ECON10004 Lecture Notes - Lecture 3: Demand Curve, Time Horizon, Complementary Good
Microeconomics Week 3
CHAPTER 5: ELASTICITY AND ITS APPLICATION
Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to
one of its determinants
Price Elasticity of Demand: a measure of how much the quantity demanded of a good
responds to a change in the price of that good, calculated as the percentage change in
quantity demanded divided by the percentage change in price
• Demand for a good said to be elastic if quantity demanded responds substantially to
price changes
• Inelastic is quantity demanded responds only slightly to changes in price
Availability of Close Substitutes
• Goods with close substitutes tend to have more elastic demand because it is easier
for consumers to switch
Necessities versus Luxuries
• Necessities tend to have inelastic demands
• Luxuries tend to have elastic demands
• Whether good is necessity or luxury depends on preferences of buyer, not intrinsic
properties of goods
Definition of the Market
• Narrowly defined markets tend to be have more elastic demand than broadly
defined markets since its easier to find close substitutes for narrowly defined goods
Time Horizon
• Goods tend to have more elastic demand over longer time horizons
COMPUTING THE PRICE ELASTICITY OF DEMAND
Price elasticity of demand = % change in quantity demanded / % change in price
• Percentage change in quantity will always have opposite sign to percentage change
in price as quantity demanded of good is negatively related to its price
THE VARIETY OF DEMAND CURVES
• Demand elastic when elasticity greater than 1, so that quantity moves
proportionately more than price
• Inelastic when less then 1, quantity moves proportionally less than price
• If elasticity is 1, percentage change in quantity equals percentage change in price;
demand is said to have unit elasticity
• The flatter the demand curve that passes through given point, the greater the price
elasticity of demand
• The steeper the demand curve, the smaller the price elasticity of demand
• Zero elasticity = perfectly inelastic = vertical, perfectly elastic = horizontal
find more resources at oneclass.com
find more resources at oneclass.com
TOTAL REVENUE AND THE PRICE ELASTICITY OF DEMAND
Total Revenue (in a market): the amount paid by buyers and received by sellers of a good,
calculated as the price of the good times quantity sold
General Rules:
• When a demand curve is inelastic (a price elasticity less than 1), a price increase
raises total revenue and a price decrease reduces total revenue.
• When a demand curve is elastic (a price elasticity greater than 1), a price increase
reduces total revenue and a price decrease raises total revenue.
• In the special case of unit elastic demand (a price elasticity exactly equal to 1), a
change in the price does not affect total revenue.
find more resources at oneclass.com
find more resources at oneclass.com
OTHER DEMAND ELASTICITIES
Income Elasticity of Demand: a measure of how much the quantity demanded of a good
respods to a hage i osuers’ ioe, alulated as the peretage hage i
quantity demanded divided by the percentage change in income
Income elasticity of demand = % change in quantity demanded / % change in income
Cross-Price Elasticity of Demand: a measure of how much the quantity demanded of one
good responds to a change in the price of another good, computed as the percentage
change in quantity demanded of the first good divided by the percentage change in the
price of the second good
Cross-Price Elasticity of Demand = % change in quantity of good 1 / % change in price of
good 2
THE ELASTICITY OF SUPPLY
Price Elasticity of Supply: a measure of how much the quantity supplied of a good responds
to a change in the price of that good, calculated as the percentage change in quantity
supplied divided by the percentage change in price
• Supply of good is elastic if quantity supplied responds substantially to changes in
price
• Inelastic if quantity responds only slightly to changes in price
• Price elasticity of supply depends on flexibility of sellers to change the amount of
good they produce
• In most markets, key determinant of price is time period being considered; supply
usually more elastic in long run than short run
COMPUTING THE PRICE ELASTICITY OF SUPPLY
Price elasticity of supply = % change in quantity supplied/ % change in price
THE VARIETY OF SUPPLY CURVES
• Zero elasticity = supply is perfectly inelastic = vertical
• Perfectly elastic = horizontal
• In some markets, the elasticity of supply is not constant but varies over supply curve
• As quantity supplied rises, firms begin to reach capacity, once capacity reached,
increasing production requires more expenses so supply becomes less elastic
• Because firms often have a maximum capacity for production, the elasticity of supply
may be high at low levels to quantity supplied and low at high levels of quantity
supplied
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants. Inelastic is quantity demanded responds only slightly to changes in price. Availability of close substitutes: goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch. Necessities versus luxuries: necessities tend to have inelastic demands, luxuries tend to have elastic demands, whether good is necessity or luxury depends on preferences of buyer, not intrinsic properties of goods. Definition of the market: narrowly defined markets tend to be have more elastic demand than broadly defined markets since its easier to find close substitutes for narrowly defined goods. Time horizon: goods tend to have more elastic demand over longer time horizons. The variety of demand curves: demand elastic when elasticity greater than 1, so that quantity moves proportionately more than price. Inelastic when less then 1, quantity moves proportionally less than price.
