ECON1010 (Lec 05) - Elasticity and Its Applications

Elasticity and Its Applications

Elasticity

• allows precise analysis of supply and demand.
• Measures how buyers and sellers respond to market changes.

The Elasticity of Demand

• Price elasticity of demand: Measures quantity demanded response to price change.
• Determinants:
  • Availability of close substitutes
  • Necessities vs. luxuries
  • Definition of the market
  • Time horizon
    • the period of time consumer react to the change in price
    • TED lower in the short run
    • TED higher in the long run ← can find substiture goods

Computing Elasticity

• Calculated as the percentage change in quantity demanded divided by the percentage change in price.
• Midpoint method preferred for consistent results.

Types of Demand Curves

1. Inelastic Demand
   • Quantity demanded less responsive to price changes.
   • Price elasticity of demand < 1
2. Elastic Demand
   • Quantity demanded highly responsive to price changes.
   • Price elasticity of demand > 1
3. Perfectly Inelastic
   • Quantity demanded unaffected by price changes.
4. Perfectly Elastic
   • Quantity demanded changes infinitely with any price change.
5. Unit Elastic
   • Quantity demanded changes proportionally to price changes.

Total Revenue and Elasticity

• Total revenue = price x quantity sold.
• Inelastic demand: Price increase leads to smaller quantity decrease, increasing total revenue.
• Elastic demand: Price increase leads to larger quantity decrease, decreasing total revenue.

Income Elasticity of Demand

• Measures how quantity demanded responds to changes in consumers’ income.
• Calculated as the percentage change in quantity demanded divided by the percentage change in income.

Types of Goods

• Normal Goods: Higher income raises demand.
• Inferior Goods: Higher income lowers demand.
• Necessities: Income inelastic.
• Luxuries: Income elastic.

The Elasticity of Supply

• Price elasticity of supply: Measures quantity supplied response to price change.
• Calculated as the percentage change in quantity supplied divided by the percentage change in price.

Determinants of Elasticity of Supply

• Ability to change production amount.
• Time period: More elastic in the long run.

Computing Elasticity

• Calculated as the percentage change in quantity supplied divided by the percentage change in price.

Applications of Supply, Demand, and Elasticity

• Analyzing the impact of new agricultural technology on wheat farmers.
• Examining shifts in supply or demand and their effects on market equilibrium.

Example: Increase in Supply for Wheat

• Shift in supply curve analyzed using supply-and-demand diagram.
• Market equilibrium changes evaluated.

Summary

• Price elasticity of demand measures responsiveness to price changes.
• Income elasticity measures responsiveness to income changes.
• Price elasticity of supply measures responsiveness to price changes.
• Supply is generally more elastic in the long run.
• Tools of supply and demand applicable in various market scenarios.