Lecture Notes: Oct. 2

Econ. 103, Fall 2002, Prof. Nancy Folbre

Let’s mount another assault on the concept of elasticity, based on some homegrown overheads, rather the ones that come with the book. I think these will complement the Paul Solman video.

Various Ways of Stating the Definition of Elasticity

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ELASTICITY EQUALS THE PERCENTAGE CHANGE IN QUANTITY DIVIDED BY THE PERCENTAGE CHANGE IN PRICE

	change in q, divided by q
or,     elasticity =	———————————
	change in p, divided by p

 

	Q/Q
or,     =	———————————
	P/P

or,    P/Q [(1/ (P/Q)]

or,    P/Q [1/slope]

1. If you are given the percentage change in quantity and the percentage change in price, compare the two. If the former is bigger, the ratio is greater than one.

EXAMPLE: When the price of gasoline goes up by 20%, the quantity demanded goes down by 22%. Elasticity is equal to 22% divided by 20%. That’s equal to 1.1, which is greater than one. Demand is elastic.

2. If you are given the change in price and the change in quantity, you have to compute the percentage changes before you can determine the elasticity

EXAMPLE: The price of olive oil is $1.50 a gallon and the quantity demanded is 100 gallons. When the price of olive oil goes up to $2.00 a gallon the quantity demanded is 20 gallons. The change in price is $.50. The change in quantity is 80 gallons. The percentage change in price is .50/1.50 or .33 (or 33% if you multiply by 100). The percentage change in quantity is 80/100 or .8 (or 80% if you multiply by 100). The elasticity is .8 divided by .33, which is 2.4. Demand is elastic.

3. If you are not given the specific change, but you are simply asked the elasticity of demand at a particular point on a demand curve, you can apply the formula that uses the slope of the line.

EXAMPLE: At some point A on a demand curve P=10 and Q = 6. The slope of the line is equal to -2. The reciprocal of the slope is .5 (that’s 1 divided by 2). Multiply that by P/Q or 10/6 and you get .833. Demand is inelastic.

4. If you are given the change in price and the resulting change in total expenditure (P times Q). you can determine whether demand is elastic or inelastic without calculating the actual number.

EXAMPLE. The price of walnut oil increases by 10% and total expenditures on walnut increase. Total expenditures are equal to price times quantity. If total expenditures increased, that implies that the decline in quantity was smaller percentage-wise than the increase in price. Demand must be inelastic.

A SECOND EXAMPLE. (this time with a price DECREASE) The price of patchouli oil goes down by 5% and total expenditures go up. If total expenditures increased, that implies that the increase in quantity was bigger percentage wise than the decline in price. Demand must be elastic.

Interpretations of elasticity are the same for demand and supply curves

ignore the sign of the relationship between Q and P (assume you are looking at absolute value)

if elasticity is greater than one, demand (or supply) is elastic

if elasticity is less than one, demand (or supply) is inelastic

if elasticity is equal to one, demand (or supply) is of unitary elasticity

Elasticity can change along the curve or line–(for demand it declines as you move from left to right (or as Q gets bigger and P gets smaller).

But some curves or lines are more elastic overall than others.

a vertical line is perfectly inelastic

a horizontal line is perfectly elastic

Chapter 6

Key concept: perfect competition.

Brief definition: so many sellers that NONE can affect the market price.

The market price is determined by the intersection of supply and demand in the market. The individual firm is a "price-taker"–and can sell as much as it wants or is able to at that price.

As a result, the individual firm faces a perfectly horizontal demand curve. See Figure 6.4.

Be sure you understand the relationship between the two graphs.