Chapter 5 - Elasticity

Elasticity
So…How Much Do You Really Need It?
1 Elasticity of Demand
There are certain markets with more elastic demand and supply. Sometimes the market is more
responsive/resistant. Refers to the responsiveness of the quantity demanded of a good to change in:
 The price of that good (price elasticity)  focus

 Income (income elasticity)
 The price of another good (cross elasticity)
Ex: Prices are so much higher at your local convenience store “Royal Blue Grocery” as compared
to “Trader Joe’s” because you pay a price for convenience (Royal Blue opens longer, some for
24hrs)
2 Determinants of Price Elasticity “E” is for “Escape”

When and how bad do you need it? How readily can you escape a price hike?
 Substitutes
 Necessities vs. Luxuries
 Time Horizon (can you wait)
 Definition of the market (how broad?)
2.1 Substitutes
Availability of close substitutes  it’s easier to escape a price increase  demand is more elastic
Ex: Butter has more substitutes. Eggs has less/none. Demand for eggs is inelastic.
2.2 Necessities vs. Luxuries

Luxury goods  easier to escape from when their prices rise  more elastic demand
Necessities  more difficult to escape from when their prices rise  more inelastic demand
Ex: a speedboat (luxury) to a car (necessity).
2.3 Time Horizon

Longer time horizon  more time to adjust (escape) price changes  more elastic demand. The future
allows you to adjust, the present makes you stuck. Demand is more elastic in the future.
 Short run  the time period before I have time to partially adjust.
 Long run  time to fully adjust
 Immediate-run  No time to adjust
Demand is generally more inelastic in the short run than the long run.
2.4 Definition of the market
Narrowly defined market  easier to escape  more elastic demand. There are many substitutes to
the iPhone.
Broadly defined markets  more difficult to escape  more inelastic demand. The demand for phones
in general.
*The demand for iPhone is more elastic than the demand for phones in general.
3 Calculating Elasticity in Demand

The price elasticity of demand as a result of Midpoint formula
moving from point A(Q1,P1) to point B(Q2,P2)
on the demand curve is:
Price of elasticity of demand will always be negative because by definition demand goes down.
Elasticity
|Elasticity|<1 |Elasticity|=1 | Elasticity|>1
Unitary elastic
Inelastic The price increases 1%, quantity Elastic
demanded decrease by 1%
SC: Suppose that college students can be broken up into two groups: Group 1 consists of
Freshmen & Sophomores; Group 2 consists of Juniors & Seniors. Which of the two groups has
a more elastic demand for education? A: Group 1; they haven’t invested too much in education
yet. Towards the end of your education, you’ve invested too much into it already, so it’s more
difficult for you to escape the price hike.
4 Elasticity and Revenue

Why does it matter for the supplier to know what kind of demand they have their product?
Revenue = P x Q
In Scenario 1, the revenue rose up. In Scenario 2, the revenue went down. If we have an inelastic
product, revenue goes up. If we have an elastic product, the revenue goes down.
SC: If someone is an extreme coupon clipper, what does that tell you about their price elasticity
of demand for various products? A: elastic. We’re very sensitive in increases in price.
If someone is an extreme coupon clipper, what does that tell you about the opportunity cost
of their time compared to another person who does not clip coupons at all? A: op. cost is very
low, the value of our time is lower than somebody like Bill Gates.
5 The Different Demand Curves

5.1 Perfectly inelastic 5.2 Relatively inelastic
A steep slope would indicate that it’s relatively
(extreme) inelastic. Ex: cigarettes, heroin, anything with
No matter how much the price increases, I will
addictive qualities (to the addicted) or
pay whatever it takes. Ex: Since it’s an extreme
extremely necessary like water or electricity.
this isn’t really accurate but 70% of pet owners
would pay any amount of money to save their
pet’s life. Slope is 0.
5.3 Relatively elastic 5.4 Perfectly elastic

The slope is smaller. My quantity demanded If the price goes up by a penny, you respond a
goes down a lot if the price is raised. Ex: apples, lot to that penny. Ex: Would you pay $120 to
brand of red wine, etc. get a $100 bill? No. You value $100 at $100. It
doesn’t make sense to value it more and it
does not make sense to value it less. The
demand curve is completely flat. Slope is
infinite. Another example is gasoline. It’s the
same product everywhere so it does not
matter where you buy.
6 Price Elasticity of Supply
Refers to the responsiveness of the quantity supplied of a good to change in the price of that good.
6.1 Time Horizon

Affects elasticity of supply the mos. Time allows suppliers to adjust fully, some wiggles room.

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Elasticity

So…How Much Do You Really Need It?

 The price of that good (price elasticity)  focus

2 Determinants of Price Elasticity “E” is for “Escape”

2.2 Necessities vs. Luxuries

Ex: a speedboat (luxury) to a car (necessity).

2.3 Time Horizon

3 Calculating Elasticity in Demand

4 Elasticity and Revenue

5 The Different Demand Curves

5.3 Relatively elastic 5.4 Perfectly elastic

6.1 Time Horizon

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