Elasticty

Last updated Sep 15, 2023 Edit Source

• Price elasticity measures the responsiveness of quantity demanded to changes in price
• Price elasticity of demand (Ed) can be calculated by Percentage Change
• $$Ed = \frac{% change \space in \space quantity \space demanded}{% \space change \space in \space price}$$

The quantity demanded of the product is relatively responsive to changes in price.

• Percentage change in quantity demanded > Percentage change in price
• $|Ed| > 1$

Perfectly elastic

• $Ed = \infty$
  • So if price changes, quantity demanded falls to zero

Perfectly inelastic

• $Ed = 0$
  • Quantity demanded remains the same regardless of price

Unitary elastic

• $Ed = 1$
  • Changes in price equals the change in demand

$$Ed = |\frac{(Q_{2} - Q_1)/[(Q_2 + Q_1)/2]}{(P_{2} - P_{1})/[(P_{2 +}P_1)/2]}|$$ $Ed = |\frac{\Delta Q}{Q_{Avg}} * \frac{P_{Avg}}{\Delta P}|$

$Ed = |\frac{\Delta Q}{Q_{}} * \frac{P_{}}{\Delta P}|$

TR = P * Q

Total revenue = Price * Quantity

• Effect of changes in price on total revenue is dependent on the price elasticity of the product

When price decreases

• Price elastic product: Total revenue would increase
• Price inelastic product: Total revenue would decrease
• Unit elastic: No change in total revenue

Depending on the elasticity, tax revenue and the burden of the tax would vary. Tax incidence/burden of the tax: Who bears the majority of the tax

• If a good is price inelastic in demand, the amount of tax revenue is higher and the burden of the tax falls more on the consumers
• If a good is price elastic in demand, the amount of tax revenue is lower and the burden of the tax falls more on the producers

Tax $= P_{2} - P_3$ Tax revenue $= Q_2(P_{2} - P_{1})$

Producer burden > Consumer burden

Tax $= P_{2} - P_3$ Tax revenue $= Q_2(P_{2} - P_{1})$

Consumer burden ($P_{2} - P_{1}$) > Producer burden ($P_{1} - P_{3}$)

Original price point stuff. Indirect tax will shift the supply curve to the left, the amount of tax. The tax increases price to $P_2$, and increases the price consumers now pay. Producers are now receiving $P_3$. Quantity has fallen to $Q_2$. The tax revenue is $Q_2(P_{2} - P_{3})$. The consumers bears a higher burden of the tax compared to the producers.

• If there are lots of substitutes - more elastic
• If there are no substitutes - less elastic (Inelastic)

• If a good is a necessity - Inelastic
• If a good is a luxury - Elastic

• The greater proportion of income, the more elastic
• Cheaper goods are less elastic than expensive goods

• The longer consumers to have to respond to changes, the more elastic
• As time goes on, goods become more elastic

• Narrower the market, the more responsive (Elastic)

Measures the responsiveness of quantity supplied to a change in price

$$Es = \frac{% \space change \space in \space quantity \space supplied}{% \space change \space in \space price}$$

• In the short term, goods are going to be unresponsive (Inelastic)
• After some time, people are able to react to the price changes (Elastic)

• If you can easily change products (pencils), it is elastic
• If you can’t easily change products (agriculture), it is inelastic

• If a business can easily store inventories (canned food), they can respond quicker (Elastic)
• If a business can’t easily store inventories (fruit and veg), they can’t respond as quick (Inelastic)

• Monopoly/Market power:
  • Setting prices (to influence total revenue)
  • Price discrimination

• Can control demand if aware of elasticity and influence on prices

• Tax incidence
  • IE - Greater incidence on consumers, greater tax revenue
  • E - Lesser incidence on consumers, lower tax revenue