ElasticityElasticity measuresWhy Economists Use ElasticityWhat is an Elasticity?2 VIP ElasticitiesExamples of Own Price Demand ElasticitiesExamples of Own Price Supply ElasticitiesExamples of Unit-free ComparisonsSlide 9Inelastic Economic RelationsElastic Economic RelationsSize of Price ElasticitiesGeneral Formula for own price elasticity of demandNote:Arc Formula for Elasticity - GeneralArc Formula for Own Price Elasticity of DemandPoint Formula for Own Price Elasticity of DemandSlope of the Demand CurveSlope Compared to ElasticityExample: Elasticity Calculation at “A”Exercise -- Linear DemandElasticities and Linear DemandSupply ElasticitiesSome Technical Definitions For Extreme Elasticity ValuesPerfectly Elastic DemandPerfectly Inelastic DemandPerfectly Elastic SupplyPerfectly Inelastic SupplyDeterminants of elasticityRemindersUsing Demand Elasticity: Total ExpendituresBridge Toll ExampleBridge Toll: Elastic DemandBridge Toll Example, Part 2Bridge Toll: Inelastic DemandElasticity and Total ExpendituresElasticity and Total Expenditure (Graph)Change in Expenditure ComponentsTwo real world examplesOther Price Elasticities: Cross- Price Elasticity of DemandOther Price Elasticities: Cross Price Elasticity of DemandOther Elasticities: Income Elasticity of Demand1Elasticity2Elasticity measuresWhat are they?–Responsiveness measuresWhy introduce them?–Demand and supply responsiveness clearly matters for lots of market analyses.Why not just look at slope?–Want to compare across markets: inter market –Want to compare within markets: intra market–slope can be misleading–want a unit free measure3Why Economists Use ElasticityAn elasticity is a unit-free measure.By comparing markets using elasticities it does not matter how we measure the price or the quantity in the two markets.Elasticities allow economists to quantify the differences among markets without standardizing the units of measurement.4What is an Elasticity?Measurement of the percentage change in one variable that results from a 1% change in another variable.Can come up with many elasticities.We will introduce four.–three from the demand function–one from the supply function52 VIP ElasticitiesPrice elasticity of demand: how sensitive is the quantity demanded to a change in the price of the good.Price elasticity of supply: how sensitive is the quantity supplied to a change in the price of the good.Often referred to as “own” price elasticities.6Examples of Own Price Demand ElasticitiesWhen the price of gasoline rises by 1% the quantity demanded falls by 0.2%, so gasoline demand is not very price sensitive.–Price elasticity of demand is -0.2 .When the price of gold jewelry rises by 1% the quantity demanded falls by 2.6%, so jewelry demand is very price sensitive.–Price elasticity of demand is -2.6 .7Examples of Own PriceSupply ElasticitiesWhen the price of DaVinci paintings increases by 1% the quantity supplied doesn’t change at all, so the quantity supplied of DaVinci paintings is completely insensitive to the price.–Price elasticity of supply is 0.When the price of beef increases by 1% the quantity supplied increases by 5%, so beef supply is very price sensitive.–Price elasticity of supply is 5.8Examples of Unit-free ComparisonsGasoline and jewelry –It doesn’t matter that gas is sold by the gallon for about $1.09 and gold is sold by the ounce for about $290.–We compare the demand elasticities of -0.2 (gas) and -2.6 (gold jewelry).–Gold jewelry demand is more price sensitive.9Examples of Unit-free ComparisonsPaintings and meat –It doesn’t matter that classical paintings are sold by the canvas for millions of dollars each while beef is sold by the pound for about $1.50.–We compare the supply elasticities of 0 (classical paintings) and 5 (beef).–Beef supply is more price sensitive.10Inelastic Economic RelationsWhen an elasticity is small (between 0 and 1 in absolute value), we call the relation that it describes inelastic.–Inelastic demand means that the quantity demanded is not very sensitive to the price.–Inelastic supply means that the quantity supplied is not very sensitive to the price.11Elastic Economic RelationsWhen an elasticity is large (greater than 1 in absolute value), we call the relation that it describes elastic.–Elastic demand means that the quantity demanded is sensitive to the price.–Elastic supply means that the quantity supplied is sensitive to the price.12Size of Price ElasticitiesUnit elastic: own price elasticity equal to 10 1 2 3 4 5 6Unit elasticInelastic ElasticElastic: own price elasticity greater than 1Inelastic: own price elasticity less than 113General Formula for own price elasticity of demandP = Current price of good XXD = Quantity demanded at that priceP = Small change in the current priceXD= Resulting change in quantity demandedPricein Change PercentageDemandedQuantity in Change PercentageElasticity 14Note:The own price elasticity of demand is always negative.Economists usually refer to the own price elasticity of demand by its absolute value (ignore the negative sign).So, even though the formula says that the own price elasticity of demand is negative, we would say the elasticity of demand is 1.5 in the first example and 0.67 in the second.15Arc Formula for Elasticity - GeneralAlthough the exact formula for calculating an elasticity is useful for theory, in practice economists usually calculate an approximation called the arc elasticity.You are really approximating the elasticity between two points.Need two points to perform the calculation.16Arc Formula for Own Price Elasticity of DemandGet two points of the demand curve: Points A and B.Consider PA and XA and PB and XB from the demand relationship.Note: we’ll take absolute valuePavgPPXavgXXelasticityBABA/)(/)(17Point Formula for Own Price Elasticity of DemandThe exact formula for calculating an elasticity at the point A on the demand curve.Note: we’ll take absolute valueatAPXXPel as ti cityDAA18Slope of the Demand CurveP is the change in price. (P<0)PriceQuantityDemandX X + XXPP+ PPX is the change in quantity.slope = P/ XXPslope1/slope = X/ P19Slope Compared to ElasticityThe slope measures the rate of change of one variable (P, say) in terms of another (X,