Overview
This lecture covers the concept of elasticity in economics, focusing on its types, calculations, interpretations, and real-world applications, especially regarding demand and supply.
Types of Elasticity
- Four types: Price Elasticity of Demand (PED), Income Elasticity of Demand (YED), Cross-Price Elasticity of Demand (CED), Price Elasticity of Supply (PES).
- PED is the most emphasized and measures responsiveness of quantity demanded to price change.
Price Elasticity of Demand (PED)
- PED measures the percentage change in quantity demanded due to a percentage change in price.
- PED formula: %ΔQ / %ΔP, where Q is quantity and P is price.
- PED is usually negative for normal goods (obeys Law of Demand).
- A positive PED suggests unusual goods (ostentation, expectation, Giffen, addiction).
Types of PED
- Perfectly Inelastic (PED = 0): Quantity demanded does not change with price (vertical curve; e.g., insulin).
- Inelastic (0 < PED < 1): Quantity demanded changes less than price proportionally (steep curve; e.g., petrol).
- Unit Elastic (PED = 1): Percentage change in quantity equals percentage change in price (45° curve).
- Elastic (PED > 1): Quantity demanded changes more than price (flat curve; e.g., luxury goods).
- Perfectly Elastic (PED = ∞): Any price increase drops demand to zero (horizontal curve).
Determinants of PED
- Availability of substitutes: More substitutes = more elastic.
- Complementary goods: Cheaper joint demand goods are less elastic.
- Luxury vs. necessity: Luxuries are elastic, necessities are inelastic.
- Income proportion spent: Higher proportion = more elastic.
- Durability: More durable goods are more elastic.
- Time: Demand more elastic in the long run.
- Brand loyalty: Strong loyalty makes demand inelastic.
- Alternative uses: Many uses = more elastic demand.
Income Elasticity of Demand (YED)
- YED measures response of demand to income changes.
- YED formula: %ΔQ / %ΔY, where Y is income.
- Positive YED: normal goods (demand rises as income rises).
- Negative YED: inferior goods (demand falls as income rises).
- 0 < YED < 1: Necessities; YED > 1: Luxuries.
Cross-Price Elasticity of Demand (CED)
- CED measures demand change for a good when another good's price changes.
- CED formula: %ΔQ of A / %ΔP of B.
- Positive CED: goods are substitutes.
- Negative CED: goods are complements.
- Zero CED: no relationship.
Price Elasticity of Supply (PES)
- PES measures producer responsiveness to price changes.
- PES formula: %ΔQ supplied / %ΔP.
- PES always positive or zero; zero means perfectly inelastic supply.
- Larger PES means supply is more responsive (elastic).
Determinants of PES
- Capacity: Unused capacity increases elasticity.
- Time: Longer time allows more elasticity.
- Product nature: Perishable goods have inelastic supply.
- Factor mobility: More mobility increases elasticity.
- External factors: Out-of-control issues (e.g., weather) reduce elasticity.
Application to Taxation Policy
- Raising tax on inelastic demand goods increases revenue.
- Raising tax on elastic demand goods reduces consumption but may not raise revenue.
Key Terms & Definitions
- Elasticity — Responsiveness of quantity demanded or supplied to changes in price, income, or other goods’ prices.
- Price Elasticity of Demand (PED) — Percentage change in quantity demanded due to a percentage change in price.
- Income Elasticity of Demand (YED) — Percentage change in demand due to a percentage change in income.
- Cross-Price Elasticity of Demand (CED) — Percentage change in demand for one good due to a percentage change in another good ’s price.
- Price Elasticity of Supply (PES) — Percentage change in quantity supplied due to a percentage change in price.
- Normal Good — Good with positive income elasticity; demand rises with income.
- Inferior Good — Good with negative income elasticity; demand falls as income rises.
- Substitute Good — Goods that can replace each other.
- Complementary Good — Goods used together in joint demand.
Action Items / Next Steps
- Practice calculating PED, YED, CED, and PES for sample goods.
- Memorize characteristics and examples of all five types of PED.
- Review determinants for each type of elasticity.
- Prepare to explain elasticity’s policy applications, especially in taxation.