Elasticity
- responsiveness
- a measure of how much buyers and sellers
respond to change in market conditions
Elasticity of Demand
- measures how responsive a quantity
demanded is to a price change
EOD = Percent Change in QD / Percent
Change in Price
Degrees of Elasticity
- ELASTIC
- a change in determinant will lead to a
proportionately greater change in
demand
- greater than 1
- UNIT ELASTIC
- a change in determinant will lead to a
proportionately equal change in
demand
- equal to 1
- INELASTIC
- a change in determinant will lead to a
proportionately lesser change in
demand
- less than 1
Types of Elasticity of Demand
1. Price Elasticity of Demand
- measures the responsiveness of demand
to a change in the price of the good
PED = [(Q2 - Q1) / (Q2 + Q1)] / 2
[(P2 - P1) / (P2 + P1)] / 2
- methods of measuring price elasticity of
demand:
- POINT ELASTICITY: measures the
degree of elasticity on a single point
on the demand curve
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[(Q2 - Q1) / Q1]
[ (P2 - P1) / P1 ]
- ARC ELASTICITY: aka midpoint
elasticity; value of elasticity is
computed by choosing 2 points on
the demand curve and comparing the
percentage changes in the quantity
and the price on those two points
2. Income Elasticity of Demand
- measures how the quantity demanded
changes s consumer income changes
IED = Percent Change in QD / Percent
Change in Income
3. Cross Price Elasticity of Demand
- measures how quantity demanded
changes as the price of a related good
change
- close substitutes: small changes will result
in great change in the other
- weak substitutes: big change in price of
main good will result to low quantity
demanded in the related good
Determinants of Demand Elasticity
- AVAILABILITY OF SUBSTITUTES
- if close substitutes are available, an
increase in the price of a product
prompts some people to buy those
substitutes
- the greater the availability of substitutes
for a good and the more similar these
are to the good in question, the greater
that good’s elasticity of demand
- SHARE OF CONSUMER’S BUDGET
SPENT ON THE GOOD
- the more important the item is as a
share of the consumer’s budget, other
things constant, the greater is the
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 income effect of a change in price, so
the more elastic is the demand for the
item
- DURATION OF THE ADJUSTMENT
PERIOD
- the longer the period of adjustment, the
more responsive the change in quantity
demanded is to a given change in price
Market Structures
a. Monopoly
- opposite of the perfect competition structure
- sole supplier of a product with no close
substitutes
- a monopolist has more market power than
does a business in any other market structure
- market power: ability of a firm to raise its price
without losing all its sales to rivals
- e.g. electricity
- has high barriers to entry (restrictions on the
entry of new firms into an industry)
- allows a monopolist to change a price
above the competitive price
- legal restrictions: govts can prevent new
firms from entering a market by making
entry illegal
- economies of scale: a monopoly sometimes
emerges naturally when a firm experiences
substantial economies of scale
- control of essential resources: sometimes
the source of monopoly power is a fir’s
ECONOMICS Q2
control over some resource critical to
production
b. Oligopoly
- market that is dominated by just a few
firms
- each must consider the effect of its own
actions on competitors’ behavior
- e.g. steel, oil, automobiles, breakfast
cereals, and tobacco industries
- undifferentiated/homogeneous oligopoly:
sells a commodity that is identical across
producers
- differentiated oligopoly: sells products
that differ across producers
- can be traced to some barrier to entry:
- economies of scale: if a firm’s minimum
efficient scale is large compared to
industry output, then only a few firms
are needed to produce the total amount
demanded in the market
- high cost of entry: the total investment
needed to reach the minimum efficient
size may be huge
- product differentiation costs: an
oligopolist often spends millions and
sometimes billion trying to differentiate
its product
c. Monopolistic Competition
- many firms offer products that differ
slightly
- the structure contains elements of both
monopoly and competition
- a firm can raise its price without losing all
its customers
- barriers to entry are so low that any short-
run profit attracts new competitors, and
this will erase profit in the long run
- can leave and enter the market with ease
- e.g. fast food chains
- sellers differentiate their products in four
basic ways
- physical differences: differ in physical
appearance and their qualities
TERM 3 © BANDONG
 - location: number and variety of - variable cost: cost that varies with the level
locations where a product is available of output
also are a means of differentiation
- services: differ in accompanying services Marginal Cost
- product image: differ in the image the - increase in cost that accompanies a unit
p ro d u c e r t r i e s t o f o s t e r i n t h e increase in output
consumer’s mind - additional cost dissociated with producing
d. Perfect Competition one more unit of product
- there are many buyers and sellers - so
many that each buys or sells only a tiny MC = Change in Total Cost / Change in
fraction of the total market output Quantity
- buyer/seller cannot influence the price
- firms produce a standardized product, or a Marginal Revenue
commodity - additional income you will get when you
- commodity: product that is identical produce another quantity
across suppliers, such as a sack of
wheat/corn MR = Change in Total Revenue / Change in
- buyers are fully informed about the price, Quantity
quality, and availability of products, and
sellers are fully informed about the
availability of resources and technology
- firms can easily enter or leave the industry
- e.g. markets for agricultural products
(livestock, corn, rice)

Significance of the Market Structure

- type or market structure in which the
business operates will determine the
amount of market power or control the
business owner will enjoy Law of Diminishing Return
- greater market power means a greater - adding an additional factor of production
ability to control prices, differentiate the results in smaller increases in output
products one offers for sale, this leading to - MC > MR = supply less
opportunities for more profit - MC < MR = supply more
- MC = MR = aim of the business
Cost-Benefit Analysis
- a process business use to analyze
decisions
- business/analyst turns the benefits of a
situation/action and then subtracts the
costs associated with taking that action
- fixed cost: constant whatever the quantity
of goods or services produced

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