Elasticity

A Brief Lesson byNancy Carter

Definition

• Elasticity is a measure of sensitivity. We use the coefficient of elasticity to evaluate how sensitive one variable is to the change in another.

General Formulas

I suggest you learn the relationships and then worry about formulae. There is a basic set you will use that adapt to alltypes of elasticity.

The basic formulae you will use are

1. The midpoint formula for calculating percentage change

2. The formula for the coefficient of elasticity

Variables UsedΔ = ChangeY = IncomeP = Price

Midpoint Formula

The Midpoint formula gives you a better measure of elasticityIt is the difference in values divided by the average as you movefrom one point to the next.

Example:

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Coefficient of Elasticity Formula

The name of the type of elasticity tells you which variable goes in the numerator and which in the denominator. The first variable in the name is the denominatorvalue and the last is the numerator value.

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Four Types of Elasticity

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Price Elasticity of Demand

Measures the sensitivity of Demand to a change in the price of the good.

Home Midpoint Coefficient ExitMenu

Determinants ofPrice Elasticity of Demand

Tastes and PreferencesIncomeNumber of Substitutes AvailableLuxury versus NecessityTimeExpectations

CoefficientMidpointHome ExitMenu

Ranges of Price Elasticity of Demand

Home Midpoint Coefficient ExitMenu

If Є=0 Perfectly InelasticIf Є<1 Relatively InelasticIf Є=1 Unit ElasticIf Є>1 Relatively ElasticIf Є= ∞ Perfectly Elastic

Price Elasticity of SupplyMeasures the sensitivity of Supply to a change in the price of the good.

CoefficientMidpointHome ExitMenu

Determinants ofPrice Elasticity of Supply

Time is the only significant determinant of the

Price Elasticity of Supply.

MidpointHome ExitMenu Coefficient

Ranges of Price Elasticity of Supply

CoefficientMidpointHome ExitMenu

If Є=0 Perfectly InelasticIf Є<1 Relatively InelasticIf Є=1 Unit ElasticIf Є>1 Relatively ElasticIf Є= ∞ Perfectly Elastic

Income Elasticity of Demand

Measures the sensitivity of Demand to a change in Income

CoefficientMidpointHome ExitMenu

Determinants of Income Elasticity of Demand

Normal Good – Demand rises with Income – Coefficient is Positive

Inferior Good – Demand falls as Income Rises – Coefficient is Negative

CoefficientMidpointHome ExitMenu

Cross Price Elasticity of Demand

Measures the sensitivity of Demand to a price change of another good.

CoefficientMidpointHome ExitMenu

Complements – Items consumed together – Coefficient will be Negative

Substitutes – Items consumed instead of – Coefficient will be Positive

CoefficientMidpointHome ExitMenu