CH 4
CH 4
Elasticity
Chapter Outline/Learning Objectives
Section Learning Objectives
After studying this chapter, you will be able to
4.1 Price Elasticity 1. explain what price elasticity of demand is and how
of Demand it is measured.
2. explain the relationship between total expenditure
and price elasticity of demand.
4.2 Price Elasticity 3. explain what price elasticity of supply is and how
of Supply it is measured.
4.3 Elasticity Matters for 4. see how elasticity of demand and supply determine the
Excise Taxes effects of an excise tax.
4.4 Other Demand 5. measure the income elasticity of demand and be able
Elasticities to distinguish between normal and inferior goods.
6. measure cross elasticity of demand and be able to
distinguish between substitute and complement goods.
4.1 Price Elasticity of Demand
The more elastic is demand, the less the change in equilibrium price
and the greater the change in equilibrium quantity resulting from
any given shift in the supply curve.
Fig. 4-1(i) The Effects of a Supply Shift (relatively elastic demand)
Fig. 4-1(ii) The Effects of a Supply Shift (relatively inelastic demand)
The Measurement of Price Elasticity
Elasticity (Greek letter eta:) is defined as:
Percentage change in quantity demanded
=
Percentage change in price
Q / Qave
=
p / pave
where pave and Qave are the average price and average quantity.
= (1 000)/(2 500)
(1)/(8.5)
= 0.4
0.1176 = 3.40
Fig. 4-2 Elasticity Along a Linear Demand Curve
D1 shows perfectly
inelastic demand
D2 shows perfectly
elastic demand
Availability of Substitutes
Products with close substitutes tend to have elastic demands;
products with no close substitutes tend to have inelastic demands.
S = Q / Qave
p / pave
Fig. 4-6 Computing Price Elasticity of Supply
Determinants of Supply Elasticity
Ease of Substitution
If the price of a product rises, how much more can be produced
profitably depends on how easy it is for producers to shift from the
production of other products to the one whose price has risen.
Determinants of Supply Elasticity
The question of who bears the burden of a tax is called the question
of tax incidence.
With an excise tax, the price paid by the consumer is pc and the price
received by the seller is ps. The consumer price and the seller price
differ by the amount of the tax, t.
4.4 Other Demand Elasticities
The change in the price of good Y causes the demand curve for good
X to shift.