Ch5: Elasticity and its application

Page 1

Elasticity

measures how much

one variable responds to changes in another variable

a numerical measure of the responsiveness

of Qd or Qs to one of its determinants.

Price Elasticity of Demand

� Price elasticity of demand measures how much Qd responds to a change in P

Price elasticity of demand determinants

Substitutibility: Price elasticity is higher when close

substitutes are available.

Proportion of income: proportion of price compared to income

Definition of market: Price elasticity is higher for narrowly

defined goods than broadly defined ones

Price elasticity is higher for luxuries than for

necessities.

Time horizon:Price elasticity is higher in the

long run than the short run

Variety of demand curves

Rule of thumb:

The flatter the curve, the bigger the elasticity.

The steeper the curve, the smaller the elasticity.

The price elasticity of demand is closely related to the

slope of the demand curve.

Perfectly inelastic : E=0

Inelastic : E TR rises

Unit elastic: E=1

Elastic : E>1: P rises => TR decreases

Perfectly elastic: E = infinity

Price elasticity and Total revenue

E => P and Q => TR

Price elasticity of supply determinants

Ability of the sellers to change the quantity of goods they produce

Time horizon

Price Elasticity of supply

Measures how much Qp responds to a change in P

Supply is less elastic when Q rises due to capacity limit

Income elasticity of demand:

Normal goods: E>0

Inferior goods: E

Cross-price elasticity of demand : measures the

response of demand for one good to changes in the price

of another good

Substitute: E>0

Complement: E

Independent: E=0

New Page