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Econ2103 T3

This document provides an overview of key concepts in chapters 4 and 5, including: 1. Definitions and formulas for price elasticity of demand, income elasticity of demand, and cross price elasticity of demand. Elasticity measures the responsiveness of quantity to price changes. 2. Examples are provided to illustrate how to calculate different elasticities. 3. Factors that influence elasticity are discussed, such as availability of substitutes, whether goods are necessities, and the time horizon considered. 4. The relationship between elasticity and total revenue is explained. 5. Key concepts of price elasticity of supply are also introduced.

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36 views2 pages

Econ2103 T3

This document provides an overview of key concepts in chapters 4 and 5, including: 1. Definitions and formulas for price elasticity of demand, income elasticity of demand, and cross price elasticity of demand. Elasticity measures the responsiveness of quantity to price changes. 2. Examples are provided to illustrate how to calculate different elasticities. 3. Factors that influence elasticity are discussed, such as availability of substitutes, whether goods are necessities, and the time horizon considered. 4. The relationship between elasticity and total revenue is explained. 5. Key concepts of price elasticity of supply are also introduced.

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ECON 2103 (Spring 2020)

27 March, 2020 (Tutorial 3)

This week:
Review on Chapter 4 and 5
Discussion on Assignment 3

Chapter 5 Elasticity and its Application


 Price elasticity of demand: the responsiveness of the quantity demanded to a change in
the price of the good
 𝑄 ∆𝑃
 Price elasticity of demand = |% 𝑄D ⁄%∆𝑃| = | D⁄ | 𝑄 𝑃
𝑄2 −𝑄1
×100%
𝑄1
 Price elasticity of demand = 𝑃2 −𝑃1
×100%
𝑃1

Example: (Chapter 5, Q3)


Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the
long run.
(a) If the price of heating oil rises from $1.8 to $2.2 per gallon, what happens to the
quantity of heating oil demanded in the short run and in the long run?
(b) Why might this elasticity of demand depend on the time horizon?

(a) The percentage change in price is equal to (2.20 – 1.80)/1.80 x 100 = 22.22%. If the price
elasticity of demand is 0.2, quantity demanded will fall by 4.44% [0.20  0.2222]in the
short run.
If the price elasticity of demand is 0.7, quantity demanded will fall by 15.56% [0.7 
0.2222] in the long run.
(b) Over time, consumers can make adjustments to their homes by purchasing alternative
heat sources such as natural gas or electric furnaces. Thus, they can respond more easily
to the change in the price of heating oil in the long run than in the short run.

 Price elasticity of demand is unit free, only magnitude matters (absolute value)
 Value of price elasticity of demand: 0 ≤ 𝜀𝐷 ≤ ∞

 Price elasticity of demand along a linear demand curve


 Elasticity is not equal to the slope of the demand curve. Along a linear demand curve,
the slope is constant but the elasticity moving downward along the curve.

𝜀𝐷 = 0 Perfectly inelastic demand Vertical demand curve


𝜀𝐷 < 1 Inelastic demand Below the midterm of a linear
demand curve
𝜀𝐷 = 1 Unitary elastic demand Midpoint of the linear
demand curve
𝜀𝐷 > 1 Elastic demand Below the midterm of a linear
demand curve
𝜀𝐷 = ∞ Perfectly elastic demand Horizontal demand curve

1
 Factors affecting elasticity of demand:
(1) availability of close substitutes
(2) whether the good are necessities or luxuries
(3) how broadly or narrowly the good is defined
(4) time horizon

 Elasticity and total revenue/expenditure


Inelastic demand P ↑  TR ↑, P↓  TR ↓
Unitary elastic demand P ↑  TR remains unchanged, P ↓  TR remains unchanged
Elastic demand P ↑  TR ↓, P↓  TR ↑

 Income elasticity of demand: 𝜀𝐼 = %∆𝑄𝐷 ⁄%∆𝐼


𝜀𝐼 > 0 for normal good and 𝜀𝐼 < 0 for inferior good
𝜀𝐼 > 1 for luxuries and 𝜀𝐼 < 1 for necessity

 Cross price elasticity of demand = 𝜀𝑋𝑌 = %∆𝑄𝐷𝑋 ⁄%∆𝑃𝑌


𝜀𝑋𝑌 > 0 for substitutes and 𝜀𝑋𝑌 < 0 for complements

Example:
John’s income rises from $20,000 to $22,000 and the quantity of hamburger he buys each
week falls from 2 pounds to 1 pound. Calculate John’s income elasticity of demand.
% change in quantity demanded = (1−2)/2 x 100 = -50%
% change in income = (22,000 −20,000)/20,000 x 100 = 10%
income elasticity = -50%/10% = -5.00
hamburger is an inferior good for John

Example:
The price of apples rises from $1.00 per pound to $1.50 per pound. As a result, the quantity
of oranges demanded rises from 8,000 per week to 9,500. Calculate the cross-price
elasticity. What is the relationship of the apples and oranges?
% change in quantity of oranges demanded = (9,500 − 8,000)/8,000 x 100 = 18.75%
% change in price of apples = (1.50 − 1.00)/1.00 x 100 = 50%
cross-price elasticity = 18.75%/50% = 0.375
Because the cross-price elasticity is positive, the two goods are substitutes.

 Price elasticity of supply: the responsiveness of the quantity supplied of a good to a


change in the price of that good
 𝑄 ∆𝑃
 Price elasticity of supply = |% 𝑄S ⁄%∆𝑃| = | S⁄ |
𝑄 𝑃
𝑄2 −𝑄1
×100%
𝑄1
 Price elasticity of supply = 𝑃2 −𝑃1
×100%
𝑃1
 Perfectly elastic (𝜀𝑆 = ∞) and perfectly inelastic supply (𝜀𝑆 = 0)

 Factors affecting elasticity of supply


(1) resource substitution possibilities
(2) flexibility of sellers
(3) time horizon (long run, short run)

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