Elasticity

Elastic Demand When % Change in Quantity Demanded > % Change in Price Unit Elastic Demand When % Change in Quantity Demanded = % Change in Price Inelastic Demand When % Change in Quantity Demanded < % Change in Price Perfectly Elastic Demand When Quantity Demanded Changes by a very large percentage in response to an almost zero Change in Pricesss Perfectly Inelastic Demand When the Quantity Demanded remains constant as Price changes

Significance of Price Elasticity of Demand

Profit maximization requires that business set a price that will maximize the firms profit Elasticity tells the firm how much control it has over using price to raise profit If Ep > 1, then the % Change in Qd > % Change is Price and demand is said to be elastic
An increase in price will reduce total revenue A decrease in price will increase total revenue

Significance of Price Elasticity of Demand

If Ep < 1, then the % change in Qd < % change in price, and demand is said to be inelastic
An increase in price will increase total revenue A decrease in price will decrease total revenue

If Ep = 1, then the % change in Qd = % change in Price, and

demand is said to be unit elastic
An increase in price will have no impact on total revenue A decrease in price will have no impact on total revenue

Price Elasticity of Supply

A measure of the extent to which the quantity supplied of a good changes when the price of the good changes, and all other influences on sellers plans remain the same (ceteris paribus)

Price Elasticity of Supply

Perfectly Elastic Supply When the quantity supplied changes by a very large percentage in response to an almost zero increase in price Elastic Supply When the % change in the quantity supplied > the % change in the price Unit Elastic Supply When the % change in the quantity supplied = the % change in price Inelastic Supply When the % change in the quantity supplied is < the % change in price Perfectly Inelastic Supply When the quantity supplied remains the same as the price changes

Influences on Price Elasticity of Supply

1. Fixed Production = inelastic price elasticity 2. Time Elapse longer time, > price elasticity 3. Storage Possibilities
The better the storability, the more elastic is the price elasticity of supply

Computing Price Elasticity of Supply

Percentage change in quantity supplied Percentage change in price If Price Elasticity of Supply > 1, Supply is elastic If Price Elasticity of Supply = 1, Supply is unit elastic If price elasticity of supply< 1, Supply is inelastic

Computing Price Elasticity of Supply

Percentage change in quantity supplied Percentage change in price If Price Elasticity of Supply > 1, Supply is elastic If Price Elasticity of Supply = 1, Supply is unit elastic If price elasticity of supply< 1, Supply is inelastic

Figure The Price Elasticity of Supply

(a) Perfectly Inelastic Supply: Elasticity Equals 0 Price Supply $5 4 1. An increase in price . . .

100

Quantity

2. . . . leaves the quantity supplied unchanged.

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Figure 6 The Price Elasticity of Supply

(b) Inelastic Supply: Elasticity Is Less Than 1 Price Supply $5 4

100

110

Quantity

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Figure 6 The Price Elasticity of Supply

(c) Unit Elastic Supply: Elasticity Equals 1

Price Supply $5 4

100

125

Quantity

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Figure 6 The Price Elasticity of Supply

(d) Elastic Supply: Elasticity Is Greater Than 1 Price Supply $5 4

100

200

Quantity

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Cross Elasticity of Demand

A measure of the extent to which the demand for a good changes when the price of a substitute or complement changes, ceteris paribus

% Change in Quantity Demanded % Change in Price of one of its substitutes or complements

Income Elasticity of Demand

A measure of the extent to which the demand for a good changes when income changes, ceteris paribus % Change in Quantity Demanded % Change in Income

Income Elasticity
Types of Goods
Normal Goods Inferior Goods

Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

Contd..
Goods consumers regard as necessities tend to be income inelastic
Examples include food, fuel, clothing, utilities, and medical services.

Goods consumers regard as luxuries tend to be income elastic.

Examples include sports cars, and expensive foods.

Income Elasticity of Demand

If income elasticity of demand > 1 the demand for the good is income elastic If income elasticity of demand is between 0 and 1, the demand is income inelastic * If income elasticity of demand < 0 the demand is negative income elastic

Figure 1The Price Elasticity of Demand

(a) Perfectly Inelastic Demand: Elasticity Equals 0 Price Demand $5

4
1. An increase in price . . .

100

Quantity

2. . . . leaves the quantity demanded unchanged.

Copyright2003 Southwestern/Thomson Learning