Elasticity

-​ For us to understand policies such as taxation

-​ Understand why some firms make such decisions

Important questions Elasticity answers:

Companies practice price discrimination

-​ Charge different prices to different consumers depending on the willingness and ability to pay

Value Added Tax

-​ Intended for the seller
-​ The intention of the government is to collect taxes from the sellers
-​ Add value during the production stage not during consumption

But the q is how does the seller pass the 12% VAT to the buyers?

Whether the slope increase or decrease, it is actually dependent to the magnitude of the shift of the
demand and supply curve

Elasticity
-​ A measure of the numerical response of one variable to changes in another variable
-​ Price Elasticity of Demand
-​ Price Elasticity of Supply
-​ Income Cross Price Elasticity

Price Elasticity of Demand

-​ The elasticity of demand is not constant from one point to the demand curve
-​ Measures how your QD will respond to change in your price
-​ When is the best time to increase or decrease the price of a product
-​ Numerical measure of the responsiveness of the quantity demanded to one of its
determinants

-​ FORMULA: (Memorize)
-​ It is a measure of the sensitivity of the suppliers demand in respect to your price

Factors Affecting Elasticity of Demand

1.​ Availability of substitutes
-​ w/ substitute = more elastic
-​ Less substitute = less elastic
2.​ Broad vs narrow definition of the good
-​ Broad = less elastic
-​ Narrow = more elastic
3.​ Necessity vs luxury
-​ Necessity = less elastic
-​ Luxury = more elastic
4.​ Percentage of the budget spent on the good
-​ Higher percentage = more elastic
-​ Less percentage = less elastic
Recall that ceteris paribus, when prices rise, quantity demanded can be expected to decline. When
prices fall, quantity demanded can be expected to rise. The normal negative relationship between
price and quantity demanded is reflected in the downward slope of demand curves.

Perfectly inelastic demand - Demand in which quantity demanded does not respond at all to a
change in price.
Example:
Life-saving medicines like insulin are often considered inelastic because people need them
regardless of the price.

Inelastic demand - When elasticity is less than 1 in absolute value, This means that consumers don’t
change their buying habits much when prices change.
Examples :
Oil is inelastic because even if prices go up, people still need it and find it hard to substitute with other
products.

Unit Elastic Demand - occurs when the percentage change in quantity demanded is equal to the
percentage change in price, resulting in an elasticity of -1.
Example:
If the price of a movie ticket increases by 10%, and as a result, the quantity demanded decreases by
exactly 10%, the demand for movie tickets is unitary elastic.

Elastic Demand - When elasticity is greater than -1 (in absolute value), This means that consumers
respond significantly to price changes.
Example:
Consider a luxury handbag. If its price increases by 10% and the quantity demanded decreases by
20%, the demand is elastic.

Perfectly elastic demand - Demand in which quantity drops to zero at the slightest increase in
price.
Examples:
Identical Products: If two vendors sell the same ice cream bars on the beach, and one raises their
price, all customers will go to the other vendor.
Commodities: Basic goods like wheat or corn can be perfectly elastic because many suppliers sell the
same product. A small price increase from one supplier means buyers will just switch to another.​
Perfect Substitutes: If two brands of bottled water are identical, and one brand raises its price,
customers will just buy the other brand.

Price x Quantity Demanded = Total Revenue

effect of price increase on a product with inelastic demand: If Price Increase, and QD Decrease = TR
Increase
effect of price increase on a product with inelastic demand: If Price Decrease and QD Increase = TR
Decrease
effect of price increase on a product with elastic demand: If Price Increase and QD Decrease = TR
Decrease
effect of price increase on a product with elastic demand: If price Decrease and QD Increase = TR
Increase

The Determinants of Demand Elasticity

1.​ Availability of Substitutes
-​ Elastic Demand: Many substitutes lead to a strong consumer response to price changes.
-​ Inelastic Demand: Few substitutes result in minimal change in quantity demanded despite
significant price increases.

2.​ The Importance of being unimportant

-​ Limited Reaction: Because the cost is low, consumers are unlikely to change their purchasing
habits, even with a noticeable percentage increase.
-​ Inelastic Demand: Items that represent a small part of our budget tend to have inelastic
demand, meaning price changes don’t significantly affect the quantity demanded.

