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Understanding Elasticity in Demand and Supply: Responsiveness to Price Changes

This overview dives into the concept of elasticity in economics, particularly focusing on the responsiveness of quantity demanded and supplied to price fluctuations. We explore the three primary types of elasticity: own-price elasticity (how quantity demanded changes with own price), cross-price elasticity (how quantity demanded changes due to another good's price), and income elasticity (how quantity demanded shifts with income changes). The text clarifies key factors influencing own-price demand elasticity, such as availability of substitutes, time adjustments, and the proportion of income spent, highlighting the implications of different elasticity magnitudes.

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Understanding Elasticity in Demand and Supply: Responsiveness to Price Changes

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Presentation Transcript

  1. Elasticity: Demand & Supply How Responsive is Quantity Demanded/Supplied to Changes in Price

  2. Types of Elasticities • Generally 3 categories we are concerned about • Price elasticity • Own-price: • How quantity demanded changes with the (own) price • Cross-price • How quantity demanded changes with another (cross) good’s price changes • Income • How quantity demanded changes with a change in your income • Supply elasticity • How quantity supplied changes with a change in (own/market) price

  3. Own-Price (Demand) Elasiticity • Economist use the (own) price elasticity of demand to summarize how responsive quantity demanded is to price • Demand curves are not always linear; and responsiveness can change with price

  4. Demand ElasticityOwn-Price • Always negative • First law of demand • Talk about it in absolute terms • Less than |1| -> inelastic • Not very price responsive • Equal to |1| -> unit elastic • % change in Qd = % change in price • More than |1| -> (highly) elastic • Very price responsive

  5. Elasticity Measures • 3 Major Types for Demand • Own-price • Measures the change in quantity demanded with a change in the (own) good’s price • Always negative (F.L.O.D) • Always expressed in absolute value (as it’s always negative) • Cross-price • Measures the change in quantity demanded with a change in the price of a related good (e.g. complement or substitute) • Complement (-) Substitute (+) • Income • Measures the change in quantity demanded with a change in income • Normal/superiors goods (+) Inferior goods (-)

  6. What Affects Own-Price Demand Elasticity? • Availability and closeness of substitutes • “better/closer” substitute makes it to switch • Results in either • Greater movement along the demand curve (own) • Greater shift of the demand curve (cross) • Time • More time to adjust, more options you can find • Long-run elasticity > short-run • Proportion of Income spent on the good • Larger proportion -> more sensitive to changes in Income

  7. What Does the Magnitude of the Elasticity Tell Us? • Own-price • Larger absolute value (|e| > 1) • Large changes in Qd with small changes in price • Close substitutes exist (pepsi/coke) • Or much consumption is discretionary (micro-brews) • Cross-price • Large value (e >1) • Close (or good) substitute for good exists • Complements • Large absolute value (|e| > 1) • Consumption in fixed proportions • Income • >1 superior (luxury?) good • >0 normal • < 0 inferior (Animal beer)

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