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Elasticity

Elasticity
Term used to describe sensitivity
o Ex. Price increased
a. you still buy the product not sensitive to price
b. you dont buy the product sensitive to price
3 Kinds of Elasticity (DEMAND)
A. Price Elasticity of Demand
percentage change in quantity demanded divided by the percentage change in
price
Ed = % Change in Quantity = (Q2 - Q1) / [(Q1 + Q2)/2]
% Change in Price
(P2 - P1) / [(P1 + P2)/2]
o ALWAYS an absolute value, disregard the negative sign
Elasticities:
UNITARY ELASTIC/UNITARY DEMAND (If Ed = 1)
Quantity demanded changes by the same percentage
as price

ELASTIC DEMAND (If Ed > 1)


Sensitive in price change or responds strongly to
change in price
If price increases, customer will not buy

Extreme Elasticities:
PERFECTLY INELASTIC (If Ed = 0)
Quantity demanded does not respond to price changes
o Ex. Medicine

INELASTIC DEMAND (If Ed < 1)


Quantity demanded does not respond strongly to price
changes
If price increases, customer will still buy, but at limited
amounts

PERFECTLY ELASTIC (If Ed = infinity)


Quantity demanded drops down to 0 with any change in
price
Can only be found in the perfect market system
Quantity may increase or decrease freely, but if price
increases, QD = 0

Examples

1.
BANANAS
ORANGES

QUANTITY
200
240
400
280

PRICE
20
18
40
70

o Ed BANANA = (240-200)/[(200+240)/2] / (18-20)/[(20+18)/2]


Ed BANANA = 1.73 ELASTIC; Sensitive to price change
o Ed ORANGE = (280-400)/[(400+280)/2] / (70-40)/[(40+70)/2]
Ed ORANGE = 0.65 INELASTIC; Not sensitive to price change
2. You usually buy 4 cds per month at a price of $14, but when the price rises
to $18, you purchase only
3 per month. What is your elasticity of demand for cds over this range of
prices?
1.4 ELASTIC DEMAND
FACTORS THAT AFFECT THE ELASTICITY OF GOODS
o Number and Closeness of Substitute Goods
INCREASE substitute = Elastic; easily gets discouraged/encouraged
to buy
DECREASE substitute = INELASTIC
Ex. Water
o Percentage of Income a Good Makes Up or Effect on Income
INCREASE in effect on income (change in price) = Elastic
DECREASE in effect on income = Inelastic
o Needs VS Wants
Needs = Inelastic
Wants = Elastic
o Time to Adjust
INCREASE time to adjust = Inelastic
DECREASE time to adjust = Elastic

Graphs of Elastic and Inelastic


ELASTIC

INELASTIC

Total Revenue Test for Price Elasticity of Demand


o Can determine elasticity by examining what happens to total revenue
when price changes
IF DEMAND
WHEN
THEN TOTAL
IS
PRICE
REVENUE
Elastic
Increases
Decreases
Elastic
Decrease
Increases
s
Inelastic
Increases
Increases
Inelastic
Decrease
Decreases
s
Unit Elastic
Increases Remains Constant
Unit Elastic
Decrease Remains Constant
s

B. Cross Price Elasticity


Ec = % Change in Quantity of X
% Change in Price of Y
o NOT ABSOLUTE VALUE
o If Ec is
POSITIVE Complements
NEGATIVE Substitutes
Unrelated goods should have a cross price elasticity close to 0

C. Income Elasticity of Demand


ratio of the percentage change in quantity demanded to the percentage change
in income
Normal Goods
o Increase Income Demand Decrease
o Decrease Income Demand Increase
Inferior Goods
o Increase Income Demand Increase
o Decrease Income Demand Decrease
Ei = % Change in Quantity
% Change in Income
o NOT ABSOLUTE VALUE
o If Ei is
0<Ei <1 Normal Good
Ei < 0 Inferior Good (negative)
Ei > 1 Luxury Good

Exercises
1. A 10% increase in income brings about a 15% decrease in demand for a good.
What is the INCOME ELASTICITY OF DEMAND and is the good a normal good or inferior
good?

2. If the price of a good increases by 8% and the quantity demanded decreases by


12%, What is the PRICE ELASTICITY OF DEMAND? Is it elastic, inelastic or unitary elastic?

3. Suppose a rise in the price of a good from $5.50 to $6.50 causes a decrease in
quantity demanded from 12,500 to 11,500 units. What is the PRICE ELASTICITY OF
DEMAND?

4. Product X sells at a price of $22 per kilo. An increase in the price of product X to
$25 causes your demand for the product to decrease to 6 from 8 kilos a week. What is
the PRICE ELASTICITY OF DEMAND?

5. If a 5% decrease in price causes a 6% increase in quantity demanded, what is


the PRICE ELASTICITY OF DEMAND?

6. Due to the increase of business investments in the Visayas Region, the average
income has increased by 30%. This increase was coupled by a change in quantity
demanded by a McDonalds Big Mac from 5,300 to 3000 sandwiches per day. Is the Big
Mac an INFERIOR, NORMAL or LUXURY good?

7. Freds income has just risen from $950 to $1050 per week. As a result, he
decides to increase the number of movies he watches each week from 2 to 6 times. Is
watching movies for Fred a luxury?

8. An increase in the price of good Y from $10 to $15 causes the quantity
demanded for good X to decrease by 20% from level of 80 units. Are goods X and Y
SUBSTITUTES OR COMPLEMENTARY?

Elasticity (SUPPLY)
A. Price Elasticity of Supply

it is the responsiveness of the sellers or the sensitivity of producers to price


change
Elastic Supply
o INCREASE Price INCREASE Production
o DECREASE Price DECREASE Production
ex. shirts, factory products,...
Inelastic Supply
o INCREASE Price Not responsive - cannot control production
o DECREASE Price Not responsive - cannot control production
ex. crops, handmade goods, things made with chemicals,...
(anything hard to produce)
ES = % Change in Quantity
% Change in Price
o ABSOLUTE VALUE - disregard negative sign
o if ES is
ES > 1 Elastic Supply

ES < 1 Inelastic Supply

ES = 1 Unitary/Unit Elastic Supply

Only difference between Price Elasticity of Demand and the Price Elasticity of
Supply is this is the perspective of sellers
FACTORS THAT AFFECT THE ELASTICITY OF GOODS
o Easy or Hard to produce
Easy = Elastic
Hard = Inelastic
o Time to Adjust
MORE time = Elastic
LESS time = Inelastic
Inelastic Goods - More profitable but it takes a longer time
o So, to produce ELASTIC goods, you decrease the price so that the total
revenue would increase
* IF IN THE DATA, THE PRICE IS IN PERCENTAGE FORM, THEN THE QUANTITY ALSO
HAS TO BE IN PERCENTAGE FORM.

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