Elasticity

Elasticities of Demand and Supply

• PRICE ELASCITY OF DEMAND• POINT ELASTICITY VS. ARC ELASTICITY

OTHER DEMAND ELASTICITIES

• INCOME ELASTICITY OF DEMAND- is the percentage change in Qd, resulting from 1-percent change in income (I).

EI= (ΔQ/Q)/(ΔI/I) = (I/Q) (ΔQ/ΔI)

• A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes.

• A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods.

• A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods.

• CROSS-PRICE ELASTICITY OF DEMAND- refers to the percentage change in the quantity demanded for a good that result from a 1-percent increase in the price of another good.

• So the elasticity of demand for butter with respect to the price of margarine would be written as:

• EQbPm = (ΔQb/Qb) / (ΔPm/Pm) =

• (Pm/Qb)(ΔQb/ΔPm)

• Where Qb is the qty of butter and Pm is the price of margarine.

• In the equation, the cross-price elasticity will be positive because the goods are substitutes.

• Some goods are complements, in which an increase in the price of one tends to push down the consumption of the other.

ELASTICITIES OF SUPPLY- are defined in a similar manner.

• The price elasticity of supply is the percentage in Qs resulting from 1-percent increase in price.

• The elasticity is usually positive because higher price gives producers an incentive to increase output.

• We can also refer to elasticities of supply with respect to such variables as

Interest rates

Wage rates

Prices of raw materials and other intermediate goods

• For example, for most manufactured goods, the elasticities of supply with respect to the prices of raw materials are negative.

• An increase in the price of raw a material input means higher costs for the firm, other things being equal, therefore, the Qs will fall

The Market for Wheat

• For the statistical studies, we know that for 1981 the supply curve for wheat was approximately as follows:

• Supply: Qs = 1800+240P• Demand: Qd = 3550-266P

• Qs = Qd• 1800+240P=3550-266P• 560P=1750• P= 3.46

• Q= 1800+(240)(3.46)=2630

• Price

• Market-clearing price

• Elasticity of Demand=

(3.46/2630) (-266)

= -0.35

• Elasticity of Supply=

• (3.46/2630) (240)

• = o.32

Short-Run versus Long-Run Elasticities

• When analyzing demand and supply, we must distinguish between the short run and the long run.

• If we allow only a short time to pass-say, one year of less- then we are dealing with short run.

• When we refer to long run we mean that enough time is allowed for consumers and producers to adjust fully to the price change.

Demand

• For many goods, demand is much more price elastic in the long run than in the short run.

-For one thing, it takes time for people to change their consumption habits.

• Demand and Durability- On the other hand, for some goods just the opposite is true- demand is elastic in the short run than in the long run.

• Income elasticities also differ from the short run to the long run.

For most goods and services- foods, beverages, fuel, entertainment, etc.- the income elasticity of demand is larger in the long run than in the long run.

• For a durable good, the opposite is true. If we consider automobiles, if the aggregate income rises by 10 percent, the stock of cars that consumers would like to own will rise- say by 5 percent.

• Cyclinal industries- Industries in which sales tend to magnify cyclical changes in GDP and national income.

• These industries are vulnerable to changing macroeconomic conditions and in particular to the business cycle- recessions and booms.

• Coverage: all topics covered.