Chapter 5 – Elasticity

Elasticity refers to how one variable changes in response to change in another.

Price Elasticity

Price elasticity is the ratio $\frac{\%\Delta \text{Qs or Qd}}{\%\Delta \text{price}}$. By convention, price elasticity is always an absolute value since the demand curve is decreasing while the supply curve is increasing.

Price Elasticity

$\Delta \text{Qd}$ vs. $\%\Delta \text{price}$	Price Elasticity	Name
$\Delta \text{Qd}>\%\Delta \text{price}$	$>1$	Elastic
$\Delta \text{Qd}=\%\Delta \text{price}$	$=1$	Unitary elastic
$\Delta \text{Qd}<\%\Delta \text{price}$	$<1$	Inelastic
Elastic goods see a large change in demand in response to price (e.g., luxury goods)

Unitary elastic goods see an equal change in demand in response to price

Inelastic goods see a small change in demand in response to price (e.g., medicine)

The percent change in price or quantity can be found using the midpoint method:

The Midpoint Method for Elasticity

$$\%\text{ change}=\frac{\text{difference}}{\text{mean}}\times 100$$

Applying the midpoint method for the change in price:

$$\%\Delta \text{price}=\frac{{\text{P}}_2-{\text{P}}_1}{({\text{P}}_2+{\text{P}}_1)/2}\times 100$$

Polar Elasticity

Zero elasticity (perfect inelasticity) refers to a vertical curve. Essential goods without close substitutes may have zero elasticity.

Infinite elasticity refers to a horizontal curve. Luxury goods with many substitutes may have infinite elasticity.

Elasticity and Pricing

Price elasticity of demand	Change in total revenue in response to price
Elastic	$\downarrow$ Increase
Unitary Elastic	No change
Inelastic	$\uparrow$ Decrease

Consumers benefit from inelastic demand since supply shifts will lead to lower prices. Conversely, production costs can be passed on to customers for demand-inelastic goods.

Tax Incidence

The division of the tax burden between consumers and producers is called the tax incidence.

Consumers bear most of the tax burden for demand inelastic goods.

Producers bear most of the tax burden for supply inelastic goods.

Long- and Short-Run Impact

Short run elasticities are often lower than in the long run.

Other Elasticities

Income elasticity of demand: $\frac{\%\Delta \text{Qd}}{\%\Delta \text{income}}$

Cross-price elasticity of demand: $\frac{\%\Delta {\text{Qd}}_A}{\%\Delta {\text{price}}_B}$

Elasticity of labour supply: $\frac{\%\Delta {\text{Q}}_{\text{labour}}}{\%\Delta \text{wage}}$

Elasticity of savings: $\frac{\%\Delta {\text{Q}}_{\text{savings}}}{\%\Delta \text{interest rate}}$