Elasticity

A demand curve is elastic when an increase in price reduces the quantity demanded by a lot. (and vice versa). Flatter curve.

A demand curve is inelastic when an increase in price reduced the quantity demanded by very little. Steeper slope.

Determinants of elasticity of supply

• Availability of substitutes
  • Goods with many substitutes have more elastic demand curve.
  • Oil - inelastic as not many substitutes
  • Brazilian coffee - elastic as many substitutes
• Time horizon
  • Immediately after price increase consumers may not be able to alter their consumption.
  • Overtime they may.
• Classification of product
  • Broader - more likely to not have substitutes hence inelastic demand curves.
  • Narrow - more likely to have substitutes hence elastic.
• Nature of good
  • Necessities - inelastic
  • Luxuries - elastic
• Size of purchase
  • Relative to consumers budget.
  • Low cost product - inelastic demand curve in short term. Coffee cost increase by 50% may lead to only small drop in demand in short term.
  • High cost product - elastic demand curve.

Calculating elasticity of demand

elasticity of demand = the % change in quantity demanded / % change in price.

E_{D = %∆Qdemanded / %∆Price}

Example Oil price increased by 10%, quantity demanded dropped by 5%, so E_{D(Oil) = -5/10 = -0.5}

Absolute value of ED	Elasticity
ED < 1	More inelastic
ED > 1	More elastic
ED = 1	Unit elastic.

Midpoint formula

To erase base point bias, we use following modified formula.

E_{D = %∆Q/%∆P = ((∆Q/Avg. Q) * 100)/((∆P/Avg. P) * 100) = ((Qafter - Qbefore)/((Qafter + Qbefore)/2))/ ((Pafter - Pbefore)/((Pafter + Pbefore)/2))}

Revenue

Revenue = Price * Quantity

For inelastic demand curve, if price goes up then revenue goes up. For elastic demand curve, if price goes up then revenue drops.

Elastic demand is price sensitive. Small changes in price lead to large changes in quantity demanded.

Elasticity of supply

Elasticity of supply is a measure about how responsive the quantity supplied is to price.

Elastic supply curve means increase in price increases supply by a lot. Inelastic supply curve means quantity supplied does not vary much with price.

Determinants of elasticity of supply

• Change in per unit costs of production.
  • If high production requires much higher costs, then inelastic supply curve.
  • If supply can be scaled easily, then elastic supply curve.
• Time horizon
  • Easier to expand total production capacity then elastic curve.
  • Expand output only using current production capacity, then inelastic curve.
• Input materials
  • If input materials do not contribute a large percent of toal supply of those materials, then more elastic supply.
  • For example toothpicks require wood. But toothpicks are only a very small consumer of wood supply. So even doubling production of toothpicks will have little impact on price and demand of wood.
• Geographic scope of market
  • Narrow market - elastic. You can easily increase fuel available in one city.
  • Broad market - inelastic. Very difficult to increase total fuel supply in the world.

Calculating elasticity of supply

Elasticity of supply == the % change in supply / the % change in price.

E_{S is generally positive. Whereas ED is negative. Otherwise similar math.}

Slavery

• Case study for elasticity of demand and supply.
• A christian organization tried ending slavery in Sudan by buying slave and freeing them.
• This pushed more people to be slaved.
• Organization buying slaves pushed the price, incentivising slave suppliers to enslave more people.