Prepared by: Sheen Kyra V. Alaurin Christian B.

Acosta

In economics, the concept of elasticity measures the responsiveness of one variable to a certain change of another variable. Looking into details, there are two significant words: measure, reported as numbers of coefficients, and responsiveness, meaning reaction to change. Thus, any change causes people to react, and elasticity measures this extent to which the people react. Proportional measure of percentage change in variables measures the responsiveness of consumers and producers.

 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 measure

Its concepts have several advantages to the business worlds.  It has several applications both in business and economic decision-making.  Having knowledge of elasticity helps every policy formulating body of a certain firm to formulate appropriate strategies and programs. It can determine the effect of the price changes on the revenue. Hence the producers can assess customers responsiveness with respect to any change in price of commodity.


 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.

 Gasoline and

Jewelry

It doesnt 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.

The basic formula used to determine elasticity is:

Elasticity =

Percentage change in variable x __________________________ Percentage change in variable y

Using mathematical symbols,

% x ____ % y

where: = Greek letter epsilon used as symbol for elasticity = Greek letter delta, which means change % = percentage

Elasticity, therefore, is the percentage change in one variable in relation to the percentage change in another variable.

% x % Q Elasticity = ____ = _________ % y % P

Q / Q1 P / P1 Q2 Q1 / Q1 P2 P1 / P1

= _______ = ________ x Q Q2 Q1 Whereas Slope only means: ____ = ____ = _______ y P P2 P1

Its always a ratio of percentage changes. That means it is a pure number - there are no units of measurement on elasticity. Price elasticity of demand is computed along a demand curve.

Elasticity is not the same as slope.

Price elasticity measures the percentage change in quantity with respect to percentage change in price. Categories of price elasticity include price elasticity of demand and price elasticity of supply.

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.


The price elasticity of demand measures the responsiveness of he quantity demanded with respect to its price. The basic formula used to calculate the coefficient of price elasticity of demand (P D) is: Price Elasticity of Demand = Percentage change in quantity demanded OVER Percentage change in price

% Qd

Q / Q1

Q2 Q1 / Q1

Q2 Q1

P1

D = _____ = _____ = _________ = ______ X __

% P P/ P1 P2 P1 / P1 P2 P1 Q1

Price elasticity of demand is the percentage change in quantity demanded the occurs with respect to a percentage change in price. Considering that an increase in the price of a good or service would result to a decline in quantity demanded, it is expected that the price elasticity of demand is negative because the relationship between price and quantity demanded is inversely related.

 The

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.

Values of price elasticity of demand ranges from zero to infinity. Price elasticity of demand is categorized depending upon the response of quantity demanded to change in price as follows:

A certain good is price elastic when the elasticity coefficient is greater than one. This means that a small change in price result in a greater change in quantity demanded. For example, doubling the increase in price led to almost three times decrease in quantity demanded. Thus, the price of good is responsive to each quantity demanded. This means that the consumer is sensitive to the price of goods.

A certain good is price inelastic when the elasticity coefficient is less than one. This means that a percentage change in quantity demanded is less than the percentage change in price. For example, doubling the change (increase) in price resulted to half the decrease in quantity demanded. It only shows that consumers are not sensitive to any change in price. Goods of this type are essential to the consumers so that it is difficult for them to be without it. As a result any change in price has little significance.

A certain good is unitary elastic when elasticity coefficient is equal to 1. This means that a change in price is equal to a change in quantity demanded.

A good is perfectly elastic when elasticity coefficient equals infinity is shown in figure 18. This means that without change in price, an infinite change occurs in quantity demanded.

A good is perfectly inelastic when elasticity coefficient equals zero as presented in figure 19. This means that any change in price creates no change in quantity demanded.

Some goods are more responsive to any change in price while others are not. Others are prone to being elastic or inelastic than others. There are some reasons behind these elasticity differences. These are the reasons:

The importance or degree of necessity of the goods. The more essential or necessary the goods or services are, the more inelastic the demand will be. On the other hand, goods and services that are not very important tend to have an elastic demand. Number of available substitutes. Demands for goods with greater number of substitutes are elastic, while goods with less of no substitute have inelastic demand. This is because an increase in the price of a certain product encourages consumers to look for alternative or substitute goods available in the market.

The proportion of income in price changes. Demand is inelastic for a product whose changes in price seemingly have no effect on the consumer income or budget. However, any change in price resulting to a substantial effect on consumers income has elastic demand. The time period. The longer the time period is, the more elastic or inelastic the demand will be. This is because consumers have enough time to adjust their buying behaviour.

