# Topic 4 - Elasticity

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## Elasticity

### Price Elasticity of Demand

Price Elasticity of Demand is a measure of the responsiveness of the quantity demanded of a good to changes in its price. It is the % change in quantity that results from a 1% change in price

#### Determinants of Price Elasticity of Demand

• Substitution Possibilities: Elasticity will be higher for products with close substitutes– Branded Salt
• Budget Share: Elasticity will be higher for items that take up a larger proportion of the budget
• Time: Elasticity will be higher over the long run, more time to adjust to price changes

#### Price Elasticity of Demand Along the Demand Curve

The elasticity of demand declines steadily as we move down the demand curve.

##### Exceptions to the Rule: 2 Special Cases
• Perfect Elastic Demand (E=∞) - slight increases in price lead to zero sales - Horizontal
• Perfect Inelastic Demand (E = 0) - Non Responsive to changes in price - Vertical
##### Elasticity And Total Expenditure

Will I get more sales (P×Q) with high quantity low price or high price low quantity?

• Depends on price elasticity of demand, Highest at the curve’s midpoint

E > 1, Price has an inverse relationship with revenue [responsive] E < 1, Price has a positive relationship with revenue [less responsive]

### Income And Cross Price Elasticity

1. Income [E] - The % by which the quantity demanded of a good changes in response to a 1% change in income
• Є > 0 - Normal Good
• Є < 0 - Inferior Good
2. Cross Price [E] - the % by which the quantity demanded of a good changes in response to a 1% change in the price of a second good. E.g. if a 2% increase in Cashew prices = 5% increase in quantity demanded [Peanuts} cross price elasticity = 2.5
• Є > 0 - Substitutes
• Є < 0 - Complements

### Price Elasticity of Supply

The % change in quantity supplied that occurs in response to a 1 % change in price. The elasticity of supply declines as quantity increases. If it passes through the origin price elasticity of supply = 1

• Perfect Elasticity - marginal costs are fixed, same inputs and price
• Perfectly Inelastic - supply is fixed and cannot be duplicated

#### Determinants of Price Elasticity of Supply

• Flexibility of Inputs: If additional inputs are relatively easy to attract, the price elasticity of supply is high.
• Mobility of Inputs: If inputs can be transported more easily, elasticity will be higher
• Ability to Produce Substitute Inputs: If a fixed quantity of inputs can be overcome (technology), elasticity higher
• Time: Elasticity will be higher in the long run – more time to build machinery etc.
• Spare Capacity