Elasticity (2009 – 13.a)

1.    Remember the definition:

A elasticity of B = percentage change of B/ percentage change of A

This is telling for 1% change of B, how much % change in A.

2.    Percentage change is calculated as:

(ending value – beginning value) / mid-point value

mid-point value = (ending value + beginning value)/2

3.    Elastic: Large absolute value of elasticity (>1), i.e. small change of B resulting in big change of A

4.    Inelastic: Small absolute value of elasticity (<1), i.e. big change of B resulting in small change of A

For extreme cases,

5.    Perfectly Elastic: elasticity = infinity

6.    Perfectly inelastic: elasticity = 0

Now, let’s look at each common term:

7.    Price Elasticity of Demand

e.g. gasoline is inelastic, because even there is a big change in the price (A), the demand is pretty much the same (B)

8.    Factors affecting price elasticity of demand

a.    Availability of substitutes: e.g. since it is difficult to find substitutes for gasoline, demand for gasoline won’t change much even the price increases (inelastic)

b.    % of income spent on the goods: If this is only a small portion of your income, you don’t care to buy less if the price increases (inelastic)

c.    Time evolved: When gasoline price increases, as time goes by, renewable energies will be more available. People will switch to other forms of energy. So as time goes by, elasticity increases.

9.    Income Elasticity of Demand

Now A is income, B is demand: telling you how the change of income affects the demand

a.    Inferior goods: negative income elasticity: meaning you want to buy less when you have higher income

b.    Normal goods: positive income elasticity

                                  i.    <1, necessities

                                 ii.    >1, luxuries

10.  Price elasticity of Supply, this depends on

a.    The availability of input substitutes

                                  i.    More substitutes, more elastic

b.    Time frame, for elasticity

                                  i.    Long term> short term> monetary

Finally, let’s talk about

11.  Cross elasticity of demand

For price elasticity of demand, we were talking about how the demand of a good changes when the price of the same good changes. Cross elasticity is the changes of a good’s demand when the price of the substitute or complement changes.

e.g. how is the demand of apple changes when the price of oranges changes