Elasticity Elasticity A quantitative tool of analysis used to measure __________________, or the precise change in one thing given a specific change in another. Popular Measures of Elasticity • Price Elasticity of Demand • Income Elasticity of Demand • Price Elasticity of Supply • Cross elasticity of demand Popular Uses of Elasticity • To describe the impact of changes in market conditions on equilibrium, and predict the outcome for consumers and business firms in the market. • To study the impact of price changes on the revenue of a business firm To classify goods To explain why business firms tend to charge more for certain goods, and why certain goods bear the greater burden of taxation. To describe and explain the relationship between two variables over time. In general, elasticity is ______________________________ ____________________________________. • • • • Price Elasticity of Demand Measures the response in quantity demanded to changes in price. It is the percentage change in quantity demanded given a percentage change in price. For example, when e = 0.2, a 10% increase in price leads to a 2% decrease in quantity demanded. When e = 2.0, a 10% increase in price leads to a _____ decrease in quantity demanded. Note: The value of demand elasticity will always be negative because of the inverse relationship between price and quantity demanded. However, ____________________________: equal to one, less than one, or greater than one. Characteristics of Demand Elasticity Value of Type of Demand Elasticity Elastic e>1 Inelastic e<1 Unitary elastic e=1 Magnitudes of Change Response to Price Changes %QD > %P ___________ %QD < %P ___________ %QD = %P Proportional The main determinant of demand elasticity is _______________ ____________________ for the good in question. Type of Elasticity Substitutes Available Elastic _______ Inelastic _______ Shape of Demand According to Elasticity Type of Demand Inclination Elastic ____________ Inelastic ____________ Unitary Elastic ____________ Extreme Elasticities Elasticity Value Type of Elasticity Substitutes Available _____ Perfectly Inelastic ___________ _____ Perfectly Elastic ___________ Elasticity Formulas Point Elasticity Formula Arc or Midpoint Elasticity Formula Elasticity Versus the Slope of Demand Elasticity is similar but not the same as the slope of demand. The slope is an unreliable indicator of sensitivity. Elasticity is a more precise measure used to describe the behavior of two related variables, in percentage terms. Computing the Value of Elasticity Use the Arc Elasticity formula to determine the price elasticity of demand for tennis lessons: When the price of tennis lessons is $20.00, the number of students is 12. When the price goes up to $25.00, the number of students drops to 10. What is the value of elasticity? e = ____ Elasticity Along a Downward-sloping, Linear Demand Curve Computing the Value of Elasticity e = _____ e = _____ Elasticity and Total Revenue The total revenue of a business firm is the amount of money obtained from ___________________. Total Revenue = _________________ By obtaining information about the elasticity of demand for the good it produces, a firm can _____________________________ ______________________. For example, when a good has a relatively elastic demand, a higher price will cause a substantial decrease in quantity demanded. On the other hand, a price decrease will cause a substantial increase in quantity demanded. Lower prices may lead to ______________, __________________. Elasticity, Demand and Total Revenue Price Quantity 1.0 2.0 10.0 110 100 20 11.0 10 5.5 55 Total Revenue Total Revenue is maximum when _____. Elasticity, Total Revenue and Price Changes Income Elasticity of Demand Percentage change in the quantity demanded of a good given a percentage change in _______. Classification of Goods According to Income Elasticity: Income Elasticity Type of Good Responsiveness e i> 0 Income QD ei<0 Income QD ei>1 % QD > % I ei<1 % QD < % I Cross Elasticity of Demand Shows the responsiveness in quantity demanded of one good given a change in ___ __________________. Classification of Goods According to Cross Elasticity: Cross Elasticity Relationship Responsiveness e xy > 0 Py Qx e xy < 0 Py Qx Price Elasticity of Supply Measures the response in quantity supplied to changes in price. Is the percentage change in quantity supplied given a percentage change in price. Interpreting the Value of Supply Elasticity: Value of Elasticity Type of Supply Response to price changes Response to price changes e>1 Elastic %QS > %P ___________ e<1 Inelastic %QS < %P ___________ e=1 Unitary %QS = %P ___________ Shape of Supply According to Elasticity Elasticity Value Type of Supply Inclination e>1 Relatively Elastic ___________________ e<1 Relatively Inelastic ___________________ e=1 Unitary Elastic ___________________ e= Perfectly Elastic __________________ e=0 Perfectly Inelastic ___________________ Shape of Supply According to Elasticity Elasticity and Time Supply and demand tend to be _________________________ ________________________. Supply Elasticity and Capacity Utilization Supply tends to be elastic when _____________________, and inelastic when _______________________. Elasticity and Tax Burdens The ability of the government to collect tax revenue depends to a great extent on _____________________. The government can collect more revenue by taxing goods with ____________________. Ramsey Pricing is the concept that greater equity in taxation is accomplished by ____________________________________ _________________. Elasticity and Tax Burdens Since demand is elastic, ___________________ _______________. Suppose that the government imposes a tax of 20 cents to be collected by producers on each unit of output sold. The tax __________________ ________________________ ________________. The market settles in equilibrium at 40 units of output sold at $1.05. Producers collect $1.05 for each unit of output sold, and pay the government 20 cents. Effectively, producers receive only 85 cents per unit sold. Elasticity and Tax Burdens The same tax has a different incidence when demand is inelastic. The market settles in equilibrium at 46 units of output sold at $1.15. Producers collect $1.15 for each unit of output sold, and pay the government 20 cents. Since demand is inelastic, __________ bear the greater burden of the tax. Effectively, producers receive only 95 cents per unit sold. Elasticity and Tax Burdens When demand is elastic, the loss to producers ________ than the loss to consumers, and the deadweight loss to society as a whole is ______. When demand is inelastic, the loss to consumers is _______ than the loss to producers, and the deadweight loss to society as a whole is ______. Extreme Elasticities and Tax Burdens When demand is perfectly elastic, _______________ _________________. When demand is perfectly inelastic, _________ bear the full burden of a tax.