Elasticity

A measure of the responsiveness of one variable (usually quantity demanded or supplied) to a change in another variable

Most commonly used elasticity: price elasticity of demand, defined as:

Elasticity(film)

Price elasticity of demand =priceofchange

demandedquantityofchange

__%

___%

usually takes negative values◦ when price grows, quantity demanded decreases◦ when price decreases, quantity demanded increases

the exceptions:◦ The Veblen effect is one of a family of theoretically

possible anomalies in the general theory of demand. It is claimed that some types of high-status goods, such as diamonds or luxury cars, are Veblen goods, in that decreasing their prices decreases people's preference for buying them because they are no longer perceived as exclusive or high status products.[1] Similarly, a price increase may increase that high status and perception of exclusivity, thereby making the good even more preferable.

Price elasticity of demand

Giffen good the classic example given by Marshall is staple foods of inferior

quality, whose demand is driven by poverty, that makes their purchasers

unable to afford superior foodstuffs. As the price of the cheap staple food rises, they can no longer

afford to supplement their diet with better foods, and must consume more of the staple food.

Marshall wrote in the 1895 edition of Principles of Economics: As Mr. Giffen has pointed out, a rise in the price of bread makes so

large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.

exception cont.

Demand is said to be:◦ elastic when Ed < -1,◦ unit elastic when Ed = -1, and◦ inelastic when Ed >-1.

Price elasticity of demand

Even small change of price results decreasing of demand till zero

Perfectly elastic demand

Customers buy the same amount of good, regardless of good’s price

Perfectly inelastic demand

a price increase from $1 to $2 represents a 100% increase in price,

a price increase from $2 to $3 represents a 50% increase in price,

a price increase from $10 to $11 represents a 10% increase in price.

Notice that, even though the price increases by $1 in each case, the percentage change in price becomes smaller when the starting value is larger.

Elasticity & slope(film)

Elasticity along a linear demand curve

Elasticity along a linear demand curve

Elasticity measure

where: ΔQ - change of quantity demandedQ – quantity demanded before price change ΔP – change of priceP – price before change

PPQQ

demandofelasticityprice

___

Suppose that quantity demanded falls from 60 to 40 when the price rises from $3 to $5. The price elasticity of demand equls…

Example

In this interval, demand is inelastic (since elasticity >- 1).

Total revenue = price times quantity What happens to total revenue if the price

rises?

Elasticity and total revenue

Ticket prices Demand Price elasticity of demand

Total revenue

12,5 0 oo 0 10 20 4 200 7,5 40 1,5 300 6,25 50 1 312,5 5,0 60 0,67 300 2,5 80 0,25 200 0 100 0 0

A reduction in price will lead to:◦ an increase in TR when demand is elastic.◦ a decrease in TR when demand is inelastic.◦ an unchanged level of total revenue when

demand is unit elastic.

Elasticity and TR (cont.)

Price elasticity of demand =priceofchange

demandedquantityofchange

__%

___%

Elasticity and TR (cont.)(film)

different customers are charged different prices for the same product, due to differences in price elasticity of demand

higher prices for those customers who have the most inelastic demand

lower prices for those customers who have a more elastic demand.

Price discrimination

Theatres usually charge three different prices for a show. The prices target various age groups, including youth, adults and seniors. The prices fluctuate with the expected income of each age category, with the highest charge going to the adult population.

Some companies, such as firms selling alcoholic beverages, produce similar products but try to promote one as a prestige brand with a much higher price.

Examples of Price discrimination

Price elasticity of demand is relatively high when:

close substitutes are available, the good or service is a large share of the

consumer's budget, a longer time period is considered, the customers are rather poor.

Determinants of price elasticity

Price elasticity of demand is relatively low when:

There are no close substitutes (e.g. electricity, water)

Goods are necessities Customers are rather rich The good or service is a small share of the

consumer's budget

Determinants of price elasticity

The cross-price elasticity of demand between two goods j and k is defined as:

Cross-price elasticity of demand

cross-price elasticity is positive if and only if the goods are substitutes

cross-price elasticity is negative if and only if the goods are complements.

Cross-price elasticity (cont.)

A good is a normal good if income elasticity > 0.

A good is an inferior good if income elasticity < 0.

Income elasticity of demand(film)

A good is a luxury good if income elasticity > 1.

A good is a necessity good if income elasticity < 1.

Income elasticity of demand

Price elasticity of supply

Example: land

Perfectly inelastic supply

Example: perfect competition

Perfectly elastic supply

short run - period of time in which capital is fixed

all inputs are variable in the long run supply will be more elastic in the long run

than in the short run since firms can expand or contract their capital in the long run.

Determinants of supply elasticity

równanie – equation układ równań - simultaneous equations ułamek – fraction ułamek piętrowy – compound fraction malejąca (rosnąca) funkcja – decreasing (increasing) function funkcja liniowa – linear function iloraz – quotient iloczyn – product różnica – difference suma – sum sumowanie – summation dodatni – positive ujemny – negative licznik – numerator mianownik - denominator

Math dictionary

http://www.oswego.edu/~kane/eco101.htm Czarny B. „Podstawy Ekonomii”, 2002 www.wikipedia.org Wood, John C. (1993). Thorstein Veblen:

Critical Assessments, 352. London Alfred Marshall, 1895. Principles of

Economics Bk.III,Ch.VI in paragraph III.VI.17

Bibliography