Lecture on Elasticity

Introduction to Elasticity

• Elasticity measures how much one thing changes in response to a change in another.
• Examples: Price increase in Starbucks vs. gasoline and their impact on consumption.

Types of Elasticity

• Price Elasticity of Demand: How quantity demanded changes with price changes.
  • Illustrated with demand curves for Starbucks coffee and gasoline.
  • Gasoline: Price increase leads to a small decrease in demand.
  • Coffee: Price increase leads to a large decrease in demand.

Quantifying Responsiveness

• Slope vs. Elasticity:
  • Slope relates to rise over run (price over quantity).
  • Elasticity considers percentage changes rather than absolute changes.
  • Formula: % Change in Quantity Demanded / % Change in Price.

Determinants of Elasticity

• Price Elasticity Characteristics:
  • Elasticity is negative due to the law of demand.
  • Elasticity is often expressed in absolute value for simplification.
  • Calculating elasticities with given problems (e.g., price drop from $10 to $9).

Interpreting Elasticity

• Elasticity Values:
  • Elastic: Absolute value > 1 (large quantity change for price change).
  • Inelastic: Absolute value < 1 (small quantity change for price change).
  • Unit elastic: Absolute value = 1 (proportionate change in quantity and price).

Extreme Cases of Elasticity

• Perfectly Inelastic Demand:
  • Example: Snake anti-venom, price changes do not affect quantity demanded.
• Perfectly Elastic Demand:
  • Example: Price for quarters, any increase in price leads to zero demand.

Elasticity and Revenue

• Total Revenue and Elasticity Relationship:
  • Elastic Demand: Price increase reduces revenue.
  • Inelastic Demand: Price increase increases revenue.
  • Revenue maximization occurs at unit elastic point.

Factors Affecting Elasticity

• Substitutes:
  • More substitutes lead to more elastic demand.
• Necessities vs. Luxuries:
  • Necessities are inelastic; luxuries are elastic.
• Budget Share & Time Period:
  • Smaller budget share, less elastic.
  • Over time, elasticity increases as substitutes can be found or adjustments made.

Cross-Price Elasticity

• Substitutes and Complements:
  • Positive elasticity indicates substitutes.
  • Negative elasticity indicates complements.

Income Elasticity of Demand

• Normal and Inferior Goods:
  • Normal goods: Positive elasticity.
  • Inferior goods: Negative elasticity.

Elasticity of Supply

• Price Elasticity of Supply:
  • Measures how quantity supplied changes in response to price changes.
  • Factors: Inventories, available inputs, capacity, entry/exit from the market, time.
• Always positive due to supply curve sloping upwards.

Conclusion

• Elasticity is a crucial concept in economics for understanding how changes in price affect supply and demand.