 2) Land highly inelastic
• B)Time horizon

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MIDPOINT FORMULA

• The midpoint formula eliminates the problem
• of end points and start points
• Midpoint formula
• ?Q ?P
• Sum of Qs/2 Sum of
  Ps/2
• If coefficient gt 1 Elastic
• If coefficient lt 1 Inelastic
• If coefficient 1 unit elastic

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Perfectly Elastic
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Perfectly Inelastic