The concept of price elasticity of supply measures the responsiveness of quantity supplied in response to a percentage change in the price of the goods. The formula of the price elasticity of supply is identical to that of price elasticity of demand only that substitutes supply for demand, as follows:

Price Elasticity of Supply = Percentage change in quantity supplied OVER Percentage change in price

Mathematically,
% Qs Q / Q1 Q2 Q1 / Q1 Q2 Q1 P1

S = _____ = _____ = _________ = ______ X __

% P P/ P1 P2 P1 / P1 P2 P1 Q1

 The

price elasticity of supply is always positive.  Economists refer to the price elasticity of supply by its actual value.

Like demand elasticity, there are five cases of responses of suppliers to any price changes:

A change in price leads to a greater change in quantity supplied. This only shows that suppliers are sensitive at any change in price. As presented in figure 21, an increase in price from 5 to 10 led to an increase in quantity supplied from 4 to 12. This particular reaction also applies if the price of certain product decreases. That is, a certain product decreases. That is, a certain decrease in price let to a greater decrease in quantity supplied. Goods that can be produced immediately by manufacturing firms are of this type of elasticity.

A change of price leads to a lesser change in quantity supplied. This manifests that suppliers are weak in response to any price changes. For instance, figure 22 shows that an increase in price from 4 to 8 led to an increase in price from 4 to 6 only. This type of elasticity is very common to agricultural products which take time to be produced.

A change of price leads to an equal change in quantity supplied. As shown in figure 23, the increase in price from 4 to 8 equally matches an increase in quantity supplied.

This occurs when there is no change in price, and there is an infinite change in quantity supplied. Figure 24 represents this type of elasticity which displays an indefinitely large quantity response even without change in the price.

This happens when a change in price has no effect on quantity supplied as shown in figure 25. This is very common to a fixed input in production particularly land. Regardless of any change in price of land brought about by development, suppliers (developers) cannot increase the land they will supply.

The primary determinant of price elasticity of supply is the time period involved. Alfred Marshall, noted economist, distinguished the time period of supply as follows:

Monetary or Intermediate. In this period supply will be perfectly inelastic and the supply is fixed. Short-run. In this state supply is inelastic. The output of production can increase even if equipment is fixed. Long-run. In this period, supply is elastic. New firms are expected to enter or the old one may leave the industry.

In principle, you can compute the elasticity between any two variables.
Income elasticity of demand Cross price elasticity of demand Of which the two elasticities have different purposes

Elasticity

slide 36

How Sensitive Is The Quantity Demanded Of Good X To Changes In Income

Each of these concepts has the expected definition. For example, income elasticity of demand is the percent change in quantity demand divided by a percent change income: EINCOME =

% change in Q % change in I

Income elasticity of demand will be positive for normal goods, negative for inferior ones.

The elasticity of demand with respect to a consumers income is called the income elasticity.

When the income elasticity of demand is positive (normal good), consumers increase their purchases of the good as their incomes rise (e.g. automobiles, clothing). When the income elasticity of demand is greater than 1 (luxury good), consumers increase their purchases of the good more than proportionate to the income increase (e.g. ski vacations). But when the income elasticity of demand is positive but less than 1, the goods are considered as necessity goods. When the income elasticity of demand is negative (inferior good), consumers reduce their purchases of the good as their incomes rise (e.g. potatoes).

Coefficient
IEd < 0 (Neg)

Classification
Inferior Good Inverse Relationship Between Demand & Income

IEd > 0 & < 1 Normal - Necessary Good Direct Relationship Between Demand & Income IEd > 1 Normal - Luxury Good

How Sensitive The Quantity Demanded Of X Is To Changes In The Price Of Y



Elasticity of demand with respect to the price of a complementary good (cross-price elasticity) This elasticity is negative because as the price of a complementary good rises, the quantity demanded of the good itself falls. Example software is complementary with computers. When the price of software rises the quantity demanded of computers falls.

Elasticity of demand with respect to the price of a substitute good (also a cross-price elasticity) This elasticity is positive because as the price of a substitute good rises, the quantity demanded of the good itself rises. Example. Consider two goods as substitute goods (playstation and xbox). If the price of the playstation increases, its quantity demanded tends to decline because the customers shifts to buy xbox. Thus, demand for xbox will increase.

Ced > 0 (+) Substitute Good

Ced = 0 Independent Good

Ced < 0 (-) Complement Good