Elasticity and Its ApplicationsElasticity: a measure of the responsiveness of quantitydemanded or quantity supplied to one of its determinantse.g.:Price elasticity of demand: a measure of the responsivenessof quantity demanded of a good to its price· One of the most important applications:Example: You own a museum and you want to increase yourrevenue (P x Q), should you raise or lower the entrance fee?To answer this question, we need to know the responsivenessof quantity demanded of museum visiting to its pricechange, i.e., we need to know the price elasticity of demandfor museum.
This chapter:· Elasticity of demand· Elasticity of supply· How and where to apply the concept of elasticityThe elasticity of demand· The price elasticity of demand: how sensitive is thequantity demanded of a good to its price change?-- What determine the price elasticity of demand?· Necessities versus Luxuries· Availability of close substitute· Definition of the market· Time horizon
Examples:For each of the following pairs of goods, circle the onethat you expect to have a more elastic demand.1). Automobile v.s. Honda Civic2). Gasoline in New York City v.s. Gasoline in Arizona3). Cosmetics v.s. Salt4). Dentists v.s. EconomistsComputing the price elasticity of demandprice elasticity of demand = (% Δ in QD) / (% Δ in P)= (percentage change in quantity demanded) /(percentage change in price)
e.g. when price ↑ from $2 to $3, QD ↓ from 100 to 50-- Why not simple use ΔQD /ΔP?1. Unit: percentage change is unit free2. Size of the changes in relative term.Case 1: P ↑ from $100 to $101QD ↓ from 2 to 1Case 2: P ↑ from $1 to $2QD ↓ from 100 to 99
-- The elasticity of demand along a linear demand curvePoint A: (P, Q) = ($6, 1)Point B: (P, Q) = ($4, 2)Point C: (P, Q) = ($2, 3)ΔQD / ΔP = -1/2 for all points.Ed (A) = -3Ed (B) = -1Ed (C) = -1/3
-- Total Revenue and the Price Elasticity of Demand-- The Variety of demand curvesRoughly speaking, a flatter demand curve is more elastic thana steep demand curve.· The income elasticity of demand: a measure of the responsiveness of the quantity demandedof a good to a change in consumers’ incomeincome elasticity of demand = (% Δ in QD) / (% Δ in Y)= (percentage change in quantity demanded) / (percentagechange in income)
e.g.:Let price = $10When income = $10,000, QD = 20When income = $20,000, QD = 30Income elasticity of demand = 0.6* “Sign” matters here: Normal goods versus Inferiorgoods
· The cross-price elasticity of demand: a measure of the responsiveness of the quantitydemanded of a good to a change in the price of anothergoodcross-price elasticity of demand= (% Δ in QDGood A) / (% Δ in PGood B)e.g.:Let price of apples unchanged.When price of orange = $2, QDApples = 20When price of orange = $4, QDApples = 30Cross-price elasticity of demand = 0.6* “Sign” matters here: Substitutes versus Complements
The elasticity of SupplyThe price elasticity of supply: how sensitive is the quantitysupplied of a good to its price change?-- price elasticity of supply = (% Δ in QS) / (% Δ in P)= (percentage change in quantity supplied) / (percentagechange in price)-- What determines the price elasticity of supply?· The property of the goods- flexible: manufacturing goods- inflexible: lands with good views, good athletes· the time horizon: the longer, the larger-- The variety of supply curves
Applications1. Can good news for farming be bad news for farmers?- new hybrid of wheat- supply of wheat increases- P ↓ and Q ↑- if price elasticity of demand is small (P x Q) ↓- bad news for farmers!What should farmers have learned from this?- cut production together supply ↓ P ↑and Q ↓ (P x Q) ↑- problem: hard to monitor
2. Does drug interdiction increase or decrease drug-related crime?