Economics Chapter 4: Elasticity

Elasticity

• Price Elasticity of Demand: measures responsiveness of quantity demanded to changes in price, expressed as a percentage change in quantity demanded in response to a 1% change in price.
• Formula: ε = (percentage change in quantity demanded) / (percentage change in price)
• Elastic demand: ε > 1 (quantity demanded responds strongly to price changes)
• Inelastic demand: ε < 1 (quantity demanded responds weakly to price changes)
• Unit elastic demand: ε = 1 (quantity demanded responds equally to price changes)

Determinants of Price Elasticity of Demand

• More options, more elastic
• Large share of budget, more inelastic
• Long time to adjust, more elastic

Examples of Elasticities

• Green peas: 2.8 (elastic)
• Restaurant meals: 1.6 (unit elastic)
• Beer: 1.2 (inelastic)
• Coffee: 0.3 (inelastic)

Graphical View of Price Elasticity

• ΔQ / Q = ε x ΔP / P
• Slope of the demand curve affects price elasticity
• At the midpoint, demand is unit elastic
• At high P and low Q, demand is elastic
• At low P and high Q, demand is inelastic

Unintended Effects of the Yacht Tax

• Hypothesis: Luxury tax on yachts over $100,000 would yield $31 million in tax revenue
• Actual tax revenue: $16.6 million (people bought yachts outside the US to avoid the tax)

Price Elasticity Notation

• ε = (percentage change in quantity demanded) / (percentage change in price)
• ΔQ is the change in quantity, ΔP is the change in price

Special Cases

• Perfectly Elastic Demand: infinite price elasticity of demand
• Perfectly Inelastic Demand: zero price elasticity of demand

Cross-Price Elasticity of Demand

• measures responsiveness of quantity demanded of good A to changes in the price of good B
• Sign of cross-price elasticity shows the relationship between the goods
  • Complements: negative cross-price elasticity
  • Substitutes: positive cross-price elasticity

Income Elasticity of Demand

• measures responsiveness of quantity demanded to changes in income
• Positive income elasticity: normal good
• Negative income elasticity: inferior good

Price Elasticity of Supply

• measures responsiveness of quantity supplied to changes in price
• Formula: ε = (percentage change in quantity supplied) / (percentage change in price)

Determinants of Price Elasticity of Supply

• Supply curve with a positive intercept: price elasticity of supply decreases as Q increases
• Supply curve with a zero intercept: price elasticity of supply is 1.00### Perfectly Elastic Supply
• A perfectly elastic supply means selling all units at a fixed price with no volume discounts.
• The cost of production remains constant at $0.14 for all levels of quantity.
• An example of this is a lemonade stand where the cost of production is $0.14.

Determinants of Price Elasticity of Supply

• Input flexibility leads to more elastic supply as resources can adapt to changes.
• Mobility of inputs increases elasticity as resources can be moved to where they are needed.
• The use of substitute inputs makes supply more elastic.

Gas Prices and Car Prices

• Short-run elasticity of demand for gasoline is smaller compared to car prices.
• This is because it is difficult to adjust quickly to changes in gas prices.
• Supply of cars is relatively stable, and inputs are readily available.

Supply Bottleneck: Unique Inputs

• The supply of a product becomes inelastic if it relies on a single unique input with no alternatives.
• Examples include sports stars, actors, and musicians who have unique talents.
• Over time, producers can develop alternative production methods, making supply more elastic.

The Midpoint Formula for Elasticity of Demand

• Elasticity of demand changes at each point on the demand curve.
• The midpoint formula is used to calculate elasticity, taking into account average quantity and price.
• The formula is: ε = ΔQ / [(QA + QB)/2] / ΔP / [(PA + PB)/2].
• Using the midpoint formula provides a more stable solution.