Elasticity in Economics

Study Notes

Understanding Elasticity

Elasticity measures the responsiveness of quantity demanded (Qd) or quantity supplied (Qs) to changes in its determinants.
Key issues analyzed through elasticity include consumer behavior, market dynamics, and business pricing strategies.

Price Elasticity of Demand (PED)

PED quantifies how much the quantity demanded of a good responds to price changes, indicating price sensitivity of consumer demand.
Formula: Price Elasticity of Demand = (Percentage Change in Qd) / (Percentage Change in Price)
Typically expressed as a positive number, though it is inherently negative due to the inverse relationship between price and quantity demanded.

Demand Curve Relationship

Along the demand curve, price and quantity move in opposite directions, leading to a negative PED value.
For practical purposes, the minus sign is usually dropped when reporting elasticity.

Revenue and Expenditure

Changes in price directly impact total revenue and consumer expenditure.
An increase in price may lead to decreased quantity demanded, affecting overall revenue.

Price Elasticity of Supply (PES)

PES measures how the quantity supplied responds to price changes.
Related to the supply curve, higher elasticity indicates that producers can increase supply without a significant delay.

Income and Cross-Price Elasticities of Demand

Income elasticity assesses how demand changes with consumer income variations.
Cross-price elasticity measures the responsiveness of demand for one good in relation to the price change of another good.

Practical Scenario: Website Pricing

Current price charged is $200 for website design, resulting in 12 sales per month.
Rising costs prompt consideration of a price increase to $250, invoking the law of demand; potential reduction in sales is anticipated.
Understanding how many fewer websites will be sold and the resulting impact on revenue is crucial.

Calculating Price Elasticity of Demand

Example calculation:
- Initial price $200 to $250 results in a percentage change of 25%.
- Quantity change from 12 to 8 reflects a percentage change of -33%.
- Resulting price elasticity = 33% / 25% = 1.33 for the first scenario.
Alternative calculation approaches, including the midpoint method, provide varied elasticity values based on different starting and ending points.

Midpoint Method of Elasticity Calculation

The midpoint method averages the start and end values, refining percentage change calculations:
- Percentage change in Price = (End Value - Start Value) / Midpoint
- Example yields a price increase of 22.2% and a quantity decrease of 40%, resulting in a price elasticity of 1.8.

Application to iPhones

Given a scenario with price set at $400, applying elasticity concepts would help evaluate market behavior for iPhone purchases based on price adjustments.

Description

This quiz covers the concept of elasticity in economics, including its definitions and applications. Explore the price elasticity of demand and supply, and understand their impact on revenue, expenditure, and the demand and supply curves. Delve into income and cross-price elasticities to enhance your grasp of this fundamental economic principle.