3.​ The Time Dimension

Short-Run Demand Elasticity

●​ Example: Initial oil price increases due to OPEC cuts.

○​ Situation: Few substitutes available; consumers continue to buy oil despite higher
prices.
○​ Result: Demand is relatively inelastic; prices rise significantly without a large drop in
quantity demanded.

Long-Run Demand Elasticity

●​ Adjustment Over Time:

○​ As prices remain high, consumers and producers adjust their behavior.
○​ Examples:
■​ Automobiles become more fuel-efficient.
■​ Homeowners insulate their homes and adjust thermostats.
■​ Some consumers switch from SUVs to hybrids.
●​ Response to Price Changes: Over time, as alternatives develop and consumers adapt,
demand becomes more elastic.

4.​ Income Elasticity of Demand

-​ Policy Implications: Governments assess how changes in income levels affect demand for
various goods and services, guiding effective policy decisions.
-​ Consumer Behavior: It helps to understand which goods are considered necessities versus
luxuries, influencing spending patterns as incomes rise or fall.
-​ (Common) Positive Income Elasticity: As income rises, demand for certain goods increases.
-​ Example: Jewelry; people tend to buy more as they earn more
-​ (Inferior)Negative Income Elasticity: As income rises, demand for certain goods decreases.
-​ Example: Low-quality beef; consumers shift to higher-quality options as their income
increases.

5.​ Cross - Price Elasticity of Demand

-​ Positive Cross-Price Elasticity:
-​ Indicates Substitutes: If the cross-price elasticity is positive, an increase in the price of good
X leads to an increase in the demand for good Y.
 -​ Example: Big Macs and Chicken McNuggets at McDonald's. When the price of Big Macs goes
down, the quantity demanded for McNuggets declines as consumers switch to the cheaper
option.

(NOTES NI KIT)
1.​ Availability of Substitutes
-​ With Substitute = more elastic If a good has many substitutes, it means consumers can easily
switch to other similar products if the price of the good rises. This leads to more elastic
demand.
-​ Less substitute = less elastic If a good has few or no substitutes, consumers have limited
options. This leads to less elastic demand.
2.​ Broad vs Narrow Def. of Goods
-​ Broad = Less Elastic A broad definition typically encompasses many products, leading to less
elastic demand. Changes in price for soft drinks as a whole might not significantly affect the
quantity demanded because consumers consider the entire category rather than one
specific item.
-​ Narrow = More Elastic A narrow definition often means there are fewer substitutes available.
Therefore, demand tends to be more elastic because consumers will switch to other similar
options (like other colas) if the price rises significantly.
3.​ Necessity vs Luxury
-​ Need = Less Elastic, Demand for needs tends to be less elastic. Even if prices rise, consumers
will continue to purchase these goods because they are essential.
-​ Wants = More Elastic, Demand for luxuries is typically more elastic. When prices increase,
consumers can more easily choose not to buy these items or switch to less expensive
alternatives.
4.​ Percentage of the Budget spent on the Good
-​ Higher Percentage = more elastic, When a good takes up a significant portion of a consumer's
budget, price changes can lead to a larger change in quantity demanded. Consumers are
more likely to adjust their purchasing behavior.
-​ Less Percentage = Less Elastic, When a good represents a small portion of a budget, price
changes have a smaller impact on quantity demanded. Consumers are less sensitive to price
changes.
5.​ Time given before buying (Time Horizon)
-​ Short run = Less elastic, In the short term, consumers have limited ability to adjust their
purchasing decisions. They may not have time to find alternatives or change their
consumption habits.
-​ Long Run = more elastic, Over a longer period, consumers can adjust their behavior more
effectively. They can seek substitutes, change habits, or make long-term decisions (e.g.,
switching to public transport or buying a more fuel-efficient car).

The determinants of supply elasticity

1. The more easily sellers can change the quantity they produce, the greater the price elasticity of
supply

2. For many goods, price elasticity of supply is greater in the long run than in short run, because
firms can build new factories, or new firms may be able to enter the market.

The Slope of a straight line is constant but in elasticity it is not.

Monopoly - single seller of a product, always operate on the elastic demand