1. Ch. 5 Elasticity and Its Application By Sophia TC and Kristin Soreide

2. Elasticity Elasticity measures how buyers and sellers respond to changes in market conditions If a good is inelastic, the quantity demanded responds only slightly to a change in price If a good is elastic, the quantity demanded responds substantially to a change in price

3. Perfectly inelastic demand-Quantity demanded is the same regardless of price Perfectly inelastic supply- Quantity supplied is the same regardless of price Perfectly elastic demand- Very small changes in price lead to very large changes in quantity demanded Perfectly elastic supply- Very small changes in price lead to very large changes in quantity supplied

4. Price Elasticity of Demand Measures how much the quantity demanded of a good responds to a change in the price of that good %change in QD/ % change in P Shows how willing consumers are to move away from a good as its price rises

5. What determines PEOD? Availability of close substitutes Necessities vs. Luxuries Definition of the Market Time Horizon More substitutes have higher elasticity of its demand Narrow vs. Broad markets Long vs. Short period of time

6. Continue of PEOD… EX. Eggs have no close substitute where as butter has many substitutes(margarine..etc); therefore the demand for eggs is less elastic than demand for butter Necessities are more inelastic than luxuries which are more elastic because people can go without having luxuries for a certain period of time, but it is hard to go by without necessities Narrowly defined markets(bean burritos) have more elastic demand than broadly defined markets(food) Goods have more elastic demand over longer time horizons EX. When price of gas rises, the QD falls only slightly in the first few months but over time people find different ways of transportation and QD falls substantially

7. Mid Point Method The Mid Point method is used to calculate the price elasticity of demand and prevents from making small mistakes between two points Gives the same answer regardless of the direction change Elasticity >1- elastic Elasticity<1- inelastic Elasticity=1- unit elasticity Ex. (Q2-Q1)/[(Q2+Q1)/2] (P2-P1)/[(P2+P1)/2]

8. Total Revenue Information The amount paid by buyers and received by sellers Computed as PRICE of the good x QUANTITY of the good Changes in total revenue depend on elasticity of demand GRAPH

9. Income Elasticity Of Demand A measure of how much the quantity demanded of a good responds to a change in consumer income % change in quantity demanded % change in income Normal goods: positive elasticity Most goods (higher income raises quantity demanded) Inferior goods: negative elasticity Ex. Bus rides ( higher income lowers the quantity demanded)

10. Cross Price Elasticity of Demand A measure of how much the quantity demanded of one good responds to a change in the price of another good % change in quantity demanded (1st good) % change in price (2nd good) Substitutes and complements affect whether the cross price elasticity is a positive or negative number Substitutes= positive elasticity Complements= negative elasticity

11. Price Elasticity of Supply A measure of how much the quantity supplied of a good responds to a change in the price of that good % Change quantity supplied % Change in price

12. For example… An increase in the price of milk from $2.85 to $3.15 a gallon raises the amount that dairy farmers produce 9,000 to 11,000 gallons (3.15-2.85)/3.00x100 = 10 percent (11,000-9,000)/10,000x100= 20 percent Price elasticity of supply= 20 percent/ 10 percent =2.0

13. Determinants of PEOS Flexibility of sellers Goods that are somewhat fixed in supply Time Horizons Beach fronts (inelastic) vs. Manufactured goods (elastic) – harder to supply more beach land Supply is usually more inelastic in the short run than in the long run