Elasticity

Econ 2106 Principles of Microeconomics Dr. Jon Mansfield Micro Lecture 2

1. Elasticity - sensitivity, responsiveness Can Be Calculated for Any Variable in the Demand Function. Examples: Price, Income, Advertising, etc. Compare Percentage Changes to Avoid a Units Problem in Measurement

Definition:

e p = ( % Q) /( % P)

( Q / Q) / ( P / P)

( Q / P) ( P / Q)

Arc Elasticity Discrete Range e p = (( Q2 - Q1) / Q) / ((P2 - P1) / P) e p = [ (Q2 - Q1) / (Q1 + Q2) / 2] / [ (P2 - P1) / (P1 + P2) / 2]

Point Elasticity Point on the Demand Curve e p = (Q / P ) ( P / Q ) Linear demand curve (price form): P = a + bQ b = (P / Q ) and (1 / b) = (Q / P ) e p = (Q / P ) ( P / Q)

e p = [ (Q2 - Q1) / (Q1 + Q2)] / [ (P2 - P1) / (P1 + P2)]

e p = (1 / b) [P / (P - a) / b] = [P / (P - a)]

Values |ep| > 1 |ep| < 1 |ep| = 1 Elastic Inelastic Unit Elastic %Q>%P %Q<%P %Q=%P

You should be able to work through the derivation of both elasticity formulas.

Elasticity

2. Downward-sloping Linear Demand Curve Demand Function Total Revenue Function (TR) Average Revenue Function (AR) Marginal Revenue Function (MR) MR using calculus (MRc) P = 12 - Q (or Q = 12 - P) TR = (P)(Q) = (12 - Q)(Q) = 12Q - Q 2 AR = TR / Q = [(P)(Q)] / Q = P MR = (TR) / (Q) = (TR2 - TR1) / (Q2 - Q 1) MRc = TR / Q = 12 - 2Q

Calculate the elasticities using the formulas.

TR

MR

MRc

Arc elasticity e p = [ (Q2 - Q1) / (Q1 + Q2)] / [ (P2 - P1) / (P1 + P2)]

Point elasticity e p = [P / (P - a)]

0 1 2 3 4 5 6 7 8 9 10 11 12

12 11 10 9 8 7 6 5 4 3 2 1 0

0 11 20 27 32 35 36 35 32 27 20 11 0

11 9 7 5 3 1 -1 -3 -5 -7 -9 -11

12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12

-23

-11

As the price decreases from 12, what happens with both types of elasticities?

Econ 2106 Principles of Microeconomics Dr. Jon Mansfield

Elasticity

Based on the information and table above, graph the Demand and Marginal Revenue functions on one diagram and the Total Revenue function directly beneath.

P$ 12

P = 12 - Q MR = 12 - 2Q

Q 6 TR $ 40 TR = 12Q - Q 2 12

Q 6 12

Econ 2106 Principles of Microeconomics Dr. Jon Mansfield

Elasticity

3. Price Elasticity and Total Revenue: The Price Effect and Quantity Effect of a Price Change.

P1 P2

A area A B Demand area B

C D

Q1

Q2

4. What is the significance of vertical and horizontal demand curves?

D D ep = 0 ep =

Econ 2106 Principles of Microeconomics Dr. Jon Mansfield

Elasticity

5. How sensitive is the amount demanded to a change in price? This is primarily determined by: Elastic number of substitute goods importance in consumers budget product durability time period under consideration

6. Other Elasticities Income Elasticity of Demand e I = (% QX) / (% I) (= ( Q X / I) (I / QX)) e I > 0 Normal Good e I < 0 Inferior Good Cross Elasticity of Demand e C = (% QX) / (% PY) (= ( Q X / P Y) (P Y / QX)) e C > 0 Substitute Goods e C < 0 Complementary Goods

Econ 2106 Principles of Microeconomics Dr. Jon Mansfield