When price falls and TR is unchanged, demand is unit elastic
o
When price falls and TR declines, demand is inelastic
•
Determinants of Price Elasticity of Demand
1.
Substitutability
The larger the number of substitute goods, the greater the price elasticity of
demand
With more substitutes available, consumers have more alternative options
When there is a change in price, there is a greater percentage change in quantity
demanded, making the demand more elastic.
The broader the market for the product, the more elastic the demand.
The narrower the mark for the product, demand is more inelastic.
2.
Proportion of Income
The greater the proportion of income needed to buy the good the more elastic the
demand
Consumers will be more sensitive to changes in prices because the price change
can result in thousands of dollars difference
3.
Luxuries vs. Necessities
Demand is very elastic because luxuries are things people can go without
Consumers will change the amount they purchase by a greater amount even if the
price changes by a small amount.
4.
Time
It takes time to alter the amount being purchased, so the more time available, the
more elastic the demand.
Ex: A person doing their Christmas shopping on Christmas Eve has a very
inelastic demand because they doesn’t have the time to look around for alternative
purchases
•
Applications of Price Elasticity of Demand
o
Large Crop Yields
Highly inelastic; lower total revenue
When the supply rises it tends to depress both the prices of farm products and the
total revenues (incomes) of the farmers
Large crop yields are undesirable
o
Excise Taxes
Inelastic demand, higher total revenue
Elastic demand, less total revenue
o
Decriminalization of Illegal Drugs
Legalizing drugs would allegedly reduce drug trafficking
Inelastic demand, higher total revenue
Price Elasticity of Supply
If the quantity supplied by producers is relatively responsive to price changes, supply is elastic. If not, it
is inelastic.
•
How to measure the degree of elasticity
o
E
s
=
% change in quantity supplied
% change in price of product
o
E
s
> 1 supply is elastic
o
E
s
< 1 supply is inelastic
•
Price Elasticity of Supply depends on how easily producers can shift resources between
alternative uses
•
Price Elasticity of Supply: The Market Period
o
Market Period- The period that occurs when the time immediately after a change in
market price it too short for producers to respond with a change in quantity supplied
Means that there is no time to adjust output in response to a price change
There is no time to adjust to a price change, making the supply perfectly inelastic.
Example: Farmer’s Market on a Saturday, cannot adjust supply
With a perfectly inelastic supply, the increase in demand does not change
the quantity at all.
•
Price Elasticity of Supply
o
The Short Run
There is enough time to adjust output by increasing or decreasing the variable
inputs but not the fixed inputs
Example: On a farm, can’t change size of land and machinery, but can change the
amount of labor
Supply is more elastic than in the market period, resulting in a smaller increase in
price but also an increase in quantity
