Basic Microeconomics Day

3 lecture
Atty. Roentgen Jude Paolo L. Ignacio
Elasticity
• an economic concept that measures responsiveness of one variable to
changes in another variable
• important in making policies on tax and pricing for it measures the
effect of demand and supply on changes in price
• Price elasticity- ratio between the percentage change in the quantity
demanded or supplied and corresponding percent change in price.
• Price elasticity of demand- percentage change in the quantity
demanded of a good or service divided by the percentage change in
the price.
• Price elasticity of supply- the percentage change in quantity supplied
divided by the percentage change in price
Elastic, Inelastic and Unitary Elastic
• Elastic demand/supply- is one in which the elasticity is greater than one,
indicating responsiveness to changes in price
• Inelastic demand/supply- elasticity that are less than one and indicate low
responsiveness to price changes
• Unitary Elasticities- indicate proportional responsiveness of either demand or
supply
Formula
Calculating Price Elasticity of Demand
• since the above amount is less than 1, this means that demand is inelastic.
• Price elasticity of demand is always negatice since price and quantity demanded
always move in opposite directions on the demand curve.
• Note that price elasticities are always positive, mathematically, this means taking
the absolute value of the result
• Note that price elasticity of demand changes at different points along a straight-
line demand curve.
• As a matter of exercise compute price elasticity of demand from G to H
Calculating price elasticity of supply
• as always we take the absolute value of the results
• In this case since the value is above 1, this means that supply is elastic
Extreme cases of elasticity
• Infinite elasticity or perfect elasticity- extreme case where either the Quantity
Demanded (Qd) or supplied (Qs) changes by an infinite amount in responds to
any change in price at all.
• Demand and supply curves are horizontal
• Perfectly elastic supply curves are mostly unrealistic but goods with readily available inputs
ans whose production can easily expand will feature a highly elastic supply curve
• Perfectly elastic demand is also an exteme example but luxury goods and goods with many
substitutes are likely to have highly elastic demand curves
• Zero elasticity or perfect inelasticity- refers to the extreme case in which
percentage change in price no matter how large, results in zero change in
quantity.
• necesities with no close substitutes are likely to have highly inelastic demand curves.
examples are life saving drugs and gasoline
Graphs
• Constant Unitary Elasticity- occurs when a price change of one percent results in a
quantity change of one percent
• this means that the elasticity will be equivalent to 1 througout the curves
• A contant unitary elastic demand curve is curved in shape while a constant uniraty elastice
supply curve is a straight line
Elasticity and pricing
• Note that demand for necessities as housing and electricity is
inelastic, while items that are not necessities such as restaurant meals
are more price sensitive
Does Raising the Price Bring in More Revenue? (No)
• The key concept in thinking about collecting the most revenue is the price
elasticity of demand
• total reveue is price times the quantity of tickets sold
• if demand is elastic at a price level, then you should cut the price, because a
percentage drop in price will result in an even larger percentage increase in the
quantity sold, thus raising total revenue
• if demand is inelastic at that original quantity level, then you should raise the
ticket price, because a certain percentage increase in price will result in a smaller
percentage decrease in quantity sold and total revenue will rise
• if demand has a unitary elasticity at that quantity, then an equal percentage
change in quantity will offset a moderate percentage change in price, so the band
will earn the same revenue whether it increases or decreases the ticket price
Tabular form
• sometimes increasing your volumes can maximize revenue specially when
demand is elastic