lecture 3: Elasticity in Microeconomics: Demand, Supply, and Other Elasticities

Elasticity: A Measure of Responsiveness

Definition and Overview

Elasticity is a fundamental concept in microeconomics that measures how responsive the quantity demanded or supplied of a good is to changes in price, income, or the price of other goods. It helps economists and businesses understand consumer and producer behavior in the marketplace.

• Elasticity: The degree to which quantity responds to changes in price, income, or other factors.

• Highly elastic: Highly responsive (Elasticity > 1).

• Highly inelastic: Unresponsive (Elasticity < 1).

• Four main types: Price elasticity of demand, Price elasticity of supply, Income elasticity of demand, Cross-price elasticity of demand.

I think this might be related to how the market shifts in price and quantity when they have to reach equilibrium

Price Elasticity of Demand

Definition and Calculation

Price elasticity of demand measures how much the quantity demanded of a good change in response to a change in its price. The more responsive the quantity demanded, the more elastic the demand curve.

• Formula: $\text{Price Elasticity of Demand} = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in price}}$

• Elasticity is often expressed as an absolute value for clarity.

Types of Demand Elasticity

• Elastic Demand: $|E_d| > 1$; quantity demanded is relatively responsive to price changes and leads to a big decrease in quantity.

• Inelastic Demand: $|E_d| < 1$; quantity demanded is relatively unresponsive to price changes and leads to a small decrease in demand

• Perfectly Elastic Demand: $|E_d| = \infty$; quantity demanded changes infinitely with any price change.

• Perfectly Inelastic Demand: $|E_d| = 0$; quantity demanded does not change with price.

Elasticity and Slope

Elasticity is related to the slope of the demand curve but is not the same. Slope measures the rate of change, while elasticity measures percentage responsiveness.

• Elasticity: $\frac{\%\ \text{change in quantity}}{\%\ \text{change in price}}$

• Slope: $\frac{\text{change in price}}{\text{change in quantity}}$

The Midpoint Elasticity Formula

To avoid ambiguity in percentage change calculations, economists use the midpoint formula:

• $\%\ \text{change in quantity} = \frac{\text{New Quantity} - \text{Old Quantity}}{\frac{\text{New Quantity} + \text{Old Quantity}}{2}}$

• $\%\ \text{change in price} = \frac{\text{New Price} - \text{Old Price}}{\frac{\text{New Price} + \text{Old Price}}{2}}$

Elasticity and Total Revenue (finish this tmr :)

The effect of price changes on total revenue depends on the price elasticity of demand:

• Elastic demand: Raising price lowers revenue.

• Inelastic demand: Raising price increases revenue.

• Total Revenue: $\text{Total Revenue} = \text{Price} \times \text{Quantity}$

Determinants of Price Elasticity of Demand

Factors Influencing Elasticity

Several factors determine how elastic or inelastic demand is for a good:

• Number of substitutes: More substitutes make demand more elastic.

• Specific brands vs. categories: Specific brands have more elastic demand than broad categories.

• Necessities vs. luxuries: Necessities are less elastic; luxuries are more elastic.

• Consumer search: Easier search increases elasticity.

• Time horizon: Demand becomes more elastic over longer periods.

Examples: Substitutes and Categories

Individual brands often have many close substitutes, making their demand more elastic. Categories of goods have fewer substitutes, making demand less elastic.

Price Elasticity of Supply

Definition and Calculation

Price elasticity of supply measures how much the quantity supplied of a good changes in response to a change in its price. The more responsive the quantity supplied, the more elastic the supply curve.

• Formula: $\text{Price Elasticity of Supply} = \frac{\%\ \text{change in quantity supplied}}{\%\ \text{change in price}}$

Types of Supply Elasticity

• Elastic Supply: $|E_s| > 1$; quantity supplied is relatively responsive to price changes.

• Inelastic Supply: $|E_s| < 1$; quantity supplied is relatively unresponsive to price changes.

• Perfectly Elastic Supply: $|E_s| = \infty$; quantity supplied changes infinitely with any price change.

• Perfectly Inelastic Supply: $|E_s| = 0$; quantity supplied does not change with price.

Determinants of Price Elasticity of Supply

• Inventories: More inventories make supply more elastic.

• Easily available inputs: Supply is more elastic when inputs are easily available.

• Extra capacity: More capacity increases elasticity.

• Easy entry and exit: Markets with easy entry/exit are more elastic.

• Time horizon: Supply becomes more elastic over longer periods.

Other Demand Elasticities

Income Elasticity of Demand

Income elasticity of demand measures how much the quantity demanded of a good changes in response to a change in income.

• Formula: $\text{Income Elasticity of Demand} = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in income}}$

• Normal goods: Positive income elasticity; demand increases as income rises.

• Inferior goods: Negative income elasticity; demand decreases as income rises.

Classification Table: Income Elasticity

Type of Good	Income Elasticity
Normal (income-elastic)	> 1
Normal (income-inelastic)	0 < elasticity < 1
Inferior	< 0

Cross-Price Elasticity of Demand

Cross-price elasticity of demand measures how much the quantity demanded of one good changes in response to a change in the price of another good.

• Formula: $\text{Cross-Price Elasticity of Demand} = \frac{\%\ \text{change in quantity demanded of Good B}}{\%\ \text{change in price of Good A}}$

• Substitutes: Positive cross-price elasticity; demand for one increases as the price of the other rises.

• Complements: Negative cross-price elasticity; demand for one decreases as the price of the other rises.

Examples: Substitutes and Complements

Substitute goods, such as different brands of cookies, have positive cross-price elasticity. Complementary goods, such as cookies and milk, have negative cross-price elasticity.

Elasticity in Practice: Applications and Examples

Market Strategies and Elasticity

Businesses use elasticity to inform pricing strategies. For example, airlines may target markets with high price elasticity of demand for low-price strategies, as a price reduction leads to a large increase in quantity demanded.

Key Takeaways

• Elasticity is a measure of responsiveness: % change in quantity / % change in some factor.

• Price elasticity of demand is determined by substitutability.

• Price elasticity of supply is determined by flexibility.

• Income elasticity distinguishes normal and inferior goods.

• Cross-price elasticity distinguishes substitutes and complements.