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Chapter 5

Econ 1B03 - Chapter 5 Part 3.docx

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Hannah Holmes

Richard Damra Wednesday, January 30, 2013 Econ 1B03 – Chapter 5 Elasticity Cross-Price Elasticity of Demand  Denoted E subscript ab, cross prioce elasticity measures the response of Qd of a good “a” to a change in price of good “b”  E(ab) = % change in Qd of good “a” / % change of good “b”  Midpoint formula is: o E(ab) =[ (Q2a – Q1a) / (Q2a + Q1a)] / 2 / [(P2b – P1b) / (P2b + P1b) / 2]  The plus or minus sign matters.  If elasticity is > 0 an increase in P of “b” will lead to an increase in Qd of “a o The goods are substitutes o If elasticity is < 0, an increase in P of “b” will lead to a decrease in Qd of “a”  Example: The price of a soft drink increases from $1.99 to $2.49 per 2 litre bottle. Demand for a fruit juice increases from 500 to 1000 bottles. o Q1a = 500 o Q2a = 1000 o P1b = 1.99 o P2b = 2.49  Eab = [(1000-500) / (1000+500)/2] / [(2.49 – 1.99) / (2.49 + 1.99) / 2 o = 0.67 / 0.22 o = 3.05  Elasticity is positive so the goods are substitutes Some notes about Elasticity  If cross-price elasticity equals 0, the goods are not related.  The larger the cross price elasticity coefficient, the stronger the relationship between the two goods.  In first year, we don’t use point elasticity for income elasticity or cross-price elasticity.  The larger the coefficient, the more elastic is the good. Elasticity of Supply  Price elasticity of supply, Es, is a measure of how much the quantity supplied of a good responds to a change in the price of that good.  Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price  Since P and Qs will always move in the same direction, Es will always be > 0  Es = % change in Qs / % change in P  Midpoint formula is: Richard Damra Wednesday, January 30, 2013 o Es = [(Q2 – Q1) / ([Q2 + Q1] /2)] / [(P2 – P1) / ([P2 + P1] /2)] Where Q = quantity supplied  The point elasticity formula is Es = dQ/dP * P/Q  Just as we did for price elasticity of demand, we can categorize types of elasticity of supply  Perfectly Inelastic Supply: o Es = 0 o Qs will not change for any change in Price. o Supply curve is vertical. o Eg rare art, agricultural products o  Inelastic Supply: o Es is between 0 and 1 o Qs doesn’t respond strongly to a change in Price o Supply curve is fairly steep. o E.g. Lakefront property o  Elastic Supply: o Es > 1 o Qs does respond to a change in Price. o Supply curve is fairly flat o E